1999 Ruling 9914583 - DERIVATIVES TO MIMIC FOREIGN MUTUAL FUNDS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Does the use of derivatives by one mutual fund trust to mimic the return of another mutual fund trust that holds foreign property qualify to be a registered investment and if so, would such a transaction be subject to GAAR?

Position: Yes and GAAR is not applicable.

Reasons: The cost amount of the forward contract will be based on legal fees, brokerage fees and any similar fees related to the entering into of the forward contract (expected to be nominal). The forward contracts themselves are not foreign property based on the facts given. Thus, provided that the mutual fund trust limits its investments in foreign property to 20%, the mutual fund trust will qualify as a registered investment.

xxxxxxxxxx 991458

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above noted taxpayers in respect of the income tax consequences arising out of the proposed transactions described below. We also acknowledge your correspondence of XXXXXXXXXX.

We understand that, to the best of your knowledge and the taxpayers noted above, none of the issues involved in this ruling request are:

a) in an earlier return of the taxpayers or a related person;

b) being considered by a tax services office and/or a tax centre in connection with a tax return previously filed by the taxpayers or a related person;

c) under objection by the taxpayers or a related person;

d) before the courts; or

e) the subject of a ruling previously issued by this Directorate to the taxpayers or a related person.

In this letter, unless otherwise indicated, all statute references are to the Canadian Income Tax Act and Regulations (R.S.C. 1985, 5th Supplement, c.1, as amended) (the "Act"), and the following terms have the meanings specified:

"Cost amount" means the cost amount of property as defined in subsection 248(1) of the Act;

"Counterparty" means one or more persons resident in Canada that deal at arm's length with each Fund and with the Trustee which has agreed to enter into a Forward Contract with any of the Funds, individually;

"Forward Contract" means a contract as described in paragraphs 6 to 9 below between a Counterparty and the Fund, individually;

"Fund A" means XXXXXXXXXX;

"Fund B" means XXXXXXXXXX; "Fund" means Fund A or Fund B, individually; "Funds" means Fund A and Fund B, collectively;

"Money Market Securities" means securities offered in the Canadian money market, including treasury bills of the Government of Canada, bankers' acceptances of chartered Canadian banks and short-term debt obligations of Canadian corporations, the Government of Canada, a province or a municipality, or in units of a mutual fund trust that invests in such securities;

"Payment Date" in respect of a Forward Contract means any date specified in the Forward Contract on which either the Counterparty or Fund is required to make a payment and at minimum, shall occur semi-annually;

“Trustee" means XXXXXXXXXX, a taxable Canadian corporation under the Act; its business number is XXXXXXXXXX and its tax services office is XXXXXXXXXX;

"Underlying Fund" means XXXXXXXXXX, individually; and

"Underlying Funds" means XXXXXXXXXX, collectively.

Facts

1. Trustee is the manager and trustee of each of the Underlying Funds. The Underlying Funds are not registered investments under the Act and units of each of the Underlying Funds are "foreign property" as defined in subsection 206(1) of the Act.

Proposed Transactions

2. Trustee will establish two inter vivos trusts, Fund A and Fund B, pursuant to separate declarations of trusts. The only activity of each Fund, as described in paragraphs 4 to 6 below, will be the investing of its funds in property (other than real property or an interest in real property), The interest of each beneficiary under each Fund (the "Unitholder") will be described by reference to units of the Fund (the "Units").

3. The Units will be offered to the public by each Fund pursuant to the terms of a prospectus to be filed by each Fund with the securities regulatory authorities of each province and territory of Canada (the "Offering"). The Units are intended to be sold to residents of Canada and it is reasonable to consider that none of the Funds will be established or maintained primarily for the benefit of persons who are not residents of Canada. Each Fund intends to comply with the conditions prescribed in section 4801 of the Income Tax Regulations for the purposes of paragraph 132(6)(c) of the Act in order to qualify as a mutual fund trust under the Act. Each Fund expects to meet such conditions before XXXXXXXXXX and will each elect in its return of income under Part I of the Act for 1999 to be deemed to have been a mutual fund trust from the time of its establishment, pursuant to subsection 132(6.1) of the Act.

4. From time to time, each Fund will invest the proceeds of the Offering and any amount received under a Forward Contract, net of its expenses, primarily in Money Market Securities and in short term deposits with Canadian financial institutions denominated in Canadian currency. The Money Market Securities and short term deposits will not be foreign property under the Act. Each Fund may invest some of its assets in other investments, including in units of the corresponding Underlying Fund,

5. The Fund intends to apply to become a "registered investment" under subsection 204.4(2) of the Act.

6. Each Fund will enter into one or more separate Forward Contracts with one or more Counterparties. Collectively, the Forward Contracts entered into by a Fund will provide for a payment from time to time of an amount either by the Fund to the Counterparties or vice vers~, which payments are linked to the investment returns generated by a particular Underlying Fund. In particular, under a Forward Contract, on each Payment Date, each Fund will pay to the Counterparty (or the Counterparty will pay to the Fund), the amount by which

(a) the sum of

(i) an interest amount in respect of the period from the last Payment Date imbedded in the price of the Forward Contract (the "Premium"), and

(ii) an amount determined by reference to any decrease in the net asset value of a unit in a particular Underlying Fund (taking into account any distributions made by the Underlying Fund to its Unitholders),

exceeds (or is less than)

(b) an amount determined by reference to any increase in the net asset value of a unit in that Underlying Fund (taking into account any distributions made by the Underlying Fund to its Unitholders).

A sample contract was included with your submission.

7. After settlement of the payment owing by the Counterparty or the Fund as the case may be on a Payment Date, each Forward Contract will have no intrinsic value at the close of each Payment Date. Each Forward Contract may be terminated by either the Fund or the Counterparty on 60 days' prior notice.

8. Each forward contract will be executed in Canada, will be governed by the laws of Canada and both parties to the contract will be resident in Canada. No such forward contract will be listed, or traded over-the-counter, on any stock exchange. None of the Forward Contracts will be convertible into, exchangeable for, or provide the Funds with any right to acquire property that is foreign property. Each Forward Contract will be settled by means of a cash payment and is subject to any risks of default by the Counterparty. The timing, amount and character for tax purposes of payments under a Forward Contract will differ from the timing, amount and character for tax purposes of payments that would be made to an investor who acquired an equivalent amount of units in an Underlying Fund.

9. The Forward Contract between the Counterparty and each Fund will relate to one of the Underlying Funds exclusively.

10. It is expected that the Unitholders of a Fund will receive the same investment return as holders of units in the related Underlying Fund, plus the income derived from the Fund's short term deposits, Money Market Securities and other investments less the Premium and any expenses of the Fund. It is expected that the income derived from the Fund's short term deposits, Money Market Securities and other investments will be less than the Premium. As a result, the public documents relating to the Offering will state that the Fund's rate of return is expected to be less than the rate of return of the related Underlying Fund.

11. Furthermore, the public documents relating to the Offering will advise that the taxation of taxable investors in a Fund will compare adversely to the taxation of taxable investors in the related Underlying Fund, with respect to the timing and character for tax purposes of distributions. Accordingly, Units will be stated to be suitable for investment only by investors subject to the foreign property limits under Part XI of the Act, because a direct investment in units of the Underlying Fund will be always more appropriate for other investors.

12. At all times, the cost amount of the short term deposits, Forward Contracts and Money Market Securities held by each Fund will exceed 80% of the cost amount 6f all the property of that Fund. As noted in paragraph 4 above, the Money Market Securities and short term deposits with Canadian financial institutions will not be foreign property under the Act.

Purpose of Proposed Transactions

13. The purpose of the proposed transactions is to permit each Fund to invest in properties that will allow it to achieve its investment objective, which is to provide investors the opportunity to gain exposure to foreign investments, on a more actively managed basis than is presently available through investments linked to foreign stock indices, while maintaining 100% eligibility for investors that are subject to foreign property limits under Part XI of the Act.

Rulings Given

Provided that the preceding statements are accurate and constitute complete disclosure of all relevant facts, proposed transactions and purpose thereof and the proposed transactions are carried out as herein described, our advance income tax rulings are as follows:

A. Provided that the Funds are accepted by the Minister as registered investments as set out in subsection 204.4(2), and have not been notified of a revocation of such status under subsection 204.2(3) of the Act, the Units of the Funds will not be foreign property as defined in subsection 206(1) of the Act.

B. A Forward Contract described in paragraphs 6 to 9 above, and which is substantially similar to the sample Forward Contract included with your submission, will not be considered to be foreign property for the purposes of Part XI of the Act.

C. For the purposes of subsection 248(1) and section 5000 of the Income Tax Regulations, the cost amount to the Fund of its investments in Forward Contracts which are substantially the same as the draft Forward Contract submitted will be equal to the brokerage fees, legal fees and other costs incidental to entering into or acquiring the investment and will not include an amount in respect of the contract price. Provided that the cost amount of each Fund's Money Market Securities, Forward Contracts and short term deposits with Canadian financial institutions denominated in Canadian currency is not less than 80% of the cost amount of all property of the Fund at the end of any month, the Fund will not be liable for tax under subsection 206(2) of the Act for that month.

D. Subsection 245(2) of the Act will not apply to redetermine the tax consequences arising from the above rulings.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3, Advance Income Tax Rulings, and are binding on Revenue Canada with respect to Forward Contracts as described in paragraphs 6 to 9 above which are entered into or acquired by the Fund within six months of the date of this letter. Ruling A is also subject to the proviso that the Funds are accepted by the Minister as registered investments within six months of the date of this letter.

The above rulings should not be construed as providing the Department's views on whether the Funds will qualify as unit trusts, mutual fund trusts or registered investments for purposes of the Act.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch