25 July 2011 External T.I. 2010-0386841E5 - SIFT partnership

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.

Principal Issues: In a specific hypothetical situation, would a partnership that has none of its units listed or traded on a stock exchange or other public market meet condition (b) of the definition of "SIFT partnership" in subsection 197(1) if the common shares of one of its investors are listed or traded on a stock exchange or other public market? Specifically, would the common shares of the investor be viewed as an "investment" in the partnership as that term is defined in subsection 122.1(1)?

Position: Question of fact but unlikely given the facts in the hypothetical situation.

Reasons: Given the facts in the hypothetical situation, it is unlikely that the common shares of the investor would be viewed as an "investment" in the partnership since neither the "security test" nor the "replicate test" appears to be met.

XXXXXXXXXX
									2010-038684
									Chrys Tzortzis, CA

July 25, 2011

Dear XXXXXXXXXX :

Re: XXXXXXXXXX and the SIFT rules

We are writing in reply to your fax of November 9, 2010, wherein you inquire about the application of the SIFT partnership rules to a partnership that has none of its units listed or traded on a stock exchange or other public market. In particular, you ask whether the publicly-traded common shares of one of the investors would be viewed as an "investment" in the partnership as that term is defined in subsection 122.1(1) of the Income Tax Act (the "Act").

Since your inquiry concerns an actual situation involving questions of fact, it should be dealt with by your local tax services office. If you wish to have the Canada Revenue Agency review your actual situation, you should submit all of the relevant information and documentation to the particular tax services office serving your area, a list of which is available on the "Contact Us" page of the CRA Web site at www.cra-arc.gc.ca. However, we are prepared to provide the following general comments to a hypothetical situation, which may be of assistance. Please note that the lack of comment on any particular issue should not be construed as assurance of the tax consequences relating to that issue.

Hypothetical Situation

• A wholly-owned subsidiary ("Subco") of a private company forms a limited partnership with an Indian Band that is tax exempt pursuant to paragraph 149(1)(c) of the Act. Subco holds a majority interest in the partnership.
• The private company subsequently becomes a public company ("Public Co") following an initial public offering of common shares and is listed for trading on a stock exchange.
• Both Subco and Public Co's authorized share capital consists of an unlimited number of common shares (the "Shares"). The holders of the Shares are entitled to one vote per share at all meetings of shareholders. They are also entitled to receive dividends if, as and when declared by the Board of Directors. In the event of the dissolution, liquidation, winding-up or other distribution of the assets, such holders are entitled to receive on a pro-rata basis any remaining assets after payment of all liabilities. The Shares carry no exchange or conversion rights.
• Public Co has never paid dividends and does not have a dividend policy. It intends to retain all available funds for use in its business and does not anticipate paying any dividends in the foreseeable future.
• The holders of the Shares of Public Co do not have any specific legal entitlement to, or in respect of, amounts of capital, revenue or income of the partnership or interest payable by the partnership.
• The partnership has issued limited partnership units which are not listed or traded on a stock exchange or other public market. The partnership agreement restricts the sale or transfer of units. None of the units of the partnership are directly or indirectly exchangeable for Shares of Subco or Public Co and none of the Shares of Subco or Public Co are directly or indirectly exchangeable for units of the partnership.
• Public Co has other material assets and business undertakings.
• All parties are resident in Canada.

Our Comments

As noted in your correspondence, condition (b) of the definition of "SIFT partnership" in subsection 197(1) of the Act is met if at any time during the taxation year "investments (as defined in subsection 122.1(1)) in the partnership are listed or traded on a stock exchange or other public market". Under paragraph (a) of the definition of "investment" in subsection 122.1(1) of the Act, an investment in a trust or partnership means "(i) a property that is a security of the trust or partnership, or (ii) a right which may reasonably be considered to replicate a return on, or the value of, a security of the trust or partnership" [referred to hereafter as the "security test" and the "replicate test", respectively]. A "security" of the partnership is defined in subsection 122.1(1) and means "any right, whether absolute or contingent, conferred by the particular entity or by an entity that is affiliated with the particular entity, to receive, either immediately or in the future, an amount that can reasonably be regarded as all or any part of the capital, of the revenue or of the income of the particular entity...and for greater certainty includes...(d) if the particular entity is a partnership, an interest as a member of the partnership; and (e) a right to, or to acquire, anything described in this paragraph and any of paragraphs (a) to (d)."

In your correspondence, you refer indirectly to our document 2009-0309281E5 dated May 3, 2010 wherein we provided our views on the "security test" and the "replicate test" with reference to hypothetical examples. We note that the above hypothetical situation is similar to Example 3 of that document wherein we opined that the security test would not be met in that example provided the terms of the shares are such that they do not provide shareholders with any legal entitlement to, or in respect of, amounts of capital, revenue or income from the partnership, or interest payable by the partnership, and there are no exchange features. Further, we noted that factors that likely would result in the shares of the company being regarded as a security of the partnership would include share terms requiring that:

(i) the value of, or return on, a class of shares be specifically based on amounts that may reasonably be tracked to revenue, income, or capital of the partnership, or to interest payable by it; or
(ii) in the event of dissolution of the partnership, or where the partnership returns capital to the corporation for whatever reason, shareholders are entitled to receive from the corporation a return of capital or dividend payment equal to a preset amount or a proportionate amount as determined by an existing formula.

Therefore, given the terms of the publicly-traded common shares in the hypothetical situation and the above comments, it is our view that the publicly-traded common shares of Public Co would not cause the security test to be met.

As for the replicate test, the facts in the hypothetical situation do not state what proportion of Public Co's assets is invested (directly or indirectly) in the partnership. In document 2009-0309281E5, we stated that the amount of the company's investment in a partnership is expected to be a relevant, but not necessarily a determinative consideration in applying the replicate test. In addition, we stated that there is no "safe harbour" to be identified based only on this consideration. In our view, the question whether a right "may reasonably be considered" to replicate the value of or return on a security of the partnership is an objective determination based on the reasonable expectations of a hypothetical investor. We further stated that we do not think that such expectations would require that there be a 1:1 matching between actual values or returns. However, we agreed that it would require that the anticipated values or returns would reasonably be expected to be very close.

For example, in and of itself, an initial investment by the company of 10% of its assets - or 50% - may not be a sufficient basis for an objective investor to consider that the company's shares would replicate the value of, or the return on, a security of the partnership, particularly if the company's remaining assets were invested in other commercial undertakings. However, where the corporation derives all or most of its value from the partnership or where the corporation's business undertakings are represented wholly or largely by the activities of the partnership, we would generally expect that an objective investor would consider the company's shares to replicate the value of, or the return on, a security of the partnership.

Example 4 of document 2009-0309281E5 involved a similar situation where the proportionate size of a corporation's investment in the partnership was not known. We stated that the following factors may reduce the potential that the publicly-traded shares would be regarded as investments in the partnership:

(a) the corporation is a large corporation with other sources of income, or the investment in the partnership is a relatively small component of its business;

(b) there are no share provisions or corporate practices in place to track revenue, income or capital from the partnership, or interest payable by it, to any dividends paid on the corporation's shares or returns of capital paid to shareholders; and

(c) there are no exchange features to allow a partner to exchange their partnership interest for shares of the corporation.

In contrast, the following factors may increase the likelihood that the replicate test could be satisfied at some time:

(a) the corporation had no other material business undertakings; and

(b) the corporation has a practice of paying dividends based on its earnings from the partnership (by reason of the share terms or otherwise).

The facts in the hypothetical situation state that Public Co has other material assets and business undertakings. This would suggest that Public Co does not derive all or most of its value from the partnership and its business undertakings are not represented wholly or largely by the activities of the partnership. As a result, it would appear unlikely that an objective investor would expect the common shares of Public Co to replicate a return on, or the value of, the units of the partnership. Accordingly, it would be unlikely that the publicly-traded common shares of Public Co would cause the replicate test to be met. However, it is a question of fact whether or not a corporation's other assets and business undertakings are sufficient in a particular situation so as to materially influence the reasonable expectations of an objective investor such that it would not be reasonable for the shares of the corporation to be considered to replicate a return on, or the value of, the units of the partnership.

Therefore, having regard to the above comments and given only the limited facts in the hypothetical situation, it would be unlikely, in our view, that the publicly-traded common shares of Public Co would be viewed as an "investment" in the partnership as that term is defined in subsection 122.1(1) since neither the "security test" nor the "replicate test" appears to be met. However, this determination is essentially a question of fact to be made from an examination of all the rights that are listed or traded on a stock exchange or other public market having regard to all the facts and surrounding circumstances of the particular situation. Generally, this information would be obtained in the normal course of an audit carried out by a Tax Services Office.

We trust that these comments will be of assistance.

Yours truly,

G. Moore
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch