Messrs. Jones and Love discuss numerous fund taxation issues including restrictions on pushing out capital gains, and the onerous investment fund and EIFEL rules

There is space in this post to mention only a few of the fund issues discussed.

S. 132(5.3)(b) produced an inappropriate result for exchange-traded funds (ETFs) where a market maker, in order to avoid the units trading at a significant discount to NAV, would purchase units on the exchange and redeem them, and also subscribe for units, so that effectively all the redemption proceeds were paid to a unitholder (the market maker) with full cost for its redeemed units, without account being taken of the gains of the unitholders selling their units to the market maker.

This led to s. 132(5.31). However, if a significant portion of an ETF’s capital gains related to satisfying units redemptions rather than being from ordinary course trading activities, and the amount paid to redeeming unitholders was small relative to the aggregate NAV of all ETF units, then the ETF would only be able to allocate a small portion of those capital gains to redeemed unitholders (and a July 29, 2020 IFIC submission suggested that the ETF should be allowed to allocate to redeemed unitholder a proportionate amount of the ETF’s unrealized gains at the beginning of the day on which the redemptions occurred).

A trust breaching any of the conditions in paras. (a) or (b) of the definition of investment fund, even momentarily, will permanently lose its investment fund status and thus lose protection from the occurrence of a loss restriction event.

In practice, it is possible for funds to violate the concentration test in (b)(vi)(D) of the investment fund definition by investing in a bottom fund that is a partnership, a Canadian resident trust that is not an investment fund, or a non-resident trust or corporation, given that the fund might have obtained exemptive relief in this regard from the application of NI 81-102.

The s. 18.2 limitations on deducting interest and financing expenses can be relevant to a fund, for example, if the bank-owned asset manager (by virtue of providing seed capital) or the bank-owned broker-dealer (by virtue of its market-maker function) owned more than 50% of the FMV of the fund units.

The adjusted taxable income (ATI) definition in relation to a trust requires adding back (under Variable B(g)) the s. 104(6) deductions of the trust except to the extent of any portion designated under s. 104(19) in respect of taxable dividends, and Variable C(h) deducts any s. 104(13) inclusion to the trust except to the extent of the portion designated under s. 104(19).

A trust with interest and financing expenses of $30 (e.g., loan interest) which invested in Canadian equities, received $100 of taxable dividends and distributed $70 to its unitholders which it designated under s. 104(19), would have an ATI of $30 (reflecting the add-back of the IFE, but with not the add-back of the $70 under B(g) because of the s. 104(19) designation) so that the trust could deduct no more than $9 of interest in the year, thereby requiring a further distribution of $21 of income.

A trust receiving all of its income (being $100 of ordinary income) from a trust investment would have an ATI of nil - since, although it would have an addback of its $30 of IFE under B(a) and of $70 under B(g) for its s. 104(6) deduction, the $100 of income received from the subtrust and included in its income under s. 104(13) would be deducted under C(h), so that the IFE could not be deducted.

Neal Armstrong. Summaries of Josh Jones and Jeffrey Love, "Recent Developments in Asset Management", draft 2023 CTF Annual Conference paper under s. 132(5.3)(a), s. 132(5.3)(b), s. 104(7.1), s. 132(4) – capital gains redemption, s. 132(5.31), s. 251.1(2)(b), s. 251.2(1) – investment fund, s. 18.2(1) – excluded entity – (c), eligible group entity, adjusted taxable income, and s. 94(1) - fixed interest.