2000 Ruling 2000-0005513 - Mutual Fund - Reclassification of Units

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:

This ruling request involves certain mutual fund trusts in a particular family or group of mutual funds which propose to amend their trust agreements to: i) rename their existing units; ii) add two new series of units that will be available to investors who satisfy certain criteria; and iii) add reclassification features to each series of units which, in certain circumstances, will allow these units to be reclassified as another series of units of the same fund. The purpose of the proposed transactions is to permit the manager of the funds to more effectively market the funds to different segments of the investor market and to tailor the fees and expenses applicable to such segments by offering a separate series of units of each such fund. In this ruling, the principal issues are:

1) Does the creation of a new series of units result in a disposition of the existing unitholders units?

2) Since the proposed amendments to the trust agreement provide that an existing series of units (or a new series of units) of a fund may be reclassified as another series of units of the same fund, will such a reclassification of units result in a disposition to the unitholder?

3) Will subsection 104(7.1) apply to the proposed transactions?

Position TAKEN

Unitholders are not considered to have disposed of their units because of the addition of a new series or the reclassification of the units from one series to another series of units of the same fund. Subsection 104(7.1) does not apply.

Reasons FOR POSITION TAKEN

Amendments to the trust agreement which will allow the trustee to create a new series of units and the creation of a new series of units will not result in the disposition of the existing units of a fund held by a unitholder as the rights of the unitholders have not been changed. Also, since a unitholder will not be entitled to proceeds of disposition on any reclassification of units and the units will not be redeemed or cancelled upon the reclassification, and the rights, privileges and conditions attached to the reclassified units will be substantially the same as the existing units, the reclassification of units will not result in a disposition. Subsection 104(7.1) is an anti-avoidance provision intended to prevent the streaming by commercial trusts of income and capital to different beneficiaries depending on their taxable status. However, as outlined above the main purpose of the proposed transactions is to permit the manager of the funds to more effectively market the funds to different segments of the investor market. Although the addition of a new series and the reclassification of existing units can result in the existing unitholders percentage share of a fund's income being greater than their percentage interest in the property of the fund, this result was not one of the main purposes of the proposed transactions and subsection 104(7.1) should not apply. Similar rulings (no disposition and the non-application of subsection 104(7.1)) were given in ruling 9930143, 9905003, 9818043 and 9827053. The paragraph 104(6)(b) and 104(13(a) rulings were straight forward and it was clear that GAAR should not apply to the proposed transactions.

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XXXXXXXXXX 2000-000551
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Attention: XXXXXXXXXX

XXXXXXXXXX, 2000

Dear Sirs/Mesdames:

Re: Advance Income Tax Ruling
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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 and your subsequent correspondence of XXXXXXXXXX, in respect of the income tax consequences arising out of the proposed transactions described below.

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

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

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or related persons;

(c) under objection by the taxpayers or related persons;

(d) before the courts; or

(e) the subject of a ruling previously issued by this Directorate to the taxpayers or related persons with the exception of rulings 981804 and 993014.

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

"Manageco" means XXXXXXXXXX.

"Fund" means a fund listed in Schedule A.

"Funds" means, collectively, the funds listed in Schedule A.

"XYZ Group of Funds" means the XXXXXXXXXX.

"Series A Units" means the XXXXXXXXXX.

"Series B Units" means the XXXXXXXXXX.

"Series C Units" means the XXXXXXXXXX.

Manageco deals with the XXXXXXXXXX. The Funds file their returns at the XXXXXXXXXX.

Our understanding of the relevant facts, proposed transactions and purpose thereof is as follows:

FACTS

1. The Funds are part of a group of XXXXXXXXXX mutual funds, known as the XYZ Group of Funds, which reflect a variety of investment objectives. Each of the Funds was established by a declaration of trust under the laws of a province of Canada and is a mutual fund trust as defined in subsection 132(6).

2. Manageco is a taxable Canadian corporation as defined in subsection 89(1) and is the trustee of the Funds. Under management agreements between Manageco and each Fund, Manageco provides management services to each Fund for a fee and, as such, is responsible for providing or arranging for the day-to-day business administration of the Funds. Manageco is also the principal distributor of the Funds and under distributorship agreements between Manageco and each Fund, Manageco is responsible for marketing and distributing units of the Funds.

3. Each of the Funds, under its declaration of trust, is authorized to issue one class of units. Except as regards to management fee distributions described in 7 below, each unit of a Fund ranks equally in the payment of distributions and return of capital in the event of liquidation, dissolution or winding-up of the Fund. Each unitholder of a whole unit is entitled to one vote at all meetings of the Fund.

4. The units of the Funds are offered for sale by prospectus to Canadian residents and the primary type of investor in these units is a retail investor.

5. Unitholders purchasing the units of the Funds may either pay a negotiable up-front commission to their investment dealers at the time of the purchase or pay a redemption fee if their units are redeemed within XXXXXXXXXX years from the time of purchase. In either case, Manageco will pay the investment dealer a trailing commission based on a percentage of the value of units held by the unitholder.

6. The management fee charged by Manageco pursuant to the management agreement between Manageco and each Fund is a specified annual percentage of the average daily net asset value of the units of each such Fund. The total management fees payable by the Funds for the units range from XXXXXXXXXX% to XXXXXXXXXX% annually. The management fee is computed daily and payable monthly.

7. To encourage holdings of Fund units by groups, such as group registered retirement savings plans, defined contribution pension plans, groups of investors receiving services (including investment selection services from a third party provider) and by other large investors, Manageco occasionally negotiates a reduction of the effective management fee payable by such investors. The goal of such reduced fee arrangements is to achieve fees that are competitive for such large holdings. Such fee reductions are fully negotiable between Manageco and the particular investor and are based, among other factors, on the size of the holdings of the investor or group. Manageco reduces the effective management fee payable by such investors in a Fund by reducing the management fee it charges to the particular Fund on the condition that the Fund makes a special distribution to the investor in an amount equal to the amount of the management fee reduction negotiated with the investor. Such distributions are referred to as management fee distributions.

8. Under its declaration of trust, each Fund is required to distribute at least annually to its unitholders the amount, if any, by which its net income and realized capital gains (net of any realized capital losses of the Fund in such year or prior years) exceeds any non-capital loss of the Fund and certain adjustment amounts to be determined by Manageco, including those in respect of taxable dividends received by the Fund from taxable Canadian corporations and capital gains realized by the Fund (in particular, the non-taxable portion of such gains and any capital gains refund to which the Fund may be entitled), each computed in accordance with the relevant provisions of the Act.

9. Units of each Fund are issued or redeemed at their net asset values. The net asset value per unit of a Fund is computed by dividing the total net asset value of the Fund (which is assets less liabilities of the Fund as calculated in accordance with the declaration of trust of each Fund) by the total number of units of the Fund outstanding at the time. The net asset value per unit of a Fund is usually determined on a daily basis on each day that Manageco is open for business.

PROPOSED TRANSACTIONS

10. Manageco proposes to amend the declaration of trust for each Fund to provide for the renaming of the existing units of each Fund as Series A Units. The existing rights, privileges, restrictions and conditions of the existing units of a Fund will be substantially the same after they are renamed as Series A Units. The unitholder will not be entitled to proceeds of disposition, and the units will not be redeemed or cancelled, as a result of the existing units being renamed.

11. In addition, Manageco proposes to amend the declaration of trust for each Fund to permit each Fund to create and issue an unlimited number of series of units. The rights (including reclassification rights which may be similar to those described in 13, 14, 16 and 17 below), privileges, restrictions and conditions of any new series of units will be determined by Manageco and will be set out in the declaration of trust for each Fund. Initially, two new series of units, Series B Units and Series C Units, are proposed to be created for each Fund. Series B Units for each Fund will be offered pursuant to the terms of a simplified prospectus, a copy of which was enclosed with your ruling request. It is intended that Series C Units of each Fund will only be offered to eligible institutional investors XXXXXXXXXX.

12. With respect to the Series B Units, the proposed amendments to the declaration of trust for each Fund will provide that this new series of units will only be issuable to unitholders who satisfy certain criteria (the "Series B Criteria") related to the nature of the investment program offered and certain other matters which will be established by Manageco from time to time. The Series B Units are designed primarily for unitholders who

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13. The proposed amendments to the declaration of trust for each Fund will also provide that, commencing with the offering by the Fund of the Series B Units, the Series A Units of the Fund may be reclassified as Series B Units of the same Fund if the unitholder of the Series A Units satisfies the Series B Criteria and requests this reclassification. At the time of such reclassification, the aggregate net asset value of the Series A Units of the Fund to be reclassified and the aggregate net asset value of the Series B Units into which they are reclassified will be equal. A unitholder will not be entitled to proceeds of disposition upon any reclassification and the reclassified units will not be redeemed or cancelled upon any reclassification.

14. In addition, the proposed amendments to the declaration of trust for each of the Funds will specify that if a unitholder no longer meets the Series B Criteria, the Series B Units of the Fund held by the unitholder will be reclassified into Series A Units of the same Fund. At the time of such reclassification, the aggregate net asset value of the Series B Units of the Fund to be reclassified and the aggregate net asset value of the Series A Units into which they are reclassified will be equal. A unitholder will not be entitled to proceeds of disposition upon any reclassification and the reclassified units will not be redeemed or cancelled upon any reclassification.

15. With respect to the Series C Units, the proposed amendments to the declaration of trust for each Fund will provide that this new series of units will only be issuable to unitholders who satisfy certain criteria (the "Series C Criteria") related to the total net asset value of units held by that unitholder and certain other matters which will be established by Manageco. Unitholders purchasing Series C Units of the Funds generally will make their purchase without paying any up-front commission or redemption fee.

16. The proposed amendments to the declaration of trust for each Fund will also provide that, commencing with the offering by the Fund of the Series C Units, the Series A Units of the Fund may be reclassified as Series C Units of the same Fund if the unitholder of the Series A Units satisfies the Series C Criteria and requests this reclassification. At the time of such reclassification, the aggregate net asset value of the Series A Units of the Fund and the aggregate net asset value of the Series C Units into which they are reclassified will be equal. A unitholder will not be entitled to proceeds of disposition upon any reclassification and the reclassified units will not be redeemed or cancelled upon any reclassification.

17. In addition, the proposed amendments to the declaration of trust for each Fund will provide that if a unitholder no longer meets the Series C Criteria, the Series C Units of the Fund held by the unitholder will be reclassified into Series A Units of the same Fund. At the time of such reclassification, the aggregate net asset value of the Series C Units of the Fund to be reclassified and the aggregate net asset value of the Series A Units into which they are reclassified will be equal. A unitholder will not be entitled to proceeds of disposition upon any reclassification and the reclassified units will not be redeemed or cancelled upon any reclassification.

18. It is intended that Manageco will not pay trailing commissions to Investment Dealers on the new Series B Units and Manageco does not anticipate paying trailing commissions in connection with the new Series C Units. As a result, Manageco will have lower distribution costs for these new series of units than for the Series A Units and therefore is in a position to charge a lower management fee to the Fund for each new series of units. It is anticipated that the total management fee for both the Series B and Series C Units will range from XXXXXXXXXX% to XXXXXXXXXX%. Accordingly, the Series Expenses of a Fund referable to each series of units of a Fund may differ. Also, the declaration of trust for each of the Funds will authorize a Fund to pay management fee distributions with respect to the new series of units. However, the Funds do not intend to pay such distributions at this time.

19. The declaration of trust for each of the Funds will be amended to provide that if there is more than one series of units outstanding, certain expenses of a Fund attributable only to a particular series of units of the Fund, including expenses related to the sale of the units of the series, expenses which are allocated based upon the number of transactions or accounts in that particular series such as securityholder administration and regulatory fees and management fees in respect of the series (collectively, "Series Expenses") will be borne by that particular series. Any other expenses incurred by a Fund that are not allocable to a particular series will be borne proportionately by all unitholders of the Fund ("Common Expenses"). This result will be achieved by way of the determination of the net asset value of each series of units of the Fund and will impact the allocation and distribution of income and taxable capital gains, if any, of the Fund to unitholders in accordance with the provisions of the amendments to the declaration of trust for each Fund described herein.

20. The net asset value per unit of a series of a Fund will generally be calculated on each business day. This series net asset value per unit will be computed by dividing the total net asset value of the series (calculated in accordance with the declaration of trust of each Fund) by the total number of units of the series of the Fund outstanding at the time.

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21. The portion of the distribution to which a series of units of a Fund will be entitled will be determined by taking its proportionate share of the adjusted net income of the Fund less the expenses of the Fund that are Series Expenses (as described in 19 above) and any management fee distributions to unitholders of that series of units, in each case not previously charged during the year to a distribution to all holders of that series. Adjusted net income of a Fund is the Fund's net income generally after adding back expenses related to a specific series which have not previously been charged during a year to a distribution to all holders of the series.

22. Other than the rights, privileges, restrictions and conditions described above, the rights, privileges, restrictions and conditions of the new Series B Units and the new Series C Units will be substantially the same as those of the existing units of each Fund.

PURPOSE OF PROPOSED TRANSACTIONS

23. The purpose of the proposed transactions is to permit Manageco to more effectively market the Funds to different segments of the investor market and to tailor the fees and expenses applicable to such segments by offering a separate series of units of each such Fund.

RULINGS GIVEN

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

A. The proposed amendments to the declaration of trust governing each Fund as described above will not result in existing unitholders of such Fund being considered to have disposed of their existing units of the Fund.

B. The unitholders of a Fund whose units are reclassified as units of the same Fund, as described in 13, 14, 16 and 17 above, will not be considered to have disposed of their units by virtue only of such reclassification.

C. In computing its income for a taxation year, each Fund will be entitled to deduct, under paragraph 104(6)(b), the amount of Fund income (including taxable capital gains) that was paid or payable by the Fund to unitholders of the Fund in such taxation year pursuant to the amended declaration of trust governing the Fund and the provisions of subsection 104(7.1) will not apply to the Fund by virtue only of the implementation of the proposed transactions.

D. The amount of Fund income (including taxable capital gains) that is paid or payable to a unitholder in a taxation year will be included in computing the income of that unitholder under paragraph 104(13)(a).

E. Subsection 245(2) will not be applied to redetermine the tax consequences of the rulings given above solely as a result of the implementation of the proposed transactions described herein.

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 the Canada Customs and Revenue Agency (CCRA) provided that the proposed transactions are completed within six months of the date of this letter. These rulings are based on the law as it currently reads and do not take into account any proposed amendments to the Act, which if enacted into law, could have an effect on the rulings provided herein.

The above rulings should not be construed as providing the CCRA's views on whether the Funds qualify as mutual fund trusts for purposes of the Act.

Yours truly,

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

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