2001 Ruling 2001-0088163 - Mutual Fund Trust Mimic Foreign Investment

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 CCRA.

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

Principal Issues: Will the proposed forward contract used by a mutual fund trust (MFT) to mimic the return of the underlying fund be "foreign property" as defined in subsection 206(1)? Will subsection 245(2) apply to the proposed transactions?

Position: No. GAAR is not applicable.

Reasons: The forward contract will be executed in Canada, governed by the laws of Canada and will not be convertible into, or exchangeable for, foreign property, nor will the MFT be entitled to acquire any foreign property under the terms of the contract. The counterparty to the forward contract will not be acting as agent for the MFT nor will it be obliged in any way to hedge its exposure under the contract. The application of subsection 245(2) to similar transactions was previously considered by the GAAR Committee and it was their view that GAAR was not applicable to the proposed transactions.

XXXXXXXXXX 2001-008816

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of June 11, 2001, in which you requested an advance income tax ruling on behalf of XXXXXXXXXX and the funds listed in Appendix A in respect of the income tax consequences arising from the proposed transactions described below. We also acknowledge your correspondence of XXXXXXXXXX.

We understand that, to the best of your knowledge, and that of the taxpayers on whose behalf this ruling is requested, none of the issues involved in this ruling request is:

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

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

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

(d) before the courts and that no judgement has been issued which may be under appeal; or

(e) the subject of a ruling previously issued by the Directorate to the taxpayers or a person related thereto, other than advance income tax rulings 991774 dated XXXXXXXXXX, 1999, 992304 dated XXXXXXXXXX, 1999, 2000-000526 dated XXXXXXXXXX, 2000 as amended by 2000-001631 dated XXXXXXXXXX, 2000, 2000-004532 dated XXXXXXXXXX, 2001, and 2001-007645 dated XXXXXXXXXX, 2001.

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:

"Business Day" means any day that is a business day in XXXXXXXXXX and that is a trading day on the XXXXXXXXXX Stock Exchange;

"Cash Settlement Amount" in respect of a Forward Contract means an amount (net of the financing charge imposed on a Fund by the Counterparty) equal to the Cumulative Notional Units multiplied by an amount that is the net asset value per unit of a Notional Unit on the Termination Date minus the Weighted Average Forward Price;

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

"Counterparty" means XXXXXXXXXX in either case, a resident in Canada;

"Cumulative Notional Amount" in respect of a Forward Contract means the sum of all amounts, each of which is a positive or negative amount that is calculated as the product obtained by multiplying the net asset value per unit of a Notional Unit on the Business Day preceding the day on which the Notional Unit was added to or subtracted from the number of Cumulative Notional Units, by the number of Notional Units so added to or subtracted from the number of Notional Units on which the Forward Contract is based as a result either of entering into the Forward Contract or of a particular amendment to the Forward Contract;

"Cumulative Notional Units" in respect of a Forward Contract means the number of Notional Units upon which the payment by the Counterparty to the Fund on the Termination Date is based, which number is equal to the number of Notional Units specified in the Forward Contract on the Trade Date, adjusted to reflect the total of all increases and decreases in the number of such Notional Units as specified in any amendment to the Forward Contract prior to the Termination Date;

"Existing Forward Contract" and "Existing Forward Contracts" means a forward contract or contracts with the Counterparty, XXXXXXXXXX or any other party with which a Fund has entered into a forward contract where such other party may or may not be resident in Canada and may or may not be related to the Manager;

"Forward Contract" and "Forward Contracts" have the meaning set out in paragraphs 5 and 6;

"Fund" means any one of XXXXXXXXXX, individually;

"Funds" means each Fund collectively;

"Manager" means XXXXXXXXXX, the manager and trustee of the Funds and the Underlying Funds; XXXXXXXXXX business number is XXXXXXXXXX and its Tax Services Office is XXXXXXXXXX;

"Margin" means the amount XXXXXXXXXX, which the Fund is required under the terms of the Forward Contract to post as collateral with the Counterparty. The assets posted as Margin may consist of either Money Market Securities or short-term cash deposits with Canadian financial institutions but in either case, will be held by the Counterparty in Canada;

"Money Market Securities" means securities offered in the Canadian money market such as 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;

"Notional Unit" and "Notional Units" in respect a Forward Contract means a unit or units of the Underlying Fund, the value of which is relevant in determining the amount of any payment required under the Forward Contract;

"Services Agreement" means an agreement between the Counterparty and an Underlying Fund in respect of the Counterparty's acquisition of units of the Underlying Fund for the purpose of hedging its obligations under the Forward Contract;

"Trade Date" means the date on which a Forward Contract commences;

"Termination Date" means the date on which a Forward Contract will be settled XXXXXXXXXX;

"Underlying Fund" means any one of XXXXXXXXXX, individually;

"Underlying Funds" means each Underlying Fund collectively; and

"Weighted Average Forward Price" in respect of a Forward Contract means an amount equal to the quotient obtained by dividing the Cumulative Notional Amount by the Cumulative Notional Units.

Facts

1. The Manager is a taxable Canadian corporation within the meaning of the Act.

2. The Manager established each of the Underlying Funds pursuant to a declaration of trust. The Underlying Funds are mutual fund trusts as defined in section 132. The Underlying Funds are not registered investments under the Act and units of the Underlying Funds are foreign property as defined in subsection 206(1).

3. The Manager established each of the Funds pursuant to a declaration of trust. The Funds are mutual fund trusts as defined in section 132 and are registered investments under the Act. The only activity of each of the Funds, as described below, is the investing of its funds in property (other than real property or an interest in real property). Units are offered to the public by each Fund pursuant to the terms of a prospectus which was filed by the Funds with the securities regulatory authorities of each province and territory of Canada. The units are sold to residents of Canada.

4. The Funds have invested their funds in short-term cash deposits with Canadian financial institutions, Money Market Securities and Existing Forward Contracts. The Existing Forward Contracts relate either to units of the particular Underlying Fund or to a basket of securities which generally corresponds to the securities held by the particular Underlying Fund. The terms of the Existing Forward Contracts require a portion of the Fund's assets to be deposited with the counterparty to the Existing Forward Contract as a margin deposit. The margin deposit consists of Money Market Securities and cash deposits which are held by the counterparty in Canada. The terms of these Existing Forward Contracts also provide for a payment from time to time of an amount either by the Fund to the counterparty to the Existing Forward Contract, or vice versa, which payment is linked to the investment returns generated by the relevant Underlying Fund or basket of securities. The Funds may also invest in units of their respective Underlying Funds provided that the cost amount of such investment and any other foreign property held by a Fund does not exceed 30% of the cost amount of all the property of the Fund at the end of any month.

Proposed Transactions

5. In addition to entering into forward contracts that are substantially the same as any of the Existing Forward Contracts, the Funds will enter into one or more Forward Contracts with the Counterparty. 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 Counterparty or vice versa, which payments are linked to the investment returns generated by a particular Underlying Fund. In particular, under the terms of the sample Forward Contract submitted for our review, on each Termination Date, the Counterparty will pay the Cash Settlement Amount to the Fund if such amount is a positive amount or the Fund will pay the Counterparty the Cash Settlement Amount if such amount is a negative amount. The Forward Contract will be adjusted each day, if necessary, to reflect the net cash received by a Fund from subscriptions and cash paid by the Fund in respect of the redemption of units.

6. Each Forward Contract will be executed in Canada and will be governed by the laws of Canada. No Forward Contract will be listed on any stock exchange or traded over-the-counter. Each Forward Contract will not be convertible into, exchangeable for, or provide the Fund with any right to acquire property that is foreign property. The Forward Contract will require the Fund to post Margin as collateral with the Counterparty. Under the terms governing the Counterparty's use of property posted as Margin, the Counterparty may sell, pledge, rehypothecate, assign, invest, use, commingle or otherwise dispose of the property so posted and for greater certainty may acquire units of the Underlying Fund with the property posted as Margin or with any property substituted therefor. Each Forward Contract will be settled by means of a cash payment, in Canadian dollars, and will be subject to any risk of default by the Counterparty. Each Forward Contract will be for a term not exceeding XXXXXXXXXX but will be subject to renewal at the option of the parties. The Counterparty and the Funds represent that they are each entering into the Forward Contract as principal with respect to the other party and not as agent or in any other capacity, fiduciary or otherwise with respect to the other party.

7. When it is considered appropriate, the obligations of the Counterparty under the Forward Contract will be guaranteed by another person who may or may not be resident in Canada pursuant to a guarantee agreement that is substantially the same as the draft guarantee agreement submitted for our review. The Funds will not incur any costs in connection with such a guarantee and thus, the Cost Amount to the Funds of the guarantee will be nil.

8. As a result of a Fund entering into a Forward Contract, the return on the investment in units of the Fund will approximate the investment return on a particular Underlying Fund less the financing charge required to be paid by the Fund to the Counterparty under the Forward Contract and any expenses of the Fund. The public documents relating to the offering will state that the Units are suitable for investment by investors that are subject to the foreign property limits under Part XI of the Act.

9. At the end of any month, the aggregate Cost Amount of the Forward Contract and any other assets held by each Fund that are not foreign property will equal or exceed 70% of the Cost Amount of all the property of the Fund.

10. In order to ensure that the Counterparty has the option to hedge its obligations under the Forward Contract, the Counterparty will enter into a Services Agreement with the Underlying Fund that is substantially the same as the service agreement submitted for our review and under which the Counterparty will place a standing order to acquire or redeem a number of units of the Underlying Fund corresponding to the increase or decrease in the number of Notional Units in effect under the Forward Contract on each Business Day. As permitted under the terms governing the Counterparty's use of property posted as Margin, the Counterparty plans to use the property posted by the Fund as Margin to acquire units of the Underlying Fund.

11. The Counterparty may cancel the purchase or redemption order for any particular Business Day by notifying the Underlying Fund of its intent in writing. The Services Agreement limits the purchase of units of the Underlying Funds in certain circumstances. As a result, the Counterparty is not obligated under the Services Agreement or the Forward Contract to hedge its obligations under the Forward Contract by acquiring or redeeming any units of an Underlying Fund. The Services Agreement also requires the manager of the Underlying Fund to reduce the management fee and certain other costs related to the operation of the Underlying Fund that it would otherwise be entitled to receive from the Underlying Fund in respect of any units acquired by the Counterparty in connection with the Forward Contract and distribute such amounts to the Counterparty. Under the terms of the Forward Contract, the Counterparty will pay the Fund an amount equal to the amount of any such management fee distributions and other operating cost distributions received under the terms of the Services Agreement.

Purpose of Proposed Transactions

12. The purpose of the proposed transactions is to provide investors that are subject to foreign property limits under Part XI of the Act an opportunity to realize investment returns that are linked to the returns realized on Underlying Funds without increasing the amount of foreign property held by the investors.

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 each of the Funds is a registered investment as set out in subsection 204.4(2) and has not been notified of a revocation of such status under subsection 204.4(3), the units of the Funds will not be foreign property as defined in subsection 206(1).

B. A Forward Contract entered into between a Fund and the Counterparty, and which is substantially similar to the draft Forward Contract submitted with this ruling application, will not be considered to be foreign property as defined in subsection 206(1).

C. Provided that the Cost Amount at the end of a particular month of a Fund's Forward Contracts and any other property of the Fund that is not foreign property is not less than 70% of the Cost Amount of all property of the Fund, the Fund will not be liable for tax under subsection 206(2) for that month.

D. For the purposes of subsection 248(1) and section 5000 of the Income Tax Regulations, the Cost Amount to a Fund of its investment in a Forward Contract which is substantially the same as the draft contract submitted will be equal to the brokerage fees, legal fees and other costs incurred by the Fund and incidental to entering into or acquiring the investment and will not include an amount in respect of Margin posted in respect of the Forward Contract.

E. Subsection 245(2) 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 70-6R4, Advance Income Tax Rulings, and are binding on the Canada Customs and Revenue Agency (CCRA) with respect to Forward Contracts which are entered into or acquired by a Fund within six months of the date of this letter.

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

Yours truly,

XXXXXXXXXX
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

XXXXXXXXXX