20 November 2002 External T.I. 2002-0153635 - Exchange rights iss

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: Whether a publicly traded unit trust would be considered to be maintained primarily for non-residents solely by reason of the issuance of exchange rights to non-residents

Position: question of fact

Reasons: 132(7) is broad enough to apply where any combination of the trust's purposes results in the trust being maintained primarily for the benefit of non-residents at a particular point in time

XXXXXXXXXX 	2002-015363
		Annemarie Humenuk
Attention:  XXXXXXXXXX 

November 20, 2002

Dear XXXXXXXXXX:

Re: Exchange Rights Issued by a Publicly Traded Unit Trust

This is in reply to your letter of July 23, 2002, concerning the application of subsection 132(7) of the Income Tax Act (the Act) to a publicly traded unit trust which plans to issue certain rights ("exchange rights") to non-resident persons.

All statutory references in this letter are references to the provisions of the Act, R.S.C. 1985 (5th supp.) c. 1, as amended.

You describe a unit trust which, subject to the provisions of subsection 132(7) of the Act, meets the conditions necessary to qualify as a mutual fund trust within the meaning of 132(6) of the Act. The terms of the trust provide that non-residents of Canada may not collectively own more than 49% of the units of the trust. All of the trust's property is invested in shares and notes of a private corporation which is wholly owned by the trust.

The corporation proposes to significantly expand its operations by acquiring a business that currently has a value in excess of twice the value of the corporation's business. It plans to finance the acquisition of the business through the issuance of notes and shares of itself to non-resident investors. As the shares of the corporation are not traded on a stock exchange, the non-resident investors would only be willing to accept the offer if they can be provided with some form of market liquidity for the shares and notes of the corporation. As the acquisition of the business by the corporation will benefit the trust and its unitholders, the trust proposes, as part of the arrangement, to provide the non-resident investors with certain rights, "exchange rights", whereby the non-residents may exchange the shares and notes of the corporation for units of the trust on a predetermined ratio, provided that such exchange does not conflict with the terms of the trust which prohibit non-residents from owning more than 49% of the units of the trust. In addition, to safeguard the non-resident investors' access to the liquidity of the unit trust, the non-residents will have a collective right to appoint one or more trustees to the trust, not forming a majority thereof, and to hold veto rights in respect of certain fundamental trust decisions. It is expected that a non-resident investor who exercises the right to exchange notes and shares of the corporation for units of the trust will do so in order to sell his or her investment through a stock exchange.

As a result of the purchase, the non-resident investors will own in excess of 49% of the outstanding notes and shares of the corporation. Thus, the percentage of units of the trust owned by non-residents would exceed 49% if all the exchange rights could, and were, exercised immediately following the acquisition of the business. You ask us to confirm your understanding that subsection 132(7) would not apply to deem the trust not to be a mutual fund trust solely by reason of the issuance of the exchange rights to the non-resident investors.

In support of your position, you note that the purpose of subsection 132(7), as expressed in the supplementary information related to the 1990 federal budget released by the Department of Finance, is to discourage the use of mutual fund trusts as an intermediary through which non-residents of Canada might otherwise be able to invest in Canadian real estate or other taxable Canadian property without being subject to Canadian tax either directly or indirectly. In the situation you describe, the non-resident investors will hold the shares and notes of the corporation as taxable Canadian property and any accrued gain on such property will be taxable to the non-resident upon the exchange for units of the trust, subject to any treaty exemption that might be available. Thus, the arrangement does not permit the non-resident investors to engage in the type of tax planning that subsection 132(7) was intended to prevent.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. However, we are prepared to provide the following general comments, which may be of assistance.

While the primary purpose of establishing or maintaining a trust is normally to provide benefits to the beneficiaries of the trust, a trust may have any number of other purposes. The wording of subsection 132(7) is broad enough to apply when any combination of those purposes results in the trust being maintained primarily for the benefit of non-residents at a particular point in time. Thus, while a trust will generally be considered to be maintained primarily for the benefit of non-resident persons where the units are held primarily by non-residents of Canada, the application of subsection 132(7) is not restricted to such cases. In determining whether subsection 132(7) applies at any particular point of time, the issue to be decided is whether it is reasonable to conclude at that point in time that the trust was either established or is being maintained primarily for the benefit of non-residents.

For example, in the situation you describe, the exchange rights provide the non-resident investors with the benefit of liquidity for their investment. You indicate that the non-resident investors' right to liquidate their investment in the corporation would be protected by limited voting rights in trust matters and the right for the investors to collectively appoint a trustee to the trust to represent their interests. The fact that the exchange rights are to be protected in this manner is evidence that subsequent to the transactions described in your letter, at least one of the purposes of the maintaining the trust would be to provide the non-resident investors with the benefit of liquidity.

Thus, in a situation such as that described in your letter, it may be that a combination of the various purposes for which the trust is being maintained may result in the trust being maintained primarily for the benefit of non-residents. As the Canadian Customs and Revenue Agency would not normally consider the benefit of providing liquidity to the investors in a corporation to have the same weight as the benefit of being a unitholder of the trust, the fact that the number of exchange rights issued may exceed the number of units of the trust currently held by residents of Canada would not necessarily result in the application of subsection 132(7). However, it would be a factor in the determination. Thus, it is a question of fact, to be determined on a case by case basis, as to whether or not subsection 132(7) applies at a particular time to a particular trust.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5.

T. Murphy
for Director
International and Trusts Division
Income Tax Rulings Directorate