2002 Ruling 2002-0154423 - Reinvestment and consolidation 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 CCRA.

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

Principal Issues:

We are asked to rule on a proposed transaction where the Trustee would adopt a "plan of consolidation". Under this plan, immediately following a distribution and reinvestment in additional units of a Fund, the units are consolidated so that the number of units of the Class of the Fund held by a unitholder immediately after the distribution and reinvestment shall be equal to the number of units of that class of the Fund held by the unitholder immediately before such distribution.

The Rulings requested are:

1) Whether the automatic reinvestment of a distribution and consolidation will prevent the distribution to be payable as per 104(24) of the Income Tax Act (the "Act").

2) Whether the consolidation following a distribution will result in a disposition, or a partial disposition, of the units so consolidated.

Position:

1) No
2) No

Reasons:

1) Issue previously ruled in 9917313.

See also 9902633, 9906933 and 971404 where the amount of distribution required to be made by the trust to unitholders is added in computing the net asset of the units of the trust, without any additional units being issued was considered to be "payable" within the meaning of subsection 104(24) of the Act.

2) Analogy with shares: Interpretation Bulletin IT-65 - Stock Splits and Consolidations. The same ratio of consolidation is used regarding all units of a class of a Fund.

The Declaration of Trust states: Such consolidation shall not constitute a redemption or cancellation of the units so consolidated and a unitholder whose units are consolidated shall not receive, and shall not be entitled to receive, any proceeds of disposition in respect thereof.

The income distribution, re-investment and consolidation of the units will effectively give the same result as if the income was simply capitalized, such that a unit holder will end up with the identical number of units after the consolidation. However, this result does not hold true where the unit holder is a non-resident. As a result of the withholding tax

on distribution of income to non-residents, non-resident unit holders will end up with a lower number of units after the consolidation than the number of units held before the distribution because although the ratio of consolidation is the same as for residents; the amount re-invested is lower because part of the distribution is used for Part XIII tax. This has the effect of diluting the voting rights of non-resident unitholders relative to the voting rights of all unit holders because they are re-investing only a part of the distribution whereas resident unit holders are re-investing the full amount of the distribution. However, this does not affect our conclusion that a pro-rata consolidation is not a disposition because immediately after the consolidation, each unit holder, whether resident or non-resident, has rights in the trust that are virtually identical to the rights held immediately before the consolidation. We not that non-resident unitholders could be adversely impacted as far as voting rights are concerned because a fraction of a unit is not entitled to one vote. The dilution in votes is not the result of the consolidation per se, but is the result of a lower rate of re-investment.

See: 2000-0007513, 9636193, 9610043.

XXXXXXXXXX 2002-015442

Attention: XXXXXXXXXX

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request for XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you request an Advance Income Tax Ruling on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence of XXXXXXXXXX, and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling request:

(i) is in an earlier return of the taxpayers or a related person;

(ii) is being considered by a Tax Services Office or Taxation Center in connection with a previously filed tax return of the taxpayers or a related person;

(iii) is under objection by the taxpayers or a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) is the subject of a Ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

DEFINITIONS

In this letter:

"Existing Fund" and collectively "Existing Funds" means XXXXXXXXXX. All of the Existing Funds are trusts.

"New Fund" and collectively "New Funds" means XXXXXXXXXX. The New Funds are trusts to be established.

"Fund" and collectively "Funds" means "Existing Funds" and "New Funds".

"Trustee" and "Manager" means XXXXXXXXXX which is the trustee and the manager of each Existing Funds and which will be the trustee and manager of each of the New Funds.

The address of the Trustee and of each Fund is, or will be, as applicable, XXXXXXXXXX The Business Number of the Trustee is XXXXXXXXXX and its Tax Services Office is XXXXXXXXXX. No identification number has been assigned to any of the Existing Funds.

FACTS

1. The Trustee is a taxable Canadian corporation as defined in subsection 89(1).

2. The Existing Funds are governed by Declarations of Trust dated XXXXXXXXXX. A copy of the Declarations of Trust was provided with your Ruling request. Each Existing Fund is a "unit trust" as defined in subsection 108(2), satisfying the redemption requirements in paragraph 108(2)(a). Units of each Existing Fund are offered to the public pursuant to a simplified prospectus and annual information form filed with the securities regulators in each province and territory of Canada. It is expected that each Existing Fund will qualify as a mutual fund trust as defined in subsection 132(6) before the 91st day after the end of its 2002 taxation year and will elect pursuant to subsection 132(6.1) to be deemed to have qualified as a mutual fund trust from the beginning of such taxation year until such time.

3. It is expected that each Existing Fund will elect pursuant to subsection 132.11(1) to have a December 15 taxation year-end so that its first taxation year will end on December 15, 2002.

4. The Declarations of Trust provide that each Existing Fund may issue units in one or more classes as determined by the trustee of the Fund. Initially, all of the Existing Funds will offer three classes of units: Class A, Class F and Class I.

5. Class A units are available to all retail investors. Investors have two different options with respect to the payment of sales charges for Class A units:

a. They may pay a negotiable up-front commission to their registered dealer at the time of purchase; or

b. They may pay a contingent deferred sales charge to the Manager ("DSC") at the time of redemption if the units are redeemed within XXXXXXXXXX years of the original purchase. The DSC will be a percentage fee that declines each year for XXXXXXXXXX years after purchase. The percentage will generally be applied to the original net asset value per unit of the units when purchased and on any distributions on such units which are reinvested in additional units. However, in each year a unitholder will be entitled to redeem a calculated number of units without being subject to the DSC. XXXXXXXXXX.

Class F units are available to investors who participate in certain fee-based programs through their registered dealer. Participants in such programs are subject to periodic asset-based fees rather than commissions on each purchase and sale of units. Class I units are available to large investors who make large minimum investments and who agree to pay fees directly to the Manager.

6. Each unit of an Existing Fund is redeemable for an amount equal to the net asset value per unit of the relevant class. The net asset value per unit of a class of units of an Existing Fund will generally differ from that of another class because certain expenses of the Existing Fund will be borne by some classes and not by others. In particular, each Existing Fund pays a management fee to the Manager calculated with reference to the net asset value of the Existing Fund's Class A units, which management fee is borne by holders of the Class A units, and a lower management fee calculated with reference to the net asset value of the Existing Fund's Class F units, which management fee will be borne by holders of the Class F units. No management fee is payable in respect of the Class I units by the Existing Fund and, therefore, no management fee is borne by holders of the Class I units. Each unit of an Existing Fund is entitled to one vote at meetings of unitholders of the Existing Fund or of the class of units, as the case may be.

7. The net income and a portion of the net realized capital gains of each Existing Fund for each taxation year will be made payable to its unitholders in the relevant taxation year. If an Existing Fund makes an election under subsection 132.11(1), the relevant amounts will be made payable to its unitholders not later than December 31 of the calendar year that includes the end of the relevant taxation year. Where an Existing Fund has a loss for the year or a non-capital loss for a prior year which it is permitted to deduct in computing its income or taxable income for the year, the Trustee may reduce the amount of net income or net realized capital gains of the Existing Fund otherwise payable to its unitholders. The "net income" of an Existing Fund is determined in accordance with the provisions of the Act regarding the calculation of income other than paragraph 82(1)(b) and subsection 104(6) and excluding capital gains and capital losses and such portion of the Existing Fund's expenses deducted against taxable capital gains. The "net realized capital gains" of an Existing Fund for a taxation year is the amount by which the Existing Fund's capital gains for the year exceed (i) the Existing Fund's capital losses for the year, and (ii) such part of the expenses of the Existing Fund allocated by the Trustee against taxable capital gains multiplied by the reciprocal of the relevant capital gains inclusion rate for the taxation year under the Act. Net realized capital gains otherwise distributable by an Existing Fund will be reduced to the extent that they may be retained by the Existing Fund without giving rise to a tax liability in excess of the capital gains refund available to the Existing Fund under section 132 for the taxation year.

8. Distributions in respect of a class of units are made on a pro-rata basis to unitholders of the class at the applicable distribution date subject to the following two exceptions:

a. Amounts may be distributed to certain unitholders as a management fee distribution. To encourage large investments in Class A units of an Existing Fund, the Manager may reduce the management fee it is entitled to receive from the Existing Fund with respect to an investment in the Existing Fund provided that the amount of such reduction (a "Management Fee Distribution") is distributed to the unitholder for whose benefit the fee was reduced. Amounts payable as Management Fee Distributions will be considered to be a distribution of the Existing Fund's net income for the taxation year in which the amount becomes payable, except to the extent that the Trustee determines the amount to be a distribution of the Existing Fund's net realized capital gains for the year or a distribution of any other amount.

b. Net realized capital gains of an Existing Fund for a taxation year may be made payable to unitholders that redeem units of the Existing Fund in the taxation year and, if the Existing Fund has made an election under subsection 132.11(1), on or before December 15 in a calendar year ("Redemption Distributions"). Where an Existing Fund makes net realized capital gains payable to a unitholder on the redemption of a unit by the unitholder, the amount of net realized capital gains of the Existing Fund so payable will not exceed the amount by which the redemption price otherwise determined (i.e., the net asset value per unit) exceeds the adjusted cost base to the unitholder of the unit redeemed, determined on the assumption that such unit is capital property to the unitholder.

The portion of a distribution to which a class of units is entitled is determined by taking its proportionate share (determined on the basis of the net asset value of the class) of the net income or net realized capital gains, as the case may be, and adjusting such amount for the amount of any expenses that are to be borne by specific classes (e.g., management fees). Unless the Trustee otherwise determines, distributions (other than Redemption Distributions), net of any applicable withholding taxes, are reinvested in additional units of the Existing Fund.

9. In order to establish the New Funds, the Declarations of Trust will be amended in order that each New Fund be governed by the Declarations of Trust. Each New Fund will be a "unit trust" as defined in subsection 108(2), satisfying the redemption requirements in paragraphs 108(2)(a). Units of each New Fund will be offered to the public pursuant to a simplified prospectus and annual information form filed with the securities regulators in each province and territory of Canada. It is expected that each New Fund will qualify as a mutual fund trust as defined in subsection 132(6) before the 91st day after the end of its 2002 taxation year and will elect pursuant to subsection 132(6.1) to be deemed to have qualified as a mutual fund trust from the beginning of such taxation year until such time. It is expected that each New Fund will elect pursuant to subsection 132.11(1) to have a December 15 taxation year-end so that its first taxation year will end on December 15, 2002. Initially, each of the New Funds will offer three classes of units: Class A, Class F and Class I. The description of the operation of an Existing Fund in paragraphs 5 to 8 above will be equally applicable to each New Fund and is therefore not repeated.

PROPOSED TRANSACTIONS

10. Section XXXXXXXXXX of the Declarations of Trust provides that, subject to the receipt of advance income tax rulings satisfactory to counsel to the Funds or an opinion of counsel that the proposed transactions described in this paragraph 10 would not have adverse income tax consequences to unitholders of a Fund, the Trustee may without written notice adopt a plan of consolidation so that immediately after a distribution and reinvestment the units of a Fund are consolidated. The Trustee intends to adopt the following plan such that if a Fund makes a distribution of net income or net realized capital gains (otherwise than as a Management Fee Distribution or as a Redemption Distribution) to holders of a class of units, the following steps will be taken:

a. Each unitholder's share of the distribution, net of any applicable withholding tax payable under Part XIII of the Act if the unitholder is a non-resident, will be reinvested in additional units of the same class of the Fund at the applicable net asset value per unit.

b. Immediately following such distribution and reinvestment, the outstanding units of the class of the Fund will be consolidated on a basis such that the number of issued and outstanding units of that class following such consolidation is equal to the number of units of that class outstanding immediately prior to the distribution and reinvestment (or would be equal to that number of units of that class outstanding prior to the distribution if no tax were required to be withheld from the portion of the distribution payable to non-resident unitholders). For greater certainty, the number of post-consolidation units of a class held by a unitholder (whether the unitholder is a resident or a non-resident) will be determined by multiplying (A) the number of units of the class held by the unitholder after the distribution and reinvestment by (B) the quotient obtained by dividing (x) the net value per unit of the class after the distribution and reinvestment by (y) the net asset value per unit of the class before the distribution. The Declarations of Trust provide that such consolidation does not constitute a redemption or cancellation of the units so consolidated and a unitholder whose units are consolidated shall not receive, and shall not be entitled to receive, any proceeds of disposition in respect thereof.

The accounting records of the Fund will reflect the issuance of the additional units of the class on the reinvestment of the distribution and will also reflect the consolidation. However, individual holders of units will not be provided with a confirmation or any other documentation indicating an issuance of additional units and the subsequent consolidation. They will, however, receive the customary T3 supplementary form showing their share of the distribution made payable to them.

PURPOSE OF PROPOSED TRANSACTIONS

11. As stated, Class A units will be offered to investors on both an up-front commission and DSC basis. If units are purchased on a DSC basis, it is necessary for the Manager to keep track of distributions on such units in order to calculate the DSC (because it also relates to reinvested distributions on units to which the DSC applies) and the unitholder's entitlement to free redemptions. The consolidation of Class A units reinvested on distributions will simplify the recordkeeping process for calculating DSCs and free redemptions since it will not be necessary to keep track of reinvested distributions separately. The consolidation of units of other classes of units reinvested on distribution will also simplify the recordkeeping process.

RULINGS REQUESTED AND GIVEN

12. Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, our Rulings are as follows:

A. The automatic reinvestment of a distribution and consolidation of unitholders' units described in paragraph 10 will not cause the distribution not to be payable to unitholders for purposes of subsection 104(24).

B. The consolidation of units of a class of units of a Fund following such a distribution, as described in subparagraph 10 (b), will not result, in and by itself, in a disposition, or partial disposition, of the units so consolidated.

The Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

Yours truly,

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