2002 Ruling 2002-0161413 - Derivatives - Foreign property rules

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: Tax planning involving the use of bank deposits, swaps and hedging transactions in order to allow RSP funds to earn an investment return based on foreign properties while not holding such properties.

Position: The use of derivatives in respect of the returns on the Canadian bank deposit does not result in such bank deposit being considered foreign property for the purposes of the Act.

Reasons: Similar to ruling # E 2001-0079143.

XXXXXXXXXX 2002-016141

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling in respect of the income tax consequences arising from the proposed transactions described below. We also acknowledge your correspondence of XXXXXXXXXX.

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 advance income tax ruling are:

(i) contained in earlier returns of the taxpayers or a related person;

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

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

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

(v) the subject of a ruling previously issued by the Directorate to the taxpayers or a related person.

Definitions

In this letter, the following terms have the meaning specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended as at the date hereof, and any reference to any Part, section, subsection, paragraph or subparagraph is a reference to the specified Part or provision of the Act;

(b) "capital property" has the meaning assigned by section 54 of the Act;

(c) "cost amount" had the meaning assigned by subsection 248(1) of the Act;

(d) "foreign property" has the meaning assigned by subsection 206(1) of the Act

(e) "mutual fund trust" has the meaning assigned by subsection 132(6) of the Act;

(f) "registered investment" has the meaning assigned by subsection 204.4(1) of the Act;

(g) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act; and

(h) "unit trust" has the meaning assigned by subsection 108(2) of the Act.

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

Facts

1. XXXXXXXXXX (each a "Corresponding Fund" and collectively the "Corresponding Funds") are governed by Declarations of Trust dated XXXXXXXXXX (the "Trustee") is the trustee and manager of each Corresponding Fund. Each Corresponding Fund is a unit trust. Units of each Corresponding 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. XXXXXXXXXX each qualify as a mutual fund trust and it is expected that XXXXXXXXXX will so qualify before the XXXXXXXXXX.

XXXXXXXXXX will, and it is expected that XXXXXXXXXX will, elect pursuant to subsection 132(6.1) of the Act to be deemed to have qualified as a mutual fund trust from the beginning of its XXXXXXXXXX taxation year until the time it qualified as a mutual fund trust.

2. The Corresponding Funds are not registered investments and units of each of the Corresponding Funds are foreign property.

3. The Declarations of Trust provide that each Corresponding Fund may issue units in one or more classes as determined by the Trustee. All of the Corresponding Funds currently offer XXXXXXXXXX classes of units: XXXXXXXXXX Class I. Class I units are available to large investors who make large minimum investments and who agree to pay fees directly to the Trustee. No management fee is payable in respect of the Class I units by the Corresponding Fund and, therefore, no management fee is borne by holders of the Class I units.

4. The Trustee is a taxable Canadian corporation.

Proposed transactions

5. In order to establish the XXXXXXXXXX (each an "RSP Fund" and collectively the "RSP Funds"), the Declarations of Trust will be amended and restated in order that each RSP Fund be governed by the Declarations of Trust. The Trustee will be the trustee and manager of each RSP Fund. Each RSP Fund will be a unit trust. Units of each RSP 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 RSP Fund will qualify as a mutual fund trust before the XXXXXXXXXX and will elect pursuant to subsection 132(6.1) of the Act to be deemed to have qualified as a mutual fund trust from the beginning of such taxation year until such time. Initially, each of the RSP Funds will offer XXXXXXXXXX classes of units: XXXXXXXXXX.

6. Each RSP Fund will apply to become a registered investment under paragraph 204.4(2)(c) of the Act for registered retirement savings plans, registered retirement income funds and deferred profit sharing plans (collectively, "Registered Plans").

7. The investment objective of each RSP Fund will be to achieve performance that closely tracks the performance of its Corresponding Fund while not constituting foreign property to Registered Plans. XXXXXXXXXX.

8. Each RSP Fund intends to achieve its investment objective in part by investing up to XXXXXXXXXX% by cost amount of its property in units of its Corresponding Fund.

9. A special purpose trust (the "SPT") will be established by a declaration of trust made by the XXXXXXXXXX (the "SPT Trustee"), solely for the purposes of carrying out the transactions described herein. The initial trust property will consist of $XXXXXXXXXX. The activities of the SPT will all be performed in Canada. The beneficiaries of the SPT will be designated in writing by the SPT Trustee on an annual basis and will be one or more charities (other than corporations) registered under the Act.

10. Each RSP Fund will enter into a bank deposit arrangement with a Canadian chartered bank (the "Bank") pursuant to a Master Deposit Agreement with the Bank. The Bank is a taxable Canadian corporation and its shares do not derive their value, directly or indirectly, primarily from foreign property. The deposit made by an RSP Fund will be evidenced by a Deposit Confirmation executed between the Bank and the RSP Fund (the "Bank Deposit").

11. A Bank Deposit issued to an RSP Fund on a day (the "Issue Date") will mature on a subsequent day (the "Maturity Date") for an amount (the "Maturity Amount") linked to the return generated by a notional investment in a number of Class I units in the Corresponding Fund having an initial value on the business day before the Issue Date equal to the original deposit amount of that Bank Deposit. If the Issue Date is the second last business day of a month, the Maturity Date will generally be the second last business day of the following month; otherwise, it will generally be the second last business day of the month that includes the Issue Date. The RSP Fund may elect to advance the Maturity Date of a Bank Deposit. Only one Bank Deposit between an RSP Fund and the Bank will be outstanding at any time. Generally, if the value of the notional units of the Corresponding Fund has increased from the business day before the Issue Date to the business day before the Maturity Date, the Maturity Amount of the Bank Deposit will be greater than the original deposit amount and, if the value of the notional units of the Corresponding Fund has decreased, then the Maturity Amount of Bank Deposit will be less than the original deposit amount. The RSP Fund will pay a fee to the Bank pursuant to the terms of the Master Deposit Agreement in respect of each Bank Deposit. By executing a Deposit Confirmation, the Bank represents to the RSP Fund pursuant to the Master Deposit Agreement that the Bank has irrevocably committed to enter into the note transaction and swap transaction with the SPT in respect of that Bank Deposit referred to in paragraphs 13 and 14 below.

12. A Bank Deposit will not provide the RSP Fund with any right to acquire or vote units of the Corresponding Fund or to have any ownership interest in the Corresponding Fund or in any of the securities held by the Corresponding Fund. Subject to paragraph 19 below, each RSP Fund is entitled only to a cash payment of the Maturity Amount. The timing, amount and character of payments under a Bank Deposit will differ from the timing, amount and character of payments that would be made to an investor who made an equivalent investment in the Corresponding Fund.

13. On the Issue Date of a Bank Deposit, the Bank will advance the proceeds it receives from the issue of the Bank Deposit to the SPT pursuant to a Master Trust Note Agreement between the SPT and the Bank, which advance will be evidenced by a note issued to the Bank (the "Corresponding Note"). The Corresponding Note will mature on the Maturity Date of the Bank Deposit for its principal amount plus interest at a rate equal to the 30-day Canadian Dollar Bankers Acceptance rate on the Issue Date.

14. Simultaneously with the issue of the Trust Note, pursuant to a Master Total Return Swap Agreement, the Bank and the SPT will enter into a total return swap agreement (the "Corresponding Swap") based on a notional principal amount equal to the original principal amount of the Corresponding Note (the "Notional Principal Amount"). The SPT will agree to pay the Bank an amount linked to the positive investment returns generated by a notional number of Class I units of the Corresponding Fund having an initial value on the business day before the Issue Date equal to the Notional Principal Amount. The Bank will agree to pay the SPT an amount linked to the negative investment returns generated by a notional number of Class I units of the Corresponding Fund having an initial value on the business day before the Issue Date equal to the Notional Principal Amount plus an amount equal to the interest received in respect of the Corresponding Note. The Corresponding Swap will terminate on the Maturity Date of the related Bank Deposit.

15. Both the Trust Note and the Corresponding Swap will be entered into contemporaneously with the related Bank Deposit. In order to hedge its obligation under the Corresponding Swap, the SPT may, but is not required to, acquire Class I units of the Corresponding Fund. XXXXXXXXXX.

16. XXXXXXXXXX.

17. XXXXXXXXXX.

18. XXXXXXXXXX.

19. XXXXXXXXXX.

20. XXXXXXXXXX.

21. XXXXXXXXXX.

22. The SPT and the Bank will enter into an Administration Agreement under which the SPT appoints the Bank as its agent under the XXXXXXXXXX, the Master Trust Note Agreements, the Master Total Return Swap Agreements, XXXXXXXXXX and all agreements entered into pursuant thereto (including confirmations) and to carry out the activities of the SPT.

23. Unitholders of the RSP Funds will receive a lesser investment return than investors in the Corresponding Fund. The simplified prospectus and annual information form relating to the RSP Funds will state that if an investor is investing through a non-registered account or through a registered education savings plan, or if its foreign property holdings is less than the limit allowed under the Act, a direct investment should be made in the Corresponding Fund. A direct investment in the Corresponding Fund will provide a better return and generally, better tax treatment, because most of the distributions made by the RSP Fund will be considered income and taxed at higher rates than the capital gains distributions paid by the Corresponding Fund.

24. The SPT will treat its activities in relation to the Corresponding Note, Corresponding Swap and hedging as an ongoing business and will treat payments made and received under a Corresponding Swap as being on income account and will treat gains and losses on the disposition of Hedge Units as ordinary income or losses rather than as capital gains or capital losses.

25. The RSP Funds will treat XXXXXXXXXX payments made and received under a Bank Deposit as being on income account.

26. At all relevant times, the cost amount of the money market securities and the Bank Deposit XXXXXXXXXX, held by an RSP Fund will exceed XXXXXXXXXX% of the cost amount of all the property of the RSP Fund.

27. XXXXXXXXXX.

Purpose of the proposed transactions

28. The purpose of the proposed transactions is to provide an alternative to arrangements under which Forward Contracts are used to provide investors in an RSP Fund with a return that tracks the return of the Corresponding Fund. XXXXXXXXXX.

Rulings given

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

A. The Bank Deposits acquired by the RSP Funds will not constitute foreign property for purposes of Part XI of the ITA.

B. For the purposes of subsections 248(1) and 206(2) of the Act, the cost amount of a Bank Deposit to an RSP Fund will be equal to its original deposit amount.

C. The fee paid to the Bank by the RSP Funds, as described in paragraph 11 above, will be deductible by the RSP Fund in computing profit under subsection 9(1) of the Act.

D. Any loss arising on the redemption of XXXXXXXXXX pursuant to the XXXXXXXXXX by the SPT will be determined by reference to the cost of XXXXXXXXXX redeemed and the redemption price XXXXXXXXXX.

E. To the extent that the Maturity Value of a Bank Deposit is less than the original deposit amount, and the difference would otherwise be deductible in computing the RSP Fund income, subsection 18.1(7) of the Act will apply on the maturity of a Bank Deposit.

F. Section 18.1 of the Act will not apply in respect of an amount payable by the SPT to the Bank on the termination of a Corresponding Swap, XXXXXXXXXX.

G. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed within six months of the date of the present letter. These rulings are based on the Act in its present form 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.

Comments

Nothing in this advance income tax ruling should be construed as implying that we are ruling on:

a) the fair market value or adjusted cost base of any property referred to herein, or the paid-up capital of any shares referred to herein; or

b) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

You have advised that section 6.01(4) of the Amended and Restated Declarations of Trust may be amended. If so, an amendment to the Ruling will be requested.

Yours truly,

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