2002 Ruling 2002-0163383 - 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 and E 2002-016141

XXXXXXXXXX 2002-016338

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

This 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.

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) "Bank" means the XXXXXXXXXX, a Canadian chartered bank;

(c) "Corresponding Funds" means XXXXXXXXXX and each of the foregoing is referred to herein as a "Corresponding Fund";

(d) "Corresponding Note" has the meaning set out in paragraph 14;

(e) "Corresponding Swap" has the meaning set out in paragraph 15;

(f) "cost amount" has the meaning assigned in subsection 248(1) of the Act;

(g) "foreign property" has the meaning assigned in subsection 206(1) of the Act;

(h) "Fund Trustee" means XXXXXXXXXX, the manager and trustee of the RSP Funds and Corresponding Funds;

(i) "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;

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

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

(l) 1"Registered Plans" means registered retirement savings plans, registered retirement income funds and deferred profit sharing plans;

(m) "RSP Funds" means XXXXXXXXXX, and each of the foregoing is referred to herein as an "RSP Fund";

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

(o) "Trust" has the meaning set out in paragraph 13.

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

Facts

1. The Fund Trustee is a taxable Canadian corporation XXXXXXXXXX. The Bank is also a taxable Canadian corporation. The shares of the Bank do not derive their value, directly nor indirectly, primarily from foreign property.

2. Each of the Corresponding Funds is an inter vivos trust established pursuant to a declaration of trust and will be, at all relevant times, a mutual fund trust. Units of the Corresponding Funds are and will be offered to the public pursuant to the terms of a simplified prospectus and annual information form filed by the Corresponding Funds with the securities regulatory authorities of each province and territory of Canada. Each Corresponding Fund has two classes of units - Class XXXXXXXXXX units and Class F units. Class F units have a lower management fee charge than Class XXXXXXXXXX units. The Fund Trustee is the manager and trustee of each of the Corresponding Funds. None of the Corresponding Funds is a registered investment and units of each of the Corresponding Funds are foreign property.

3. Each of the RSP Funds is an inter vivos trust established pursuant to a declaration of trust and will be, at all relevant times, a mutual fund trust. Units of the RSP Funds are and will be offered to the public pursuant to the terms of a simplified prospectus and annual information form filed by the RSP Funds with the securities regulatory authorities of each province and territory of Canada. Each RSP Fund has two classes of units - Class XXXXXXXXXX units and Class F units. Class F units have a lower management fee charge than Class XXXXXXXXXX units. The Fund Trustee is the manager and trustee of each of the RSP Funds. Each of the RSP Funds is a registered investment for Registered Plans.

4. The investment objective of each RSP Fund is to substantially replicate the financial performance of an investment in units of a Corresponding Fund without units of the RSP Fund being considered foreign property. Each RSP Fund currently invests, at all relevant times, not less than XXXXXXXXXX% of the cost amount of its property in Money Market Securities and short-term cash deposits with Canadian financial institutions. Each of the RSP Funds also currently invests in units of a Corresponding Fund, provided that the cost amount of such investment and any other foreign property held by the RSP Fund does not exceed XXXXXXXXXX% of the cost amount of all the property of the RSP Fund at the end of any month. Each RSP Fund currently achieves its investment objective by entering into one or more forward contracts (a "Forward Contract") with one or more counterparties that are financial institutions. Each Forward Contract provides for a payment from time to time of an amount either by the RSP Fund to the counterparty or vice versa which is linked to the investment returns generated by a notional investment in units of the Corresponding Fund. This arrangement was the subject of an advance income tax ruling issued in respect of XXXXXXXXXX, a fund which was later renamed XXXXXXXXXX and is now known as XXXXXXXXXX (ruling number 000526, dated XXXXXXXXXX, 2000, as supplemented by ruling number 001631, dated XXXXXXXXXX, 2000).

Proposed transactions

5. Each RSP Fund now proposes to achieve its investment objective by entering into the bank deposit arrangements described below in place of entering into one or more Forward Contracts. Each RSP Fund will continue to invest up to XXXXXXXXXX% of the cost amount of its property in Class F units of a Corresponding Fund and not less than XXXXXXXXXX% of the cost amount of its property in a combination of cash, Money Market Securities, and deposits with the Bank pursuant to the arrangements described in detail below. The relevant Corresponding Fund in respect of each RSP Fund is set forth in XXXXXXXXXX.

6. Each RSP Fund will enter into a master deposit agreement (the "Master Deposit Agreement") with the Bank pursuant to which the RSP Fund will from time to time make a deposit (the "Bank Deposit") with the Bank. Each Bank Deposit made by an RSP Fund with the Bank will be evidenced by a deposit confirmation executed between the Bank and the RSP Fund (the "Deposit Confirmation").

7. Each Bank Deposit will commence on the day that the Bank Deposit is accepted by the Bank as specified in the Deposit Confirmation (the "Issue Date") and will mature on a subsequent date (the "Maturity Date") for an amount (the "Maturity Amount") linked to the investment returns generated by a notional investment in a number of Class F units of the Corresponding Fund having an initial value on the day before the Issue Date equal to the original deposit amount of that Bank Deposit. Specifically, the Maturity Amount of a Bank Deposit will generally be determined by multiplying the original amount of the Bank Deposit as specified in the Deposit Confirmation by a fraction. The denominator of the fraction is the net asset value of a Class F unit of the Corresponding Fund on the business day immediately preceding the Issue Date and the numerator of the fraction is the net asset value of a Class F unit of the Corresponding Fund on the business day immediately preceding the Maturity Date. Accordingly, if the value of the notional Class F units of the Corresponding Fund has increased, then the Bank Deposit will mature for an amount greater than the original deposit amount and, if the value of the notional Class F units for the Corresponding Fund has decreased, then the Bank Deposit will mature for an amount less than the original deposit amount. The Maturity Amount will be subject to certain adjustments to take into account distributions by a Corresponding Fund during the term of a Bank Deposit.

8. If the Issue Date of a Bank Deposit is the second last business day of a calendar month, then the Maturity Date of that Bank Deposit will generally be the second last business day of the following calendar month. However, if the Issue Date is other than the second last business day of the month, the Maturity Date will be the second last business day of the month that includes the Issue Date. The RSP Fund may also, at its option, designate an earlier Maturity Date in respect of a Bank Deposit. Only one Bank Deposit between an RSP Fund and the Bank may be outstanding at any time.

9. Under the terms of the Master Deposit Agreement, by accepting a Bank Deposit from an RSP Fund, the Bank is making a representation to the RSP Fund that the Bank has irrevocably agreed to, and will, enter into both the Corresponding Note and the Corresponding Swap contemporaneously with the Bank Deposit as described hereinafter in paragraphs 14 and 15. Pursuant to the Master Deposit Agreement, the obligation of the Bank to accept a Bank Deposit from an RSP Fund is subject to certain conditions precedent in favour of the Bank, including, inter alia, that the Bank is able to execute and maintain a hedge in respect of its exposure under the Bank Deposit by entering into the Corresponding Note and Corresponding Swap and, in general terms, that the Trust has not defaulted in its obligations under any Corresponding Note or Corresponding Swap.

10. Pursuant to the Master Deposit Agreement, the RSP Funds are required to pay a monthly servicing fee in respect of all Bank Deposits made by the RSP Fund with the Bank that have a Maturity Date in that month.

11. 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 of the Bank Deposit. 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 Class F units of the Corresponding Fund.

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

13. A special purpose trust (the "Trust") will be established by a declaration of trust (the "Declaration of Trust") made by a trustee (the "Trustee") solely for the purposes of carrying out the transactions described herein. The Trustee of the Trust will be a taxable Canadian corporation and may be related to the Bank and the Fund Trustee for purposes of the Act. The beneficiaries of the Trust will be designated in writing by the Trustee from time to time and will be one or more charities registered under the Act.

14. Pursuant to a master trust note agreement (the "Master Trust Note Agreement") entered into between the Trust and the Bank, on the Issue Date of a Bank Deposit the Bank will use the proceeds it receives from the Bank Deposit to purchase a debt obligation (the "Corresponding Note") issued by the Trust and evidenced by a confirmation (a "Note Confirmation") issued to the Bank by the Trust. The Corresponding Note will mature on the Maturity Date of the Bank Deposit for its principal amount plus interest at a per annum rate equal to the 30 day Canadian Dollar Bankers Acceptance rate on the Issue Date.

15. Simultaneously with the issue of the Corresponding Note, the Bank and the Trust will enter into a total return swap agreement (the "Corresponding Swap"), the terms and conditions of which will be specified in a master total return swap agreement (the "Master Total Return Swap Agreement") and in a confirmation (the "Swap Confirmation") executed by the Bank and the Trust evidencing such Corresponding Swap. The Corresponding Swap will be based on a notional principal amount equal to the original principal amount of the Corresponding Note (the "Notional Principal Amount") and will terminate on the Maturity Date of the Bank Deposit. Under the terms of the Corresponding Swap:

(a) the Trust will agree to pay the Bank upon termination of the Corresponding Swap an amount linked to the positive investment returns generated by a notional number of Class F units of the Corresponding Fund having an aggregate net asset value on the business day immediately preceding the Issue Date equal to the Notional Principal Amount; and

(b) the Bank will agree to pay the Trust upon termination of the Corresponding Swap an amount linked to the negative investment returns generated by a notional number of Class F units of the Corresponding Fund having an aggregate net asset 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 amount paid upon termination of the Corresponding Swap will be subject to certain adjustments to take into account distributions by a Corresponding Fund during the term of the Corresponding Swap. Any amounts owing from the Bank to the Trust under a Corresponding Swap will be netted against amounts owing by the Trust to the Bank under the Trust Note.

16. In order to hedge its obligation under the Corresponding Swap, the Trust may, but is not required to, acquire Class F units of the Corresponding Fund. XXXXXXXXXX.

XXXXXXXXXX.

17. XXXXXXXXXX.

18. XXXXXXXXXX.

19. XXXXXXXXXX.

20. XXXXXXXXXX.

21. XXXXXXXXXX.

22. The business of the Trust will consist of effecting transactions in respect of a Corresponding Note, a Corresponding Swap, and related hedging activity, on an ongoing and regular basis. XXXXXXXXXX.

23. Pursuant to an administration agreement (the "Administration Agreement") between the Trust and the Bank, the Trust will appoint the Bank as its administrative agent and confer upon it the power to manage and administer, on behalf of the Trustee and on account of the Trust, the activities of the Trust in accordance with the XXXXXXXXXX, Master Trust Note Agreement, Master Total Return Swap Agreement, XXXXXXXXXX all agreements entered into pursuant thereto (including Note Confirmations and Swap Confirmations) and all documents necessary or incidental thereto.

24. New funds (the "New RSP Funds") may be established to enter into the proposed transactions described herein, in the same manner as the RSP Funds. Each of the New RSP Funds will be a mutual fund trust and it is anticipated that any such New RSP Funds will be registered investments effective from the date they are created.

25. At all relevant times, the cost amount of the Money Market Securities, cash and the Bank Deposit or, XXXXXXXXXX, held by an RSP Fund or a New RSP Fund will equal or exceed 70% of the cost amount of all property of that RSP Fund or New RSP Fund.

26. Unitholders of each RSP Fund and of each New RSP Fund will receive a lesser investment return than investors who acquire Class F units of the relevant Corresponding Fund. The public documents relating to the RSP Funds state that the units of the RSP Fund are only suitable for investment by investors that are subject to the foreign property limits under Part XI of the Act. An investment in Class F units of a Corresponding Fund will provide a better return and, generally, better tax treatment than an investment in Class F units of an RSP Fund because most of the distributions made by the RSP Fund will be considered income and taxed at higher rates than capital gains distributions made by the Corresponding Funds.

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. Advantages of the proposed structure over the use of forward contracts include simplified administration from an operational perspective and transparency of the Bank Deposit from the perspective of unitholders of the RSP Fund.

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 an RSP Fund or a New RSP Fund will not constitute foreign property for purposes of Part XI of the Act.

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 or a New RSP Fund, as the case may be, will be equal to its original deposit amount.

C. The servicing fee paid or payable in a taxation year to the Bank by an RSP Fund or a New RSP Fund, as described in paragraph 10 above, will be deductible in such taxation year in computing the income or loss of the RSP Fund or the New RSP Fund, as the case may be, pursuant to subsection 9(1) of the Act.

D. On the maturity of a Bank Deposit, subsection 18.1(7) of the Act will apply in respect of the original deposit amount of the Bank Deposit, assuming that this amount is otherwise deductible in computing the RSP Fund or the New RSP Fund income.

E. Subsection 18.1(7) of the Act will apply with respect to any amounts paid or payable in a taxation year by the Trust to the Bank under the Corresponding Swap, assuming that such amount would otherwise be deductible in computing the Trust income.

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

Yours truly,

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

XXXXXXXXXX