17 September 2004 External T.I. 2003-0048881E5 - Mutual Fund Trust - 132(7)

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.

Principal Issues: How does the CRA interpret the rule in 132(7).

Position: A trust loses its MFT status once it is established or maintained (this concept involves a certain time span) primarily for the benefit of non-residents, unless the exceptions in 132(7)(a) or (b) applies.

Reasons: Interpretation of the provision.

XXXXXXXXXX 							2003-004888
								Yves Moreno
September 17, 2004

Dear XXXXXXXXXX:

Re: Mutual Fund Trusts - Foreign Ownership

This is in reply to your letter dated November 10, 2003, wherein you ask for clarification of the position of the Canada Revenue Agency (the "CRA") with respect to the non-resident ownership restriction in subsection 132(7) of the Income Tax Act (the "Act"). That provision results in a trust losing its mutual fund trust ("MFT") status where it is established or maintained primarily for the benefit of non-residents, unless one of the two exceptions described in its paragraphs is applicable.

The conclusion of your letter is that the policy intention underlying subsection 132(7) of the Act would be best served if the provision were only applied where the purpose of the trust is primarily to benefit non-residents, which you suggest cannot be the case where the trust takes express steps to ensure that it is not considered to be established or maintained for such purpose. In your letter, you first submit that whether a trust is established or maintained primarily for the benefit of a person or group of persons ought to be determined by taking into account the events which occur over a certain period of time and not in light of a specific event or of facts and circumstances existing on a single day (e.g., the purchase of a large block of units by a non-resident). You then submit that even where a trust would be established or maintained for the benefit of non-residents at some time, the trust should have a reasonable period of time to take steps to correct that situation without any interruption in its MFT status.

The supplementary information released by the Department of Finance related to the 1990 budget, indicates that subsection 132(7) of the Act was enacted to ensure that mutual fund trusts are not used as intermediaries through which non-residents might otherwise be able to invest in Canadian real estate or other taxable Canadian property without being subject to Canadian tax directly or indirectly. Whether a trust is maintained for such result ought to be determined objectively in light of the relevant facts. The initial objects or purposes of the trust would be considered, but they would not shelter a MFT from the potential application of subsection 132(7) of the Act. Subsection 132(7) of the Act lists two of the elements to be considered: the terms and conditions of the units and the magnitude and nature of the interests that non-residents have in the trust. Technical interpretation 2002-0153635 discusses other relevant elements:

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.

Whether the trust is maintained at any time primarily for the benefit of non-residents has to be determined in light of the relevant facts. Dictionaries define the word "maintain" as follows:

The Canadian Oxford Dictionary: "1. cause to continue; keep up, preserve (a state of affairs, an activity, etc.) (maintained friendly relationships). [...] 4. preserve or provide for the preservation of (a building, machine, road, etc.) in good repair."

Black's Law Dictionary, 7th ed.: "1. To continue (something). 2. To continue in possession of (property, etc.). [...] 4. To care for (property) for purposes of operation productivity or appearance; to engage in general repair and upkeep."

Unless the trust is established primarily for the benefit non-residents, the trust has to be "maintained" primarily for the benefit of non-residents for subsection 132(7) of the Act to apply. Arguably, the fact that the benefits derived from the existence of the trust are primarily enjoyed by non-residents at a specific moment only results in the loss of its MFT status where those circumstances are maintained.

The words "at any time" in the preamble of subsection 132(7) of the Act indicate that the test in subsection 132(7) of the Act must be applied at the inception of the trust and at every moment thereafter. It is an ongoing test, which requires appropriate monitoring of the unitholder's residency by the trustees, such that corrective measures are available to prevent the trust from continuing to exist primarily for the benefit of non-residents. It is impossible to indicate at what moment the trust is maintained for the benefit of non-residents but, certainly, if the trust does not take appropriate action, it is likely that the trust would be maintained primarily for the benefit of non-residents at that moment. Among the few income tax rulings that have been requested in respect of subsection 132(7) of the Act, the rulings that have been granted were issued on the basis of representations that the trust was not established or maintained primarily for the benefit of non-residents and that the indenture required the trustees to take remedial action to correct the situation if that statement became inaccurate at any time. The rulings that have been provided always indicated that they were "subject to the application of paragraph 132(7) of the Act". This implies that efficient mechanisms are in place to effectively monitor and correct the situation.

Once the trust is established or maintained primarily for the benefit of non-residents, there is no way back. Even if proactive measures are taken to rebalance the unit holdings, a trust which lost its MFT status cannot reacquire such status. Subsection 132(6.2) of the Act specifically provides a rule whereby a trust which fails some of the conditions to be a MFT is deemed to be a MFT throughout a calendar year. However, that rule does not apply where the trust lost its MFT status as a result of subsection 132(7) of the Act.

However, a trust which is established or maintained primarily for the benefit of non-residents retains its MFT status if the conditions described in paragraphs 132(7)(a) or (b) of the Act are met. Assuming that paragraph 132(7)(a) of the Act is not applicable, subsection 132(7)(b) of the Act provides that the trust still qualifies as a MFT where it has not issued any unit to a person who it had reason to believe, after reasonable inquiry was conducted, does not reside in Canada. If the trust had any reason to believe that the person was not residing in Canada, the exception is not applicable. The Canadian Oxford Dictionary defines the word inquiry as follows:

"1. the act or an instance of asking or seeking information. 2. a question, a query."

Where no such inquiry is made and the trust is established or maintained primarily for the benefit of non-residents, subsection 132(7) of the Act will result in the trust being disqualified as a mutual fund trust.

The same result would stem from that provision where the trust makes an inquiry before issuing units to non-residents but the inquiry is not reasonable.

Whether an inquiry is reasonable has to be determined in light of the facts. The Act does not define what is a reasonable inquiry.

The trust is required to be proactive for the exception in paragraph 132(7)(b) to apply. If the trustees are not monitoring the level of non-resident ownership, then it is possible that mutual fund trust status could be lost. The lack of knowledge by the trustees has no bearing on the applicability of subsection 132(7) of the Act. Concluding otherwise would deprive the exception in paragraph 132(7)(b) of the Act of any meaning.

The onus is on the trust. Industry standards would be considered in determining what is reasonable, but the analysis would not be limited to those standards. Whether it would be reasonable for the trust to make an inquiry beyond the industry standards in specific circumstances would also have to be ascertained. As all the trusts are subject to the same constraint to make a reasonable inquiry and they form the industry, it is expected that the sum of their individual reasonable inquiries push the industry standards to a level that is acceptable.

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

We trust our comments will be of assistance.

Theresa Murphy
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch