30 August 2004 External T.I. 2004-0060851E5 - Debts guaranteed by a mutual fund trust

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: Would the condition in 132(6)(b) be met where a MFT provides a guarantee to a wholly owned sub-trust or to a limited partnership, i.e. would the only undertaking of the MFT still be considered to be the investing of its funds.

Position: The only undertaking of the MFT could still be seen as being the investing of its funds where the circumstances indicate that the guarantee is part of that undertaking.

Reasons: The Supreme Court of Canada has opined that an undertaking can be made of an array of activities. Even though there is no case law dealing with the requirement that the only undertaking be the investing of funds, the courts have considered in several cases dealing with other issues that a guarantee can be part and parcel of an investment. The notes to the file contain the relevant excerpts from the different cases. However, the level of integration between the guarantees and the investing activities ought to be very high to make sure that the undertaking blends with the investing of funds because a guarantee is an undertaking by itself.

XXXXXXXXXX 							2004-006085
								Yves Moreno
August 30, 2004

Dear Sir:

Re: Debt guaranteed by a mutual fund trust

This is in reply to your letter dated February 5, 2004, wherein you ask whether the provision of a guarantee by a trust (the "Trust") which qualifies as a mutual fund trust according to subsection 132(6) of the Income Tax Act (the "Act") would cause the Trust to lose that status on the basis that the investing of its funds would not be its only undertaking.

Your letter states the following hypothetical facts:

1. The Trust's only assets consist of all the issued units and some notes of a trust which resides in Canada (the "SubTrust").

2. The SubTrust is a majority limited partner of a limited partnership (the "Partnership") and has guaranteed the obligations of the Partnership.

3. The SubTrust is indebted to an arm's length lender (the "Lender").

4. For no consideration, the Trust guarantees the guarantee described in point 2 and the debt described in point 3.

5. The Trust is not carrying on a business in respect of the SubTrust units and notes or of the operations of the Partnership, nor is it engaged in the business of lending money or guaranteeing loans.

The Black's Law Dictionary provides the following definition to the word undertaking:

1. To take an obligation or task . 2. To give a formal promise; guarantee
. 3. To act as surety for (another); to make oneself responsible for (a person, fact or the like) .

The Canadian Oxford Dictionary defines it as follows:

1. Take on (an obligation, responsibility, task, etc.); commit oneself to perform. 2. Accept an obligation, promise.

The mere agreement to provide a guarantee can be seen as an undertaking which would not qualify for the purposes of subparagraph 132(6)(b)(i) of the Act.

This would clearly be the case where the guarantee stands on its own as a service being provided to third parties. As indicated in technical interpretation 9206635:

The issue of whether a loan guarantee constitutes "other services" has been settled in the tax case "Melford Developments Inc. v. Her Majesty The Queen (80 DTC 6075 FCTD)". In setting out the facts of this case at pages 6076/77, the court said:

"The guarantee given...was part of its ordinary business and the fees paid to it for such service were receipts earned by it in its normal banking operations."

The decision of the FCTD was affirmed by the FCA (81 DTC 5020) and by the Supreme Court of Canada (82 DTC 6281) without, however, commenting on the aspect of the guarantee as a service. Accordingly, we consider the FCTD decision in Melford to be good law, and are of the view that the providing of a loan guarantee constitutes a service.

[...]

Furthermore, in signing the guarantee, the subsidiary has put itself at risk. In this regard, no person dealing at arm's length with another person would act as guarantor to a loan of that other person unless he received valuable consideration for the risk involved. Consequently, in our view, a benefit may be conferred on the parent notwithstanding that the subsidiary has not given up its beneficial ownership of any of its property.

However, the following cases stand for the proposition that in determining whether some activities of an entity are part of its core undertaking, the practical and functional relationship of each activity to such core undertaking must be assessed: Beauport v. Quebec R.L. and P. Company, (1945) SCR 16, Falconbridge Nickel Mines Ltd. v. M.N.R., 65 DTC 5304, Lount Corp. v. Canada, 19 D.L.R. (4th) 304, Northers Telecom Ltd. v. Communications Workers of Canada, [1980] 1 S.C.R. 115, Union des employés de service, local 298 v. Bibeault (1998), [1988] 2 S.C.R. 1048, Ontario Hydro v. Ontario (Labour Relations Board), [1993] 3 S.C.R. 327.

The degree of integration between the guarantee and the investing of funds is subject to a high standard because subparagraph 132(6)(b)(i) of the Act provides that the "only" undertaking of the trust must be the investing of its funds in property other than real property or an interest in real property. Just like a cotton strand loses its identity and becomes part of a cable when twisted round other strands, a guarantee becomes part of such undertaking where all the operations of the trust, including the provision of the guarantee, mesh together for that result.

Absent exceptional circumstances, such degree of integration would be expected to exist where for no consideration a mutual fund trust guarantees a debt incurred by a wholly-owned subsidiary to finance its commercial operation, as indicated in technical interpretation 2002-016767. In technical interpretation 2004-006822, we were satisfied that the guarantee described therein would not disqualify the mutual fund trust under subparagraph 132(6)(b)(i) of the Act even though it was provided to a corporation which was not wholly-owned by the trust because the facts indicated that the guarantee formed part of the core investment undertaking of the trust.

However, a guarantee provided by a mutual fund trust in respect of the debt of an entity not wholly-owned by the trust or of the debt of an entity in which a wholly-owned subsidiary has an interest, would have to be closely scrutinized in light of all the relevant circumstances. Close attention would be given to any benefit received by, or to any form of compensation (including reciprocal guarantees) paid or payable to, the trust or its unitholders in respect of the guarantee.

Where the guarantee is structured in such way that third parties benefit from such service, the mutual fund status might be lost where the resulting service or benefit conferred to third parties constitutes an undertaking which does not mesh completely with the investing of its funds.

Accordingly, we are not in a position to comment on the guarantees contained in point 4 above.

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