2006 Ruling 2004-0091961R3 - XXXXXXXXXX Indian reserve loan insurance arrangement

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: Arrangement whereby XXXXXXXXXX insures a loan given for on-reserve housing that is partially indemnified by a Trust and whereby the Trust is indemnified by the Band - are amounts paid out by the Trust to honour its indemnity deductible?

Position: Amounts made payable are deductible

Reasons: Trust earns business income from which to deduct payments made

XXXXXXXXXX 								2004-009196

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (No Business Number )
XXXXXXXXXX (No Business Number assigned yet)
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence in connection with your request.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this 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. This document is based solely on the facts and proposed transactions described below.

(vi) The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

In this letter, unless otherwise indicated, all statutory references are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c.1, as amended, (the "Act"), and all terms used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

DEFINITIONS

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

"Accepted Housing Loan" means a loan

(i) made or to be made to an Eligible Borrower;

(ii) made or to be made by a XXXXXXXXXX Lender;

(iii) to finance On-Reserve Housing;

(iv) approved by XXXXXXXXXX for loan insurance;

(v) approved by a Band Council Resolution of the Band Council; and

(vi) accepted in writing by the Trustees as an Accepted Housing Loan before the advance of any funds thereunder;

"XXXXXXXXXX Lender" means a lender, XXXXXXXXXX who has agreed to lend money to an Eligible Borrower pursuant to an Accepted Housing Loan;

"Band" means collectively the Members of the XXXXXXXXXX;

"Band Council" means the chief and the XXXXXXXXXX council of the Band as established or chosen in accordance with the Indian Act, R.S.C. 1985, c. I-5 (the "Indian Act"), and for greater certainty is not intended as a separate legal entity from the Band, but rather to the representative of the Band for administrative purposes;

"CRA" means Canada Revenue Agency;

XXXXXXXXXX;

"Contribution Fee" means the fee set by XXXXXXXXXX and payable by a XXXXXXXXXX Lender in respect of each Accepted Housing Loan, to be remitted to the Trust and to form part of the Trust Fund, which fee is currently to be set at XXXXXXXXXX% of the principal amount of each Accepted Housing Loan;

"Eligible Borrower" means a member of the Band who is resident on the Reserve, or who will be resident on the Reserve at the time monies are advanced under the Accepted Housing Loan, and who intends to borrow from a XXXXXXXXXX Lender for the purpose of:

(i) acquiring On-Reserve Housing; and/or

(ii) constructing or improving On-Reserve Housing;

"Minimum Balance" means the minimum value of Trust assets including Securities, net of all current, accrued and contingent debts and obligations of the Trust, which will be the greater of:

(i) $XXXXXXXXXX; or

(ii) XXXXXXXXXX% of the outstanding balances (principal and accrued interest) of all Accepted Housing Loans, calculated annually by reference to:

A. the most current annual statement of the outstanding balance of each Accepted Housing Loan, as calculated by the XXXXXXXXXX Lender; or

B. if no current or previous annual statement is available in respect of an Accepted Housing Loan, then the original principal balance of that loan;

"On-Reserve Housing" means residential housing or accommodation located on the Reserve to be used as an Eligible Borrower's principal residence and for which an Eligible Borrower may obtain a right of ownership, a dismemberment of property or a right as a lessee in a lease that is capable of being pledged, hypothecated, forfeited, terminated, renounced, surrendered or transferred to, or in favour of, the Band;

"Reserve" means:

(i) XXXXXXXXXX,

(ii) any and all lands that may be added to the reserve lands now under the control and jurisdiction of the Band through the negotiation and resolution of land grievances,

(iii) any and all lands that may be added to the reserve lands now under the control and jurisdiction of the Band as a result of any other means, and

(iv) lands which are returned to the Band as lands within the meaning of subsection 91(24) of the Constitution Act, 1867;

"Securities" means securities or fully guaranteed or insured by Canada or one or more of the provinces, and includes bonds, notes, deposit certificates, non-interest bearing certificates, debentures, mortgages, treasury bills and treasury notes;

"Trust Agreement" means an agreement to be entered into by a person who will settle the Trust, the Band, the Trustees and XXXXXXXXXX, the terms of which are summarized in paragraph 6 of the Proposed Transactions;

"Trust" means the trust patrimony established under the XXXXXXXXXX pursuant to the Trust Agreement, and further described in paragraph 5 of the Proposed Transactions;

"Trust Fund" means the moneys settled, received, assigned or transferred pursuant to terms of the Trust Agreement, including Contribution Fees, investments, re-investments, Securities, loans and amounts receivable from time to time representing the same, any property substituted therefore which continues to be held by the Trust, and the interest, dividends and other income and accumulations thereon and accretions thereto; and

"Trustees" means the individuals from time to time acting as trustees under the Trust Agreement.

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

FACTS

1. The Band is exempt from tax, pursuant to paragraph 149(1)(c) of the Act, on its taxable income under Part I of the Act.

2. XXXXXXXXXX. In order to protect XXXXXXXXXX Lenders against borrower default on residential loans, XXXXXXXXXX provides loan insurance to lenders XXXXXXXXXX. The Band and XXXXXXXXXX deal at arm's length.

3. XXXXXXXXXX.

4. Section 89 of the Indian Act prohibits the granting of security over property located on a reserve in favour of any person other than an Indian or a band. For this reason, and in the absence of a Ministerial guarantee issued by the Minister of Indian and Northern Affairs, lenders have generally not made residential loans to Indians for on-reserve housing because lenders cannot obtain effective mortgage security over such housing. Similarly, XXXXXXXXXX has generally not insured loans made to finance housing on reserves, except where the loans are guaranteed by the Minister of Indian and Northern Affairs.

PROPOSED TRANSACTIONS

5. An individual will settle the Trust with XXXXXXXXXX. The purpose of the Trust is to earn Contribution Fees and investment income on Trust assets and to partially reimburse XXXXXXXXXX for claims made against XXXXXXXXXX by XXXXXXXXXX Lenders as a result of defaults in Accepted Housing Loans. The Band will transfer irrevocably to the Trust $XXXXXXXXXX to be added to the patrimony of the Trust. The Trust will reside in the Province of XXXXXXXXXX.

6. The most relevant provisions of the Trust Agreement and of the schedules attached thereto provide the following.

(a) XXXXXXXXXX of the Trustees will be individuals appointed by the Band and the other XXXXXXXXXX Trustees will be appointed by XXXXXXXXXX. Each of the Band and XXXXXXXXXX may replace a Trustee appointed by it at any time. Decisions of the Trust will require majority approval.

(b) The sole beneficiary of the Trust will be the Band.

(c) The property of the Trust will be held outside of the Reserve.

(d) The Trust Fund will be reduced by (i) distributions of income or capital; (ii) payments to XXXXXXXXXX as described in (e) below; and (iii) administration expenses. The Trust Fund must be invested in investment grade Securities.

(e) The Trust will be liable to reimburse XXXXXXXXXX for 70% of any amount paid by XXXXXXXXXX to a XXXXXXXXXX Lender as a result of a default under an Accepted Housing Loan.

(f) The Band will be required to maintain the Trust Fund at an amount that is not less than the Minimum Balance until such time as the Trust has no further current, accrued or contingent debts, liabilities or obligations under an Accepted Housing Loan or otherwise and is terminated. This obligation is governed by Schedule A to the Trust agreement and is entitled "XXXXXXXXXX".

(g) The Band agrees to indemnify the Trust by paying to the Trust within XXXXXXXXXX days of notice, the amount specified in order to restore the Minimum Balance. A shortfall in the Minimum Balance may be caused by a default under an accepted Housing Loan, and costs and expenses of the Trust.

(h) A XXXXXXXXXX Lender will be required to pay the Contribution Fee to the Trust in respect of each Accepted Housing Loan.

(i) Subject to XXXXXXXXXX approval, the Trustees may distribute on a yearly basis at any time all or any portion of the income or capital, as determined by the Trustees, to the Beneficiary provided that the value of the Trust Fund (excluding amounts receivable from the Band) following the distribution is not less than the Minimum Balance at that time.

(j) Annually, in circumstances where the Trust has undistributed income, but the sum of the Minimum Balance and the amount of undistributed income exceeds the value of the Trust Fund, the Band may make a contribution of capital to the Trust to eliminate the foregoing excess, and the Trustees may exercise their discretion to pay on or before XXXXXXXXXX of the year in which the discretion is exercised, the amount of the Trust's undistributed income to the Band. Any such contribution by the Band will not be funded directly by the Trust. The Band will be under no obligation to make the capital contribution, and the Trustees will be under no obligation, by virtue of receipt of the capital contribution, to distribute an amount equal to the amount of the Band's capital contribution.

(k) After the XXXXXXXXXX anniversary of the creation of the Trust, subject to confirmation by the Trustees and XXXXXXXXXX and the approval of the Trustees of a surplus amount, the Band will be eligible to receive the excess of the Trust Fund over the Minimum Balance.

(l) On termination of the Trust or otherwise, no payment will be made to the Band until all obligations of the Trust due or coming due have been paid or credited.

7. Contribution Fees, investment income and indemnity payments made to the Trust in excess of any capital contribution will be included in the income of the Trust.

PURPOSES OF THE PROPOSED TRANSACTIONS

8. There exists considerable difficulty in meeting the housing needs of members of the Band who reside on the Reserve. The inability of ordinary commercial lenders to obtain effective mortgage security contributes to the shortage of adequate housing on reserves.

9. The proposed transactions are intended to make it feasible for XXXXXXXXXX to insure loans to finance On-Reserve Housing, thereby making it possible for ordinary commercial lenders, such as banks, to grant loans to Eligible Borrowers in the absence of mortgage security in their favour. XXXXXXXXXX intends to provide XXXXXXXXXX Lenders with insurance even though the XXXXXXXXXX Lender will not have mortgage security for the loan, on the strength of the Trust arrangements whereby the Trust will partially reimburse XXXXXXXXXX for claims made against XXXXXXXXXX by XXXXXXXXXX Lenders as described in paragraph 6(e) of the proposed transactions.

10. The proposed transactions offer significant benefits to the Band. Firstly, members of the Band who can afford home ownership, and who live or wish to live, on the Reserve will be able to access XXXXXXXXXX insured financing in a manner similar to Canadians who do not live on the Reserve. This accessibility should assist in developing a more robust housing market on the Reserve. Secondly, the proposed transactions should increase the availability of private mortgage capital, and promote a more competitive mortgage market on the Reserve, which should assist in ensuring both that interest rates are competitive, and that Eligible Borrowers are offered a variety of other loan features and characteristics.

RULINGS GIVEN

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

A. Income of the Trust for a particular taxation year will be considered payable to the Band provided that on or before XXXXXXXXXX of that particular taxation year:

(a) the Trustees have exercised their discretion to make the amount payable to the Band;

(b) XXXXXXXXXX has approved the distribution to the Band; and

(c) the Trust Fund is not reduced below the Minimum Balance.

B. The Band will not be a designated beneficiary of the Trust within the meaning assigned by section 210 of the Act solely as a consequence of the proposed transactions. As a consequence, the Trust will not be subject to tax under Part XII.2 of the Act provided that the Trust complies with subsection 210.3(1) of the Act.

C. Amounts paid or payable in a taxation year by the Trust to reimburse XXXXXXXXXX for 70% of any amount paid by XXXXXXXXXX to a XXXXXXXXXX Lender as a result of a default under an Accepted Housing Loan (as described in paragraph 6(e) above) will be deductible in computing the income of the Trust for that taxation year pursuant to section 9 of the Act. Such deductions will not be precluded or limited by any of paragraphs 18(1)(a), 18(1)(b), 18(1)(e) or 18(1)(h) of the Act.

Nothing in this advance income tax ruling should be construed as implying that we are ruling on any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

The rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the CRA provided that the proposed transactions are completed within 6 months of the date of issuance of the present letter.

Yours truly,

XXXXXXXXXX
Section Manager
For Division Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch