2005 Ruling 2005-0126651R3 - Trust Variation - Redemption Rights

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: Whether the variation of trust to provide for redemption rights and for the creation of a special class of units which would not provide its holder with any rights as to the income and capital of the trust but would allow it to vote at meetings of the unit holders would result: (i) in a disposition by the existing unit holders of their units; (ii) in a disposition by the trust of its assets or in a resettlement of the trust; and (iii) in the trust qualifying as a "unit trust" under paragraph 108(2)(a) and a "mutual fund trust" under subsection 132(6) of the Act immediately after the variation.

Position: (i) No; (ii) No; and (iii) Yes.

Reasons: (i) and (ii) The characteristics of the redemption right meet the test of paragraph 108(2)(a) and favourable rulings were issued in similar circumstances; and (iii) Favourable rulings were issued in similar circumstances.

XXXXXXXXXX 							2005-012665

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, in which you request an Advance Income Tax Ruling on behalf of the above named taxpayer. 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 taxpayer involved, none of the issues involved in this Ruling request:

(i) is in an earlier return of the taxpayer 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 taxpayer or a related person;

(iii) is under objection by the taxpayer 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.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c. 1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

This document is based solely on the facts and proposed transactions described below. 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.

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

Definitions

The following definitions apply in respect of this Ruling request:

"Declaration of Trust" means the declaration of trust of the Trust dated XXXXXXXXXX;

"Distributable Income" means, for any period, the income of the Trust and its consolidated subsidiaries determined in accordance with Canadian generally accepted accounting principles, adjusted for: adding back decreases in rental from income properties from step leases on a straight line basis over the remaining life of the lease, amortization of buildings, amortization of tenant improvements, amortization of in place lease values, amortization of the differential between original and above market rents, amortization of customer relationship values, amortization of debenture liability accretion expense, losses on disposition of assets, and amortization of any net discount on long term debt assumed from vendors of properties at rates of interest less than fair value; deducting increase in rentals from income properties from step leases on a straight line basis over the remaining life of the lease, amortization of the differential between original and below market rents, gains on dispositions of assets and amortization of any net premium on long-term debt assumed from vendors of properties at rates of interest greater than fair value and to reflect any other adjustments determined by the Trustees in their discretion. Distributable Income may be estimated whenever the actual amount has not been fully determined, which estimates shall be adjusted as of the first Distribution Date by which the amount of such Distributable Income has been fully determined;

"Distribution Date" means, with respect to a distribution by the Trust:

(a) a business day determined by the Trustees for any calendar month other than December, on or about the 15th day of the following month; and

(b) for the month of December, December 31;

"Net Realized Capital Gains of the Trust" for any year means the amount, if any, by which the amount of the capital gains of the Trust for the year exceeds the aggregate of (i) the amount of any capital losses of the Trust for the year and (ii) the amount of any net capital losses of the Trust carried forward from a previous year to the extent not previously deducted from realized capital gains of the Trust;

"Net Recapture Income of the Trust" for any year means the amount, if any, by which the amount required to be included in the income of the Trust for income tax purposes for such year in respect of recapture of capital cost allowance exceeds the amount permitted to be deducted under subsection 20(16) of the Act for such year;

"Real Property" means property which in law is real property and includes, whether or not the same would in law be real property, leaseholds, mortgages, undivided joint interests in real property (whether by way of tenancy-in-common, joint tenancy, co-ownership, joint venture or otherwise), any interests in any of the foregoing and securities of corporations, trusts, limited partnerships or other legal entities whose sole or principal purpose and activity is to invest in, hold and deal in real property;

"Special Voting Unit" has the meaning assigned in paragraph 16 hereof;

"Subsidiary Trust" has the meaning assigned in paragraph 10 hereof;

"Subsidiary Trust Note" means a promissory note issued by the Subsidiary Trust;

"Subsidiary Trust Unit" means a participating, voting unit of the Subsidiary Trust;

"Trust" means the XXXXXXXXXX;

"Trustee" means, at any time, an individual who is, in accordance with the provisions hereof, a trustee of the Trust at that time, including, without limitation, so long as they remain as trustees, each of the initial trustees; and "Trustees" means, at any time, all of the individuals each of whom is at that time a Trustee;

"Unit" means a participating unit of the Trust issued from time to time in accordance with the provisions of the Declaration of Trust and includes a fraction of a participating unit of the Trust;

"Unitholder" means a person whose name appears on the register as a holder of Units and includes, for the purposes of sections XXXXXXXXXX of the Declaration of Trust only, any person who is a beneficial owner of a Unit; and any reference to "property", "property of the Trust", "assets" or "assets of the Trust" includes, in each case, property and assets of the Trust.

Facts

1. The Trust is a closed-end "unit trust" as defined in paragraph 108(2)(b) and a "mutual fund trust" as defined in subsection 132(6) of the Act. The Trust was established under the laws of the Province of XXXXXXXXXX by the Declaration of Trust. The principal office of the Trust is located at XXXXXXXXXX.

2. The Trust is a limited purpose trust and was established to invest in income producing rental properties in Canada. The Trust invests primarily in XXXXXXXXXX. The Trust restricts its activities to the investing of its funds in property (other than Real Property or interests therein) and/or the acquiring, holding, maintaining, improving, leasing and/or managing of Real Property (or interests in Real Property), all within the restrictions set out in paragraph 108(2)(b) and subsection 132(6) of the Act.

3. The Trust was not established and is not maintained primarily for the benefit of non-residents of Canada. Less than XXXXXXXXXX% of the Units are owned by non-residents of Canada.

4. The Trust is a "registered investment" pursuant to paragraph 204.4(2)(c) of the Act and as such, the Units are "qualified investments" for trusts governed by registered retirement savings plans, registered retirement income funds, deferred profit sharing plans and registered education savings plans ("Registered Plans"). The Unitholders include taxable investors, Registered Plans and other tax-exempt entities such as registered pension plans. In addition, because the Trust is a "registered investment", the Units do not constitute "foreign property" for the purposes of Part XI of the Act. The Trust, as a "registered investment", is not subject to tax under Part XI of the Act because greater than 70% of the Trust's properties, measured by cost, are not "foreign property".

5. The Declaration of Trust does not provide for any conversion, redemption or pre-emptive rights with respect to the Units.

6. The Declaration of Trust requires that a majority of the Trustees be residents of Canada for the purposes of the Act. In fact, all of the current Trustees are Canadian residents. Accordingly, the Trust is a Canadian resident for purposes of the Act.

7. Unitholders are entitled to receive monthly cash distributions of a pro rata share of such portion of the Distributable Income of the Trust for the preceding calendar month then ended as the Trustees determine to distribute to the Unitholders, provided that the Trustees pay or declare each taxation year an amount equal to the greater of i) XXXXXXXXXX% of its Distributable Income for the year; or ii) the net income and Net Realized Capital Gains of the Trust in such amount as is necessary to ensure that the Trust will not be subject to tax on its net income and net capital gains under Part I of the Act. If the Trustees anticipate a cash shortfall and determine that it would be in the best interests of the Trust, they may reduce for any period the percentage of Distributable Income to be distributed to Unitholders, provided that they may not reduce the percentage of Distributable Income distributed below XXXXXXXXXX% for any taxation year. The Trust shall also distribute to Unitholders, and the Unitholders will have a right to receive, on December 31 of each year (i) the Net Realized Capital Gains of the Trust and the Net Recapture Income of the Trust for the year then ended and (ii) any excess of the income of the Trust for purposes of the Act for the year then ended over distributions otherwise made for that year. Distributions of Distributable Income may be adjusted for amounts paid in prior periods if the actual Distributable Income for the prior periods is greater than or less than the Trustees' estimates for the prior periods. Distributions shall be made in cash or Units pursuant to any distribution reinvestment plan or distribution reinvestment and Unit purchase plan adopted by the Trustees. Any distribution shall be made proportionately to persons who are Unitholders as at the close of business on the record date for such distribution which shall be the last business day of the calendar month preceding the month in which the Distribution Date falls, or if such date is not a business day then the next following business day, or such other date, if any, as is fixed in accordance with the Declaration of Trust. The Trustees, if they so determine when income has been accrued but not collected may, on a temporary basis, transfer sufficient moneys from the capital to the income account of the Trust to permit distributions to be effected.

8. The current Trustees have determined that certain amendments to the Declaration of Trust would allow for greater flexibility in undertaking acquisitions of property. Article XXXXXXXXXX of the Declaration of Trust provides the mechanism for the amendment of the Declaration of Trust.

Proposed Transactions

9. The proposed transactions described in paragraphs 10 to 20 hereof will occur on the same date and in sequence.

10. The Trust will settle a trust ("Subsidiary Trust"), in which the interest of each beneficiary will be described by reference to units of the Subsidiary Trust. All of the trustees of Subsidiary Trust will be residents of Canada for purposes of the Act. Accordingly, Subsidiary Trust will be a resident of Canada for tax purposes. Subsidiary Trust will be an open-ended limited purpose "unit trust" formed under the laws of the Province of XXXXXXXXXX and created pursuant to the Subsidiary Trust declaration of trust. The principal and head office of the Subsidiary Trust will be located at XXXXXXXXXX. Initially, the Trust will capitalize Subsidiary Trust with $XXXXXXXXXX: $XXXXXXXXXX of which will be used to purchase Subsidiary Trust Notes and $XXXXXXXXXX of which will be used to purchase Subsidiary Trust Units.

11. The Declaration of Trust will be amended so as to cause the Units to be redeemable as described in paragraphs 12 to 14 hereof. Voting rights, distribution rights and all other rights attached to the Units will not change as a result of this variation and the introduction of the redemption right, in and by itself, will not entitle a Unitholder to proceeds of disposition and the Unitholders will not receive any payments from the Trust.

12. In particular, all Unitholders will be granted the right to require the Trust to redeem his or her Units at any time on demand. Upon such redemption, all the Unitholder's rights attached to the Units tendered for redemption will be surrendered and the Unitholder will be entitled to receive a price per Unit (the "Redemption Price") equal to the lesser of:

(a) XXXXXXXXXX% of the "market price" of the Units on the principal market on which the Units are quoted for trading during the 10 trading day period on the date on which the Units were surrendered to the Trust for redemption; and

(b) XXXXXXXXXX% of the "closing market price" on the principal market on which the Units are quoted for trading on the date on which the Units were surrendered to the Trust for redemption.

For the purposes hereof, "market price" shall be an amount equal to the weighted average of the closing price of the Units for each of the trading days on which there was a closing price; provided that if the applicable exchange or market does not provide a closing price but only provides the highest and lowest prices of the Units traded on a particular day, the "market price" shall be an amount equal to the weighted average of the average of the highest and lowest prices for each of the trading days on which there was a trade; and provided further that if there was trading on the applicable exchange or market for fewer than five of the 10 trading days, the "market price" shall be the weighted average of the following prices established for each of the 10 trading days: the average of the last bid and last ask prices for each day on which there was no trading; the closing price of the Units for each day that there was trading if the exchange or market provides a closing price; and the weighted average of the highest and lowest prices of the Units for each day that there was trading, if the market provides only the highest and lowest prices of Units traded on a particular day. The "closing market price" shall be: an amount equal to the closing price of the Units if there was a trade on the date and the exchange or market provides a closing price; an amount equal to the weighted average of the highest and lowest prices of Units if there was trading and the exchange or other market provides only the highest and lowest trading prices of Units traded on a particular day; and the weighted average of the last bid and last ask prices if there was no trading on the date. During the period of time, if any, after the date on which the Units were surrendered to the Trust for redemption, that the Units issued are subject to payment of an instalment of the issue price and are represented by instalment receipts, unless a market for trading in the Units (other than those so represented by instalment receipts) develops which the Trustees consider fairly reflects the market value of the Units, the "market price" and the "closing market price" shall equal the aggregate of the "market price" or "closing market price" for such instalment receipts (calculated as aforesaid as if the instalment receipts were Units) plus the amount of the unpaid instalment of the issue price per Unit.

13. The aggregate cash Redemption Price payable by the Trust in respect of any Units surrendered for redemption during any calendar month shall be satisfied by way of a cash payment no later than the last day of the month following the month in which the Units were tendered for redemption, except that the entitlement of Unitholders to receive cash upon the redemption of their Units is not applicable if:

(a) the total amount payable by the Trust in respect of such Units and all other Units tendered for redemption prior thereto in the same calendar month exceeds $XXXXXXXXXX (the "Monthly Limit"); provided that the Trustees may, in their sole discretion, waive such limitation in respect of all Units tendered for redemption in any calendar month. In the absence of such a waiver, Units tendered for redemption in any calendar month in which the total amount payable by the Trust exceeds the Monthly Limit will be redeemed for cash and, subject to any applicable regulatory approvals, in accordance with paragraph 14 hereof on a pro rata basis;

(b) at the time the Units are tendered for redemption, the outstanding Units (or, as applicable, instalment receipts) are not listed for trading or quoted on any stock exchange or market which the Trustees consider, in their sole discretion, provides representative fair market value prices for the Units (or, as applicable, instalment receipts); or

(c) the normal trading of the outstanding Units (or, as applicable, instalment receipts) is suspended or halted on any stock exchange on which the Units (or, as applicable, instalment receipts) are listed for trading or, if not so listed, on any market on which the Units (or, as applicable, instalment receipts) are quoted for trading, on the date that such Units tendered for redemption were tendered to the Trust for redemption or for more than five trading days during the 10 trading day period commencing immediately after the date on which such Units tendered for redemption were tendered to the Trust for redemption.

14. If a Unitholder is not entitled to receive cash upon the redemption of Units as a result of the foregoing limitations, then each Unit tendered for redemption will, subject to any applicable regulatory approvals, be redeemed by way of a distribution in specie.

In such circumstances, the Redemption Price per Unit to which the Unitholder would otherwise be entitled shall, subject to receipt of all necessary regulatory approvals, be paid and satisfied by way of a distribution to such Unitholder of unsecured promissory notes with interest at a market rate to be determined by the trustees, payable monthly, issued by the Trust (the "Notes"), each in the principal amount of $XXXXXXXXXX, on the basis of such number of Notes for such Units tendered for redemption equal to the product of (i) number of Units tendered for redemption multiplied by (ii) the Redemption Price per Unit , which product will then be divided by $XXXXXXXXXX on the date the Units were tendered for redemption. The Redemption Price payable in respect of Units tendered for redemption during any month shall, subject to receipt of all necessary regulatory approvals, be paid by the transfer, to or to the order of the Unitholder who exercised the right of redemption, on the last day of the calendar month following the month in which the Units were tendered for redemption. Payments by the Trust of the Redemption Price are conclusively deemed to have been made upon the mailing of the Notes by registered mail in a postage prepaid envelope addressed to the former Unitholder. Upon such payment, the Trust shall be discharged from all liability to the former Unitholder in respect of the Units so redeemed. No fractional Notes in a principal amount less than $XXXXXXXXXX will be distributed and where the number of Notes to be received by the former Unitholder includes a fraction or a principal amount less than a multiple of $XXXXXXXXXX, such number shall be rounded to the next lowest number or multiple of $XXXXXXXXXX, as the case may be.

15. As with most other open-ended trusts, it is anticipated that trading on a stock exchange and not the right of redemption will continue to be the primary mechanism for Unitholders to dispose of their Units. The Notes that are to be distributed to Unitholders when the Redemption Price is to be paid by way of in specie distribution may not be listed on a stock exchange and there may be no market for such securities. Any securities so distributed may be subject to resale restrictions under applicable securities laws. Notwithstanding the expectation that Unitholders will usually prefer to dispose of their Units on the XXXXXXXXXX Stock Exchange rather than to redeem their Units, the Trustees are of the view that it is reasonable to expect Unitholders to redeem their Units in certain circumstances.

16. The Declaration of Trust will also be amended to create a special class of units of the Trust (the "Special Voting Units"). The Special Voting Units will have one vote per unit at meetings of the Unitholders, but otherwise will have no economic interest in the Trust. In particular, the Special Voting Units will not entitle their holders to any distributions of income or capital of the Trust, whether in the ordinary course as determined by the Trustees or on a liquidation of the Trust. In addition, the holders of Special Voting Units will have no legal or beneficial interest in the assets of the Trust. As a result, the Special Voting Units will have nominal value.

17. The Subsidiary Trust will form a corporation under the laws of the Province of XXXXXXXXXX ("GP Co."). GP Co. will be a wholly owned subsidiary of the Subsidiary Trust.

18. The Subsidiary Trust and GP Co. will form a limited partnership under the laws of the Province of XXXXXXXXXX ("REIT LP"). GP Co. will be the initial general partner of REIT LP. In addition to the interests of GP Co., REIT LP will have three classes of partnership interests, the Class A LP Units, the Class B Exchangeable Units and the Class C Exchangeable Units. Holders of Class A LP Units will be limited partners entitled to cash distributions equal to the net distributable cash of REIT LP, less the entitlements of the Class B Exchangeable Units, the Class C Exchangeable Units and GP Co.. Holders of Class B Exchangeable Units will be general partners entitled to cash distributions equal, on a per unit basis, to monthly distributions made by the Trust to the Unitholders. Pursuant to an exchange agreement, holders of Class B Exchangeable Units will also be entitled to exchange such Class B Exchangeable Units for Units on a one-for-one basis. Holders of Class C Exchangeable Units will be general partners entitled to cash distributions equal to XXXXXXXXXX% of the distributable cash of REIT LP and will have the right to convert such Class C Exchangeable Units into Class B Exchangeable Units at their option under certain circumstances.

19. On the same date that the Declaration of Trust is amended as described above, the Trust will issue Units to the public, raising an estimated $XXXXXXXXXX. These funds will be used to purchase additional Subsidiary Trust Notes and Subsidiary Trust Units on the same XXXXXXXXXX basis. The Subsidiary Trust will use this cash to subscribe for additional Class A LP Units of REIT LP.

20. Pursuant to letters of intent dated XXXXXXXXXX, REIT LP will acquire freehold, leasehold and undivided co-tenancy interests in certain real estate properties from XXXXXXXXXX. The purchase price for the real estate interests payable to XXXXXXXXXX, its affiliates and other vendors will include Class B Exchangeable Units of REIT LP, Class C Exchangeable Units of REIT LP, and Special Voting Units of the Trust, as well as debt, cash, an assumption of liabilities and other consideration.

Purposes of the Proposed Transactions

21. By adding the redemption right, it is expected that the Trust will qualify as a "unit trust" under paragraph 108(2)(a) of the Act rather than under paragraph 108(2)(b). Accordingly, the Trust will no longer be subject to the investment restrictions contained in paragraph 108(2)(b) of the Act, and will therefore be able hold a diversified portfolio of Real Property through a single, underlying entity (in this case, REIT LP). This will allow the Trust, indirectly through REIT LP, to acquire new assets in consideration for units of REIT LP, thus offering vendors a tax deferral pursuant to subsection 97(2) of the Act. No such tax deferral would be available on a direct acquisition of assets by the Trust. The acquisition described in paragraph 20 hereof is a transaction in respect of which elections will be filed pursuant to subsection 97(2) of the Act to defer the vendor's tax to the maximum extent permitted. Accordingly, the ability to offer a tax deferral to a vendor gives the Trust enhanced flexibility of making acquisitions that is already enjoyed by the Trust's competitors that were formed as open-ended trusts or that have converted from closed to open-ended trusts.

22. The creation of the Special Voting Units should be viewed in tandem with the conversion of the Trust from closed to open-ended and with the formation of REIT LP. The Special Voting Units will be issued to partners of REIT LP to give such partners proportionate governance rights on an as-converted basis. The Special Voting Units therefore support the Trust's strategy of enhancing new asset acquisition possibilities by creating a competitive package of consideration that can be delivered to vendors of assets. In particular, the Special Voting Units will give a vendor voting rights at the Trust level along with partnership interests of REIT LP, and are therefore an important part of the package given to vendors to enable them to achieve a tax deferral.

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:

We confirm that

A. The proposed transactions described in paragraphs 11 to 16 hereof will not, in and of themselves, result in a disposition by the existing Unitholders of their Units.

B. The proposed transactions described in paragraphs 11 to 16 hereof will not, in and of themselves, result in a disposition by the Trust of its property or in a resettlement of the Trust.

C. At the time immediately after the proposed transactions described in paragraphs 11 to 16 hereof have been implemented, the Trust will qualify as a "unit trust" pursuant to paragraph 108(2)(a) of the Act and a "mutual fund trust" pursuant to subsection 132(6) of the Act.

Nothing in this Advance Income Tax Ruling should be construed as implying that we are ruling on, or have considered, or discussed with you any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the Rulings given above. More particularly, no Ruling is provided herein with respect to:

(i) Any amendment to the Declaration of Trust other than those described in paragraphs 11 to 16 hereof;

(ii) The proposed transactions described in paragraphs 10 and 17 to 20 hereof;

(iii) The application of subsection 97(2) of the Act to the proposed transaction described in paragraph 20 hereof; and

(iv) The application of section 245 of the Act.

The Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the Canada Revenue Agency 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
Policy and Planning Branch