2006 Ruling 2006-0177231R3 - convert from a closed-end to open-end unit 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: A. Will the variation of the Declaration in order to provide for redemption rights in respect of the Units and for the creation of the Special Voting Units result in a disposition by the existing holders of Units of their Units or a resettlement of the REIT property?

B. The variation of the Declaration in order to provide for redemption rights in respect of the Units and for the creation of the Special Voting Units will not result in a disposition by the Trust of its assets or in a resettlement of the Trust; and
C. Will the REIT qualify as an open-end unit trust pursuant to paragraph 108(2)(a) of the Act immediately after the amendments to the trust indenture?

D. Will the trust be considered to be carrying on business solely by reason of holding the limited partnership units? Also, will any of the proposed transaction cause the Trust to cease to be a mutual fund trust provided it otherwise so qualifies?

E. Will GAAR apply?

Position: A. No disposition, based on prior Rulings B. no resettlement, based on prior Rulings C. Yes as the units will be redeemable on demand, even though in limited circumstances, a portion of the redemption proceeds will be satisfied by a distribution of a note from a subtrust. D. No, by reason of 253.1. While we are not prepared to rule on whether the trust is a mutual fund trust, we can rule that the proposed transaction do not adversely affect the trust's status as a mutual fund trust, provided it otherwise so qualifies. E. No, issue considered previously by the GAAR Committee.

Reasons: See Statement of Principal Issues

XXXXXXXXXX 								2006-017723

Attention: XXXXXXXXXX

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling in respect of the above-noted taxpayer. We also acknowledge your correspondence of XXXXXXXXXX.

To the best of your knowledge and that of your client, none of the issues involved in the ruling request is:

• in an earlier return of your client or a related person,
• being considered by a tax services office or taxation center in connection with a previously filed tax return of your client or a related person,
• under objection by your client or a related person,
• before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired, or
• the subject of a ruling previously considered by the Directorate in respect of your client or a related person.

You provided us with a copy of the proposed restated declaration of trust for the XXXXXXXXXX. 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. All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act"), and the following terms have the meanings specified:

"closed-end unit trust" means a trust that qualifies as a unit trust under paragraph 108(2)(b);

"deferred income plans" means any of registered retirement savings plans, registered educational savings plans, registered retirement income funds or deferred profit sharing plans;

"Exchangeable Securities" means any securities of the LP that are convertible or exchangeable directly for REIT Units without the payment of additional consideration therefore;

"GP" means a taxable Canadian corporation to be incorporated pursuant to the laws of the Province of XXXXXXXXXX to function as the general partner of LP, and whose share capital will initially be wholly-owned by the REIT;

"LP Unit" means the interest of a limited partner in the LP's capital, designated as a Class "A" unit or a Class "B" exchangeable unit, and issued as such pursuant to the terms of the agreement governing the affairs of the LP;

"LP" means the limited partnership to be established pursuant to the laws of the Province of XXXXXXXXXX;

"Notes" means the interest-bearing unsecured promissory notes issued by the Trust in denominations of $XXXXXXXXXX or multiples of $XXXXXXXXXX for a term not exceeding XXXXXXXXXX years, which shall be issued pursuant to a note indenture containing the customary terms and conditions;

"open-end unit trust" means a trust that qualifies as a unit trust under paragraph 108(2)(a);

"Permitted Investments" means any combination of property described in clauses 108(2)(b)(iii)(A) to (G);

"REIT Declaration of Trust" means the declaration of trust dated as of XXXXXXXXXX pursuant to which the REIT was formed under the laws of the Province of XXXXXXXXXX, as may be amended, supplemented and/or restated from time to time;

"REIT Trustees" means the individuals that act as trustees of the REIT in accordance with and subject to the provisions of the REIT Declaration of Trust, and which as of the date hereof consist of XXXXXXXXXX Canadian resident individuals;

"REIT Unit" means a unit of the REIT, other than a Special Voting Unit, each such REIT Unit representing an equal undivided beneficial interest in the REIT;

"REIT" means the XXXXXXXXXX, a closed-end unit trust which qualifies as a mutual fund trust, and which was established under the laws of the Province of XXXXXXXXXX on XXXXXXXXXX;

"Right of Redemption" means the right of redemption of a Unitholder to redeem REIT Units pursuant to and subject to the provisions of the amendments to be made to the REIT Declaration of Trust;

"Special Unitholder" means a holder of a Special Voting Unit;

"Special Voting Unit" means a non-participating, voting unit of the REIT, other than a REIT Unit, as more particularly described in paragraph 13 below;

"Stock Exchange" means the XXXXXXXXXX Exchange;

"Tax Deferral Election" means a joint election under subsection 97(2), to be filed in the manner and within the time provided in the Act that, in accordance with that subsection, the transferor's proceeds of disposition of the transferred property and the transferee's cost of the acquisition of the transferred property will be deemed to equal such elected amount as the transferor and the transferee may jointly specify;

"Trust" means an open-end unit trust created under the laws of a province of Canada as described more fully in paragraph 11 below; and

"Unitholder" means a holder of REIT Units.

The relevant Taxation Services Office for the REIT is the XXXXXXXXXX Tax Services Office and the relevant Taxation Centre is the XXXXXXXXXX. The tax account number of the Trust is XXXXXXXXXX.

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

Facts

1. The REIT is a closed-end unit trust and a mutual fund trust as defined in subsection 132(6). The principal office of the REIT is located at XXXXXXXXXX. The REIT has a year-end of XXXXXXXXXX.

2. The REIT is a limited purpose trust and was established to invest in income producing rental properties in Canada. The REIT, directly and indirectly, owns XXXXXXXXXX. On XXXXXXXXXX the REIT announced that it had entered into new conditional agreements with respect to the acquisitions of XXXXXXXXXX properties, totalling approximately $XXXXXXXXXX. On XXXXXXXXXX the REIT announced an additional XXXXXXXXXX acquisition for $XXXXXXXXXX. The acquisition is expected to close at the end of XXXXXXXXXX.

3. REIT Units are widely held by the public, and to the knowledge of the REIT Trustees no person beneficially owns, directly or indirectly, or exercises control or direction over, more than 10 percent of the issued and outstanding REIT Units, except that the accounts managed by XXXXXXXXXX. consist, in the aggregate, approximately XXXXXXXXXX% of the issued and outstanding REIT Units on a non-diluted basis and the accounts managed by XXXXXXXXXX consist, in the aggregate, approximately XXXXXXXXXX% of the issued and outstanding REIT Units on a non-diluted basis. REIT Units are listed and posted for trading on the Stock Exchange under the symbol XXXXXXXXXX, and are qualified investments for deferred income plans under subsection 4900(1) of the Income Tax Regulations. The REIT has a single class of units. As of XXXXXXXXXX REIT Units were issued and outstanding.

4. On XXXXXXXXXX, the REIT established a unit option plan pursuant to which it is able to grant options to purchase REIT Units. The number of REIT Units to be issued pursuant to the unit option plan cannot exceed XXXXXXXXXX% of the issued and outstanding REIT Units from time to time. On XXXXXXXXXX, options were granted for a total of XXXXXXXXXX REIT Units at an exercise price of $XXXXXXXXXX per REIT Unit, which options expire XXXXXXXXXX. On XXXXXXXXXX, options were granted for XXXXXXXXXX REIT Units at an exercise price of $XXXXXXXXXX per REIT Unit, which options expire XXXXXXXXXX.

5. The REIT is governed by a board of trustees consisting of XXXXXXXXXX individuals who are residents of Canada, which hold REIT property and conduct and manage the affairs of the REIT in accordance with and subject to the terms of the REIT Declaration of Trust.

6. In accordance with paragraph 108(2)(b), paragraph 132(6)(b), subsection 132(7) and relevant terms of the REIT Declaration of Trust, the REIT qualifies as a mutual fund trust and, specifically, the REIT:

• limits its undertaking to the investing of its funds in property, and to acquiring, holding, maintaining, improving, leasing and managing real property and interests in real property that is capital property;
• invests more than XXXXXXXXXX% of its property in Permitted Investments;
• earns more than XXXXXXXXXX% of its income as computed without regard to subsection 104(6), from Permitted Investments;
• does not invest any more than XXXXXXXXXX% of its property in any combination of bonds, securities or shares in the capital stock of any one corporation or debtor; and
• is not maintained primarily for the benefit of non-resident persons, and non-residents of Canada are collectively beneficial owners of less than XXXXXXXXXX% of the REIT Units.

7. Pursuant to the terms of the REIT Declaration of Trust, the REIT is required to distribute to Unitholders in each year an amount equal to not less than the greater of:

(i) a percentage, as set out in a policy of the Trustees, of distributable income as that term is defined in the REIT Declaration of Trust for each year; and

(ii) an amount of net income and Net Realized Capital Gains as defined in article XXXXXXXXXX of the REIT Declaration of Trust for such year as is necessary to ensure that the REIT will not be subject to tax on its net income and net capital gains under Part I.

8. At a XXXXXXXXXX meeting of Unitholders, the REIT received approval to amend the REIT Declaration of Trust to provide, among other things, that all Unitholders will be granted the right to require the REIT to redeem their REIT Units at any time on demand, such amendment being subject to having obtained a satisfactory advance income tax ruling from the Canada Revenue Agency.

Proposed Transactions

9. The REIT Declaration of Trust will be amended to include a Right of Redemption for the REIT Units to allow the REIT to qualify as an open-end unit trust rather than a closed-end unit trust. The voting rights, distribution rights, and all other rights attached to the REIT Units will not change. A Unitholder will be granted the right to require the REIT to redeem his or her REIT Units at any time on demand in the manner set out in the REIT Declaration of Trust, at an amount equal to the lesser of XXXXXXXXXX% of trading price and XXXXXXXXXX% of the closing trading price in the manner set out in the REIT Declaration of Trust based on the trading price as established by the Stock Exchange and in exchange for cash, in specie consideration or cash and in specie consideration as described more fully below.

10. In addition to the amendment providing for the Right of Redemption, the REIT Declaration of Trust will be amended to:

• provide for a limit on the amount of indebtedness that can be incurred by the REIT;
• modify the existing rules that restrict non-resident ownership of REIT Units to less than XXXXXXXXXX% to ensure that the non-resident ownership of the REIT Units on either an actual, or fully-diluted basis (based on the assumption that any outstanding Class B LP Units had been converted to REIT Units), does not exceed XXXXXXXXXX% and modify the mechanism for requiring those non-resident Unitholders or non-residents holding Class B LP Units to sell the excess Units or Class B LP Units within 30 days;
• providing for the issuance of new REIT Unit certificates where a Unitholder has died or a certificate is lost, and providing for the issuance of Special Voting Units; and
• in contemplation of the issuance by LP of Exchangeable Securities, authorize the REIT Trustees to enter into exchange agreements with the Trust and the LP relating to the Exchangeable Securities.

11. Pursuant to a declaration of trust to create the Trust, a Canadian resident will settle $XXXXXXXXXX of cash on the trustee of the Trust in exchange for a unit of the Trust. The trustees of the Trust may include some of the trustees of the REIT, but will not consist of all the same trustees that are trustees of the REIT. The REIT will then subscribe for one unit of the trust for $XXXXXXXXXX consideration. Immediately following the REIT's acquisition of a unit of the Trust, the settlor of the Trust will redeem his unit in the Trust. Following the redemption of the unit held by the settlor of the Trust, the REIT will be the sole beneficiary of the Trust and will be entitled to any and all distributions by the Trust. In the event of that all the property of the Trust is required to be distributed, the REIT will be entitled to all the net assets of the Trust after satisfaction of all liabilities of the Trust. The sole purpose of the Trust is to facilitate the in specie redemption of REIT units as described in paragraph 16 below. The Trust shall not undertake any activity, take any action, or make any investment that would result in the REIT not being considered a mutual fund trust for purposes of the Act.

12. The REIT will cause GP to be incorporated under the laws of XXXXXXXXXX. The trustees of the REIT will not form a majority of the directors of GP. The board of directors of GP will have the powers and authority to manage the business and affairs of GP and GP will, pursuant to the LP agreement administer, manage, control and operate the business for and on behalf of the LP. The trustees of the REIT in their capacity as trustees of the REIT will not have or limit such powers and authority. The REIT and GP will establish LP, in respect of which the REIT will be the initial limited partner and GP will be the general partner. The agreement governing the affairs of LP will provide that all of the partners of LP must be resident in Canada.

13. The LP will be structured to permit two classes of limited partnership units, Class A LP Units and Class B LP Units, in addition to the interest of the GP as the general partner of LP. The Class B LP Units are intended to be issued to persons other than the REIT who transfer properties to the LP pursuant to a Tax Deferral Election from time to time. The Class B LP units will be exchangeable for REIT Units on a one-for-one basis, subject to customary adjustments in the event of a reorganization of REIT Units, rights offerings or special distributions by the REIT. The holders of Class B LP units will also be issued Special Voting Units of the REIT which will provide them with a vote on all matters in respect of which Unitholders are permitted to vote. Holders of Class B LP units will be entitled to cash distributions from the LP equal, on a per unit basis, to monthly distributions made by the REIT to the Unitholders. The GP will be entitled to a cash distribution each month from the LP equal the XXXXXXXXXX% of the net distributable cash of the LP to a maximum of $XXXXXXXXXX per year. The REIT, as the sole holder of Class A LP units, will be entitled to cash distributions from the LP equal to the net distributable cash of LP less the entitlements of the Class B LP Units and GP. The net income, net loss, taxable income and taxable loss of LP shall be allocated to the partners of LP at the end of each year in the same proportions as the cash distributions other than any special distribution to the Class A Unitholder.

14. Pursuant to a Tax Deferral Election, the REIT will transfer all of its assets to LP. In consideration for the transfer of these assets, LP will issue Class A LP Units to the REIT and will assume all debts of the REIT relating to those assets, provided that the amount of debt does not exceed the aggregate cost amount of the assets transferred. The FMV of the Class A LP Units issued will equal the difference between the FMV of the transferred assets and the aggregate amount of the debts assumed.

15. The amount payable upon the redemption of a REIT Unit by the REIT in respect of the REIT 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 a full cash payment upon the redemption of their REIT Units is not applicable if:

a) the total amount payable by the REIT in respect of the REIT Units tendered for redemption during the same calendar month exceeds $XXXXXXXXXX, unless the REIT Trustees, in their sole discretion, waive such limitation during a particular calendar month;

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

c) the normal trading of the outstanding REIT Units is suspended or halted on any stock exchange on which the REIT Units are listed for trading or, if not so listed, on any market on which the REIT Units are quoted for trading, on the Redemption Date for such REIT Units or for more than five trading days during the 10-trading day period commencing immediately prior to the Redemption Date for such REIT Units.

16. If a Unitholder is not entitled to receive cash upon the redemption of REIT Units as a result of the foregoing limitations, the amount payable upon the redemption of a REIT Unit to which the Unitholder is entitled shall be the fair market value thereof as determined by the REIT Trustees and, subject to any applicable regulatory approvals, shall be paid out and satisfied by way of a combination of cash and an in specie distribution of the assets of the REIT on a pro rata basis. This will be accomplished by the REIT selling, pursuant to an exchange agreement with the Trust, a certain number LP units to the Trust for Notes. The Notes received by the REIT will be distributed in specie by the REIT to the redeeming Unitholder in lieu of cash. Where the number of Notes to be received by a redeeming Unitholder includes a fraction of a principal amount that is less than a multiple of $XXXXXXXXXX, the number of Notes to be issued to the redeeming Unitholder will be rounded to the next lowest multiple of $XXXXXXXXXX and the additional amount receivable by the redeeming Unitholder will be distributed in cash, notwithstanding the $XXXXXXXXXX monthly limit. The Trustees will waive the $XXXXXXXXXX monthly limit on cash redemptions to the extent required to avoid the issuance of a Note with a principal amount of less than $XXXXXXXXXX. The Trust will use distributions received on its LP units to satisfy interest and principal payments on the Notes. Periodically, the Trust may distribute LP units to the REIT as a capital distribution. The Notes that are distributed in specie to Unitholders on redemption of REIT Units will not be listed on any stock exchange and no market is expected to develop in such securities. In addition, the notes may be subject to resale restrictions under applicable securities laws. Notes would generally not be qualified investments for deferred income plans. Upon the issuance of such Notes to the beneficiaries, the REIT shall be discharged from all liability to former Unitholders in respect of the Units so redeemed.XXXXXXXXXX.

17. Notwithstanding Article XXXXXXXXXX of the REIT Declaration of Trust which provides that no amount of income or capital will be distributed to a Unitholder at any time following the receipt of the notice by the Unitholder to redeem the Units, when the REIT makes a distribution in specie on the redemption of REIT Units of a Unitholder the REIT will make any capital gain realized by the REIT on the disposition of LP Units to the Trust payable to the Unitholder and will reduce the amount payable to the Unitholder in respect of the redemption of the units by the amount so allocated to that Unitholder.

18. It is anticipated that the Right of Redemption described above will not be the primary mechanism for Unitholders to dispose of their REIT Units.

Purpose of the Proposed Transactions

19. The purpose of the Proposed Transactions is to maximize Unitholder value and to increase the value of the REIT's income producing real properties, by providing a more flexible legal and operating structure. An open-end unit trust is a more preferable vehicle to a closed-end unit trust because an open-end unit trust is not subject to many of the restrictions and limitations imposed on closed-end unit trusts. The introduction of the LP will facilitate future property acquisitions by providing Vendors with the ability to make Tax Deferral Elections.

20. The addition of the Right of Redemption will also provide Unitholders with an additional means of realizing on their investment in the REIT. While it is expected that investors' primary source of liquidity for REIT Units will continue to be through their sale on the Stock Exchange, under certain circumstances redemption may be a preferred alternative to public trading. For example, at times when REIT Units are thinly traded, a redemption might be the preferred mechanism for Unitholders to realize on the true fair market value of their investment.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. The variation of the REIT Declaration of Trust in order to provide for the Redemption Right and the addition of Special Units will not, in and by itself, result in a disposition by the existing Unitholders of their REIT Units.

B. The proposed transactions described in paragraphs 9 and 10 above will not, in and by themselves, result in a disposition by the Trust of its property or in a resettlement of the Trust.

C. The REIT will qualify as an open-ended unit trust pursuant to paragraph 108(2)(a) at the time immediately after the variation of the REIT Declaration of Trust providing for the Redemption Right.

D. The proposed transactions described in paragraphs 9 to 10 above will not, in and by themselves, adversely affect the qualification of the REIT as a mutual fund trust within the meaning of subsection 132(6).

E. Section 253.1 will apply in respect of the proposed transactions such that the REIT will not, solely because of its acquisition and holding of the units of the LP, be considered to carry on any business or other activity of the LP.

F. The general anti-avoidance rule under subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings above as a result of the proposed transactions.

Nothing in this advance income tax ruling should be construed as implying that we are ruling on, or have considered 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 REIT Declaration of Trust other than those described in paragraphs 9 and 10 above;

(ii) the application of any of the provisions of the Act to the Trust;

(iii) The deductibility of the interest payable on the Notes issued by the Trust;

(iv) The application of subsection 97(2) to the proposed transaction described in paragraph 14 above;

(v) the application of subsection 245(2) to any tax consequence other than those confirmed in the rulings as set out above.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided that proposed transactions as described in the paragraphs above, are completed within six months of the date of this letter. These rulings are based on the law as it currently reads and do not take into account any proposed amendments to the Act.

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