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: 1. Are equity substitutes (i.e., exchangeable securities of an underlying entity of a SIFT entity that are exchangeable for an interest in the SIFT entity) considered growth in the year that they are issued by the underlying entity or in the year that they are converted to units of the SIFT entity?
2. Are exchangeable securities of an underlying entity of a SIFT entity that are issued in 2007 but not converted to units of the SIFT entity before the end of 2008 also considered to be growth for 2008?
Position: 1. Equity substitutes, such as exchangeable units of an underlying entity, are considered growth in the year in which they are issued and not in the year that they are exchanged for units of the SIFT entity. 2. No.
XXXXXXXXXX 2008-026779
Annemarie Humenuk
Attention: XXXXXXXXXX
July 11, 2008
Dear XXXXXXXXXX :
Re: Normal Growth Guidelines for a SIFT Trust
This is in reply to your letters of February 11, 29 and May 6, 2008 concerning the application of the normal growth guidelines ("Guidelines") set out in the Department of Finance Press Release of December 15, 2006.
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").
You mentioned that the situation outlined in your letter relates to a proposed transaction of a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.
Subsection 122.1(2) provides that if a trust that would have been a SIFT trust on October 31, 2006 had the definition of SIFT trust been in force at that time, it will not be a SIFT trust for a taxation year that ends before the earlier of 2011 and the first day after December 15, 2006 on which the trust exceeds its normal growth as determined by reference to the Guidelines unless that excess arose as a result of a prescribed transaction (as of the date of your request, no transactions have been prescribed for this purpose). You note that for the purpose of the Guidelines, the Department of Finance press release states that new equity of the trust includes units and debt that are convertible into units of the trust. As a result, you ask for clarification as to how securities that are exchangeable for units of a trust that would have been a SIFT trust on October 31, 2006 if the definition of SIFT trust had been in force at that time effect the determination of whether the trust has exceeded its normal growth for any particular calendar year. To illustrate your question, you provided the following example:
A trust (the "Fund") that would have been a SIFT trust on October 31, 2006 if the definition of SIFT trust been in force at that time and which had a market capitalization of $150 million on October 31, 2006 would be able to issue new equity of $60 million between December 15, 2006 and the end of 2007 without causing the Fund to be considered a SIFT trust for 2007. This is because the Guidelines specify that the maximum growth for 2007 is the greater of $50 million and 40% of the Fund's market capitalization as of October 31, 2006. If the Fund issues new units with a cost of $48 million in 2007 and exchangeable securities with a cost of $12 million in 2007, the Fund would not exceed its normal growth as specified in the Guidelines for 2007 because the $60 million in new equity and equity substitutes would not exceed the Fund's normal growth limit for 2007.
To continue the example, the maximum growth of the Fund for 2008 as specified by the Guidelines is the greater of $50 million and 60% of the Fund's market capitalization as of October 31, 2006 less the amount of any new equity or equity substitutes issued since December 15, 2006. Your question is whether the exchangeable securities, as an equity substitute, would be considered growth of the Fund for 2008 as well as for 2007 such that the Fund's limit for issuing new units would be limited to $38 million in 2008. In other words, you would like to know whether exchangeable securities issued in 2007 but not converted to units before the end of 2008 would also be considered growth of the Fund for 2008. An additional question would be whether the actual conversion of the exchangeable securities into units of the Fund would be considered growth of the Fund for the year in which the holders of those exchangeable securities exercise their rights under the terms and conditions attached to those exchangeable securities.
Our Comments
While the Guidelines make it clear that new equity includes equity substitutes, equity substitutes issued in one taxation year would not cause the equity capital of a particular entity to grow (as a result of the issuance of new equity) in any other taxation year. Thus, in your example, the limit of normal growth for the Fund in 2008 would be $50 million since $50 million is greater than the amount that is 60% of the Fund's market capitalization as of October 31, 2006 less the new equity and equity substitutes issued since December 15, 2006 (60% x $150 million - $60 million = $30 million). Since the exchangeable securities were not issued in 2008, the Fund would be able to issue new equity or equity substitutes of up to $50 million in 2008. Likewise, if the Fund does not issue new equity or equity substitutes in 2008, the Fund would be able to issue new equity or equity substitutes of $60 million in 2009 on the basis that the greater of the two limits specified in the Guidelines for the Fund in 2009 would be 80% of the Fund's market capitalization as of October 31, 2006 less the total of all equity and equity substitutes issued by any entity in respect of the Fund since December 15, 2006.
With respect to your second question, we agree that exchangeable securities will only be considered as growth for the particular taxation year in which the exchangeable security was issued. As a result, while the exchangeable security is taken into account in determining the safe harbour limit, as that term is used in the Guidelines, for each year in which the exchangeable securities are outstanding, the exchangeable securities will only count as growth in the year in which the exchangeable securities are issued, and for greater certainty, will not count as additional new growth in the year in which the exchangeable security is exchanged for units of the trust.
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 to you.
T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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