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. Whether or not the Earned Fees will be subject to the tax imposed under Part XIII of the Act .
2. Whether or not section 105 of the Income Tax Regulation will apply to require withholding of tax from the Earned Fees.
3. Whether or not the effective guarantee of the Earned Fees provided by the joint and several obligation of the New Fund in respect of the Fees and the New Fund's obligation as withholding agent in respect of Deferred Sales Charges will disqualify the New Fund from meeting the requirements under paragraph 132(6)(b) of the Act.
Position: 1. The Earned Fees will not be subject to the tax imposed under Part XIII of the Act.
2. Section 105 of the Regulation will not apply.
3. They will not disqualify the New Fund from meeting the requirements under paragraph 132(6)(b) of the Act.
Reasons: 1. Such amounts are not described in any of paragraphs 212(1)(a), (b), (d) or (o) of the Act.
2. Such amounts are not consideration paid for services performed in Canada.
3. The New Fund is not engaged in the business of providing guarantees or of lending money. The provision of the guarantee is integrated to the investment of the funds. The engagement to withhold the Deferred sale charges from the proceeds of the units and remit them is not an undertaking of its own. The New Fund is not paid for the withholding and it is highly integrated with the redemption of the units which is not an undertaking that would disqualify the mutual fund trust.
XXXXXXXXXX 2008-027125
XXXXXXXXXX , 2008
Dear Sir:
Re: Advance Income Tax Ruling
XXXXXXXXXX . Business Number XXXXXXXXXX
(XXXXXXXXXX Tax Services Office and XXXXXXXXXX Tax Centre)
This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the taxpayer.
We understand that to the best of your knowledge, and that of the taxpayer involved, none of the matters considered in this ruling request are:
a) dealt with in an earlier return of the taxpayer or a related person;
b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayer or a related person;
c) under objection by one or any of the taxpayer or a related person;
d) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; and
e) the subject of a ruling previously issued by this Directorate.
In this document, unless otherwise indicated, all statutory references are to the Income Tax Act (R.S.C. 1985, 5th Supplement, c.1, as amended, the "Act")
DEFINITIONS
In this letter, unless otherwise expressly stated, the following terms have the meanings specified:
(a) "Act" means the Income Tax Act (Canada);
(b) "Agency Agreement" means the agreement between a New Fund, the Manager and Dealers regarding the sale of Units to the public, as described in paragraph 16;
(c) "Arranger" means Arranger Corp. I, 1 a XXXXXXXXXX corporation to be formed for the purpose of acting as arranger as described herein;
(d) "Arranger's Agreement" means the agreement between the Arranger, the Program Agent, the Manager and the New Fund regarding the arranging for payment of Dealers' commissions, as described in paragraph 13;
(e) "Arranger's Earned Basic Fee" means the monthly fee paid to the Arranger (or its assign), as described in paragraph 13;
(f) "Collection Account" means the account maintained outside Canada by XXXXXXXXXX ;
(g) "Collection Agent" means the XXXXXXXXXX ;
(h) "Collection Agency Agreement" means the agreement between the Funding Entity, the Program Agent and the Collection Agent, as described in paragraph 23;
(i) "Confirmation Agreement" means the agreement among the Dealers and the Arranger, as described in paragraph 16;
(j) "Dealers" means arm's length securities dealers;
(k) "Declaration of Trust" means a declaration of trust forming a New Fund that is a trust;
(l) "DSC" means the deferred sales charge to be paid by a holder of Units of a New Fund to the Arranger (or its assign);
(m) "Earned Fees" means the DSC and Arranger's Earned Basic Fee;
(n) "Existing Funds" means the existing investment funds managed by the Manager, as described in paragraph 3;
(o) "Funding Account" means the account maintained outside Canada by XXXXXXXXXX ;
(p) "Funding Entity" is described in paragraph 22;
(q) "Funding Entity Agreement" means the agreement between the Arranger, the Program Agent and the Funding Entity, as described in paragraph 18;
(r) "Manager" means XXXXXXXXXX .;
(s) "Manager Funded Offerings" means the most recent XXXXXXXXXX offerings of Existing Funds in which the Manager paid the Dealers' commissions;
(t) "New Funds" means investment funds to be managed by the Manager and formed as part of (or after) the proposed transactions from time to time;
(u) "Program Agent" means XXXXXXXXXX ;
(v) "Program Documents" include the Arranger's Agreement, the Collection Agency Agreement, the Confirmation Agreement, the Funding Entity Agreement and the Servicing Agreement;
(w) "Servicing Agreement" means the agreement among the Manager, the Program Agent and the Funding Entity, as described in paragraph 24;
(x) "Treaty" means the 1980 Convention between the United States of America and Canada with Respect to Taxes on Income and Capital and amended (and proposed to be amended) by the First, Second, Third, Fourth and Fifth Protocol; and
(y) "Units" means units of New Funds that are mutual fund trusts or shares of New Funds that are mutual fund corporations.
FACTS
1. The Manager is a corporation incorporated under the laws of Canada on XXXXXXXXXX . The Manager's address is XXXXXXXXXX . All of the Shares of the Manager are owned by XXXXXXXXXX , which is a corporation incorporated under the laws of XXXXXXXXXX on XXXXXXXXXX . The Manager is a Canadian-controlled private corporation under the Tax Act.
2. The business of the Manager is providing, or arranging for, management and/or administrative services to investment funds. In connection with this business, the Manager structures and establishes the investment funds that it manages.
3. The Manager currently provides administrative and/or management services to XXXXXXXXXX Existing Funds, which have been established over the past XXXXXXXXXX years. The securities of each of the Existing Funds are listed on the XXXXXXXXXX Stock Exchange. The Existing Funds qualify as either mutual fund trusts or mutual fund corporations under the Act. In the case of the funds that qualify as mutual fund trusts, they also qualify as unit trusts under paragraph 108(2)(a) of the Act, as their units are redeemable on a monthly basis. Where the funds have been structured as trusts, the Manager is the trustee. Where the funds have been structured as corporations, the voting Units of the fund are held by a trust which is not affiliated with the Manager or with any other person or partnership other than the fund itself.
4. When securities of the Existing Funds were sold to the public on their initial offering, Dealers such as XXXXXXXXXX acted to effect the sale of their securities. In connection with those services, the Dealers received a commission in the range of XXXXXXXXXX % of the value of the securities sold.
5. In connection with the Manager Funded Offerings, the Manager paid the Dealers' commissions for the applicable Existing Funds, as part of its services of manager and as arranger of the distribution of the Existing Funds. The investors in these offerings received the benefit of their entire gross subscription from the offering because the whole of their subscription proceeds were invested in the funds' investment portfolio. In consideration of the Manager paying the Dealers' commissions, each investor agreed to pay a redemption fee to the Manager payable if the investor redeemed his/her securities prior to the beginning of the XXXXXXXXXX calendar year following the year in which the securities were issued (i.e., the investor agreed to pay a deferred sales charge to the Manager). The applicable Existing Funds also agreed to pay a higher management fee to the Manager than it would have absent the Manager arranging for the payment of the Dealers' commissions.
6. Under the Manager Funded Offerings, the Manager cannot determine, at the time when it funds the Dealers' commissions, the amount or timing of the redemption fees or amount of the management fees (which are based on a percentage of the asset value of the fund) that it will receive. The Manager bears the risk that the redemption fees and the management fees it receives will be greater or less than the cost to it of funding the Dealers' commissions. These arrangements are similar to the practice of "deferred sales charges" that are applied to mutual funds that do not trade on stock exchanges.
7. None of the Existing Funds was liable for the Dealers' commissions nor did any of them claim such fees as an expense in calculating its accounting or tax income. None of Existing Funds was indebted to the Manager as a result of the Manager paying the Dealers' commissions. The Manager treated the payment of the Dealers' commissions as an expense incurred by it in the carrying on of its business.
PROPOSED TRANSACTIONS
Establishment of the New Funds
8. The Manager intends to establish New Funds. The New Funds will qualify as either mutual fund trusts or mutual fund corporations under the Act. The respective units of such New Funds are referred to as "Units". Similar to the Existing Funds, the New Funds will be sold to the public through Dealers and the Units will be listed on the XXXXXXXXXX Stock Exchange.
9. The Manager will execute a Declaration of Trust to establish each New Fund that is a trust. The Manager will also be subject to a management agreement with each new Fund. The Manager will perform duties including:
(a) effecting regulatory filings and ensuring regulatory compliance;
(b) directly, or through an investor manager, implementing the fund's investment policies and strategies;
(c) maintaining books and records for the fund and providing bookkeeping and accounting services for the fund; and
(d) determining Unit holder distributions.
In consideration of the Manager's services, the Manager will be entitled to receive a management fee from each of the New Funds calculated as a percentage of the fund's net asset value plus an amount equal to the ongoing trailer fee payable by the Manager to the Dealers, plus applicable taxes. The percentage amount will be higher during the period when the Manager is required to pay the Arranger (or its assign) the Arranger's Earned Basic Fee, as described in paragraph 13. Pursuant to the applicable Declaration of Trust and the Prospectus for the New Fund, as described in paragraph 13 below, each investor in the Units will be obligated to pay Arranger (or its assign) a DSC in the event it redeems a Unit prior to elapse of certain periods of time. The DSC declines each year to zero after XXXXXXXXXX years. Accordingly, the amount of the DSC to be paid and the timing is very uncertain.
Arrangements with respect to Dealers
10. Given the risks involved in funding Dealers' commissions in return for DSCs, which as noted above are uncertain in timing and amount, there are only a small number of entities that will fund Dealers' commissions. Most of those such entities are currently located in the United States where similar arrangements are in common use in the United States mutual fund industry and where packagers of similar future revenue streams regularly acquire and securitize them.
11. The Manager and the New Funds will engage the Arranger, an arm's length third party non-resident, to find a third party located in the United States to act as Funding Entity and to cause the Funding Entity to fund the payment of the Dealers' commissions on the terms set out below.
12. All of the stock of the Arranger will be owned by XXXXXXXXXX ., another XXXXXXXXXX corporation, all of the stock of which is in turn owned by a single individual who is a citizen of the United States. The Arranger is not affiliated with the Manager, the Program Agent or the Funding Entity and is a "resident of the United States" and a "qualifying person" as such terms are defined in the Treaty. The Arranger will agree pursuant to the Program Documents not to maintain any office in Canada, not to have any employees in Canada and to limit its activities to the activities contemplated by the Program Documents, none of which activities will take place in Canada.
13. The Arranger, the Program Agent, the Manager and the New Fund will enter into the Arranger's Agreement in accordance with terms and provisions described in the Summary of Principal Indicative Terms that was annexed to your request. The Program Agent and the Arranger will execute and deliver the Arranger's Agreement in XXXXXXXXXX and each will perform its obligations thereunder through the activities of its offices in XXXXXXXXXX . Pursuant to the Arranger's Agreement, Funding Entity will pay the Dealers' commissions on the closing of the sale of Units. In consideration of the services of the Arranger under the Arranger's Agreement, each investor in the New Funds will agree to pay a DSC to the Arranger (or as it may direct) if the investor redeems his/her securities prior to the beginning of the XXXXXXXXXX calendar year following the year in which the securities are issued. The DSC is a percentage of the original issue price of the Unit which percentage begins at a level of approximately XXXXXXXXXX % to XXXXXXXXXX % and declines each year thereafter to zero in the XXXXXXXXXX year. To induce the Arranger to perform its services, the New Fund will agree to withhold the DSC from the redemption proceeds of any redemption of a Unit and pay it as directed by the Arranger. To further induce the Arranger to perform its services, the Manager and the New Fund will, jointly and severally, agree to pay the Arranger (or as it may direct), a fee (the "Arranger's Earned Basic Fee") which will be payable monthly in respect of each Unit so long as the Unit remains outstanding up to a maximum of XXXXXXXXXX years. The amount of the Arranger's Earned Basic Fee is a fixed percentage per annum of the average daily net asset value of that outstanding Unit. Accordingly, like the DSC, it is uncertain in timing and amount.
14. As between the Manager and the New Fund, the Manager will agree that it is responsible for the payment of the Arranger's Earned Basic Fee. Thus the New Fund's joint and several liability to the Arranger is expected to operate in some respects like a guaranty in order to satisfy the commercial requirement of the Arranger that it have recourse to the New Fund for payment. The DSC and the Arranger's Earned Basic Fee and the right to receive them if as and when and to the extent that they arise are referred to collectively herein as the "Earned Fees". The rights to the Earned Fees are fully assignable by the Arranger and its assigns. The Arranger will assign a portion of the Earned Fees to the Funding Entity in exchange for the latter's undertaking to pay the Dealers' commissions.
15. The Arranger cannot determine when it will cause the Dealers' commissions to be paid, the amount or timing of the DSC to be received from holders of Units or the Arranger's Earned Basic Fee to be received from the Manager or the New Fund (which is based on a percentage of the asset value of the fund). The Arranger bears the risk that the DSC and the Arranger's Earned Basic Fee it receives will be greater or less than the cost to it of arranging for the Funding Entity to fund the Dealers' commissions.
16. The New Fund, the Manager and the Dealers will enter the Agency Agreement under which the Dealers will offer the Units for sale on behalf of the New Fund. In consideration of the Dealers' services in offering the Units for sale, the Dealers will be entitled to receive a commission of approximately $XXXXXXXXXX per Unit sold. Pursuant to the Agency Agreement, the Dealers will agree to look to the Arranger and the Funding Entity (described below) (and not to the New Fund or the Manager) for payment of their commissions, and closing of the sale of Units will be conditioned upon the receipt of those payments from the Funding Entity. As well, the Arranger and the Dealers will become parties to a Confirmation Agreement pursuant to which: (i) the Arranger will confirm the existence of the Arranger's Agreement and acknowledge the Agency Agreement and the Dealers' entitlement under the Agency Agreement to the Dealers' commissions upon the closing of the sale of the Units of the New Fund that are sold on a deferred sales charge basis; (ii) the Arranger will confirm that pursuant to and subject to the terms and conditions of the Arranger's Agreement, the Arranger has undertaken to arrange for a Funding Entity to pay the Dealers' commissions in connection with the sale of Units of the New Fund that are sold on a deferred sales charge basis and will expressly agree that the Dealers are entitled to rely on that undertaking; and (iii) the Dealers will instruct the Arranger to cause the Funding Entity to pay the Dealers' commissions upon the closing of the sale of the Units.
17. None of the New Funds or the Manager will be legally liable for the Dealers' commissions nor will any of them claim such commissions as an expense in calculating its accounting or tax income. None of New Funds will be indebted to the Manager, the Arranger or its assigns as a result of the payment of the Dealers' commissions. Neither the Arranger, nor its assigns will treat the payment of the Dealers' commissions as a loan or advance to the New Funds or to the Manager.
18. The Arranger will enter into a Funding Entity Agreement with the Funding Entity and the Program Agent pursuant to which the Arranger will assign to the Funding Entity all or a portion of its entitlements to the Earned Fees in exchange for the Funding Entity's undertaking to pay an amount equal to the Dealers' commissions into the Funding Account maintained by the Collection Agent outside Canada, with instructions that such funds be transferred to a closing escrow account for the initial public offering of the Units of the New Fund. All agreements to which the Funding Entity is a party will be entered into by it from its offices in XXXXXXXXXX and the Funding Entity will perform all of its obligations under such agreements from such offices.
19. The Funding Entity will, on the issuance of Units to the public by a New Fund, pay an amount equal to the Dealers' commissions to the Funding Account and the Arranger will, pursuant to the Funding Entity Agreement, assign the Earned Fees to the Funding Entity and will direct that the Earned Fees be paid directly to the Collection Account for the benefit of the Funding Entity if as and when and to the extent that they arise.
20. The Program Agent is not affiliated with the Manager, any New Fund or the Arranger, but may be affiliated with the Funding Entity. The Program Agent is a "resident of the United States" and a "qualifying Person" as such terms are defined in the Treaty.
21. The Program Agent's duties to the Arranger under the Program Documents include monitoring the performance of the Manager and the New Fund, administration of the contractual arrangements between the Arranger on the one hand, and the Manager and the New Fund on the other (including the granting of certain required consents or approvals required under the Program Documents), and the administration of the contractual arrangements that will exist between the Arranger and the Funding Entity. None of those activities, except perhaps attendance of its delegates at periodic audits or inspections of the records of the Manager and the New Funds, will take place in Canada. The regular activities of monitoring the reports provided by the Manager will be conducted by the Program Agent from its offices in XXXXXXXXXX .
22. It is expected that the Funding Entity will be a major bank formed under the laws of the United States with its head office in the United States. It is expected that it will not be affiliated with the Manager, the New Fund or the Arranger, although it may be affiliated with the Program Agent. It is expected that it will be a "resident of the United States" and a "qualifying person" under the Treaty. The Funding Entity will execute the Program Documents to which it is a party in the United States and will perform each of its obligations under the Program Documents in the United States through its offices located in the United States. If the Funding Entity has a permanent establishment in Canada, such permanent establishment will not be involved in the performance of the obligations of the Funding Entity under the Program Documents.
Other Program Documents
23. The Funding Entity will enter into a Collection Agency Agreement with the Program Agent and the Collection Agent, pursuant to which the Collection Agent will maintain the Funding Account and the Collection Account into which any collections in respect of the Earned Fees that are assigned and payable to the Funding Entity will be paid. The Funding Account and the Collection Account will be maintained outside Canada. Each of the parties to the Collection Agency Agreement will execute and deliver that agreement in XXXXXXXXXX through its respective office located in XXXXXXXXXX .
24. The Manager, the Program Agent and the Funding Entity will enter into a Servicing Agreement pursuant to which the Manager will agree to provide the other parties with certain services, including reports concerning the New Fund, the Earned Fees, answers to questions that any of the other parties may reasonably request, and using its authority as Manager or trustee of the New Funds to cause the New Funds to perform its obligations under the Arranger's Agreement. As servicer, the Manager will be entitled to a servicing fee in a fixed monthly amount for its services, payable out of collections in respect of the Earned Fees. The Program Agent and the Funding Entity will execute and deliver that agreement in XXXXXXXXXX through their respective offices located in XXXXXXXXXX . Payment of the servicing fee will be made by the Collection Agent. Depending on the commercial arrangements, the Arranger may also be a party to the Servicing Arrangement.
PURPOSE OF PROPOSED TRANSACTIONS
The purpose of the proposed transactions is to reduce the Manager's financial risk associated with the distribution of Units of the New Funds and to permit investors to obtain the maximum benefit of their subscriptions for Units without deduction for Dealers' commissions.
The current arrangements between the Manager and a fund whereby the Manager pays the Dealers' commission place an unattractive risk on the Manager since it must expend an amount equal to the Dealers' commissions at the outset and hope to recover the expenditure out of ongoing management fees and DSCs from investors that are subject to many variables, including the performance of the Fund. The proposed arrangement for the New Funds places those risks on a Funding Entity that is comfortable taking these risks.
RULINGS
Provided the above statements of facts, proposed transactions and purpose thereof are accurate and constitute complete disclosure of all relevant facts and proposed transactions, our rulings are as follows:
A. The Earned Fees will not be subject to the tax imposed under Part XIII of the Act because such amounts are not described in any of paragraphs of 212(1)(a), (b), (d) or (o) of the Act.
B. Section 105 to the Income Tax Regulation will not apply to require withholding of tax from the Earned Fees because such amounts are not consideration paid for services performed in Canada.
C. The effective guarantee of the Earned Fees provided by the joint and several obligation of the New Fund in respect of the Arranger's Earned Basic Fees and the New Fund's obligation as withholding agent in respect of the DSCs, as described in paragraphs 13 and 14 above, will not disqualify the New Fund from meeting the requirements under paragraph 132(6)(b) of the Act.
The rulings given herein are based solely on the facts, proposed transactions and purpose of the proposed transactions described above. Facts and proposed transactions in the documents referred to in your request and not described above do not form part of the facts and proposed transactions on which these rulings are based and any reference to these documents is provided solely for the convenience of the reader. The rulings are given provided that we receive a copy of the prospectus, of the Program Documents and of the Agency Agreement when these documents are available. The rulings given herein may be revoked if we do not receive these documents or if after examining the said documents they contain material information that was not included in the facts, proposed transactions and purpose of the proposed transactions described above and that has relevance in respect of the rulings given.
The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act. Nothing in this ruling should be construed as implying that the Canada Revenue Agency has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those described in the rulings given.
These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the Canada Revenue Agency provided that the Proposed Transactions are completed before
XXXXXXXXXX .
Yours truly,
XXXXXXXXXX
for the Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory
Affairs Branch
ENDNOTES
1 The actual name of this entity may change.
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