6 January 2011 External T.I. 2009-0328781E5 - Tracking Property

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: Various issues on the application of the tracking property rules.

Position: See below.

Reasons: See below.

XXXXXXXXXX 								2009-032878
									Terry Young, CA
January 6, 2011

Dear XXXXXXXXXX :

Re: Tracking Properties

We are writing in response to your correspondence dated June 5, 2009, in which you requested our views concerning the interpretation of the tracking property rules in subsection 142.2(1) of the Income Tax Act ("the Act"). We also acknowledge our conversations (Young / XXXXXXXXXX , Demeter / XXXXXXXXXX ). We apologize for the delay in replying to your letter.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we can offer the following general comments that may be of assistance.

Our Comments

Subsection 142.2(1) defines mark-to-market property as follows:

"mark-to-market property" of a taxpayer for a taxation year means property (other than an excluded property) held at any time in the taxation year by the taxpayer that is

(a) a share,
(b) if the taxpayer is not an investment dealer, a specified debt obligation that is a fair value property of the taxpayer for the taxation year,
(c) if the taxpayer is an investment dealer, a specified debt obligation, or
(d) a tracking property of the taxpayer that is a fair value property of the taxpayer for the taxation year;

Paragraph (d) above was added for taxation years that began after November 6, 2007. The subsection defines tracking property as follows:

"tracking property" of a taxpayer means property of the taxpayer the fair market value of which is determined primarily by reference to one or more criteria in respect of property (referred to in this definition as "tracked property") that, if owned by the taxpayer, would be mark-to-market property of the taxpayer, which criteria are

(a) the fair market value of the tracked property,
(b) the profits or gains from the disposition of the tracked property,
(c) the revenue, income or cash flow from the tracked property, or
(d) any other similar criteria in respect of the tracked property; (emphasis added)

Based on the wording of the provision, it is our view that the tracking property rules are anti-avoidance provisions that should be interpreted broadly. This view is supported by the technical notes that were released by the Department of Finance with the introduction of the tracking property rules. The technical notes state:

Property qualifying as tracking property is added as mark-to-market property to ensure that a financial institution will not be able to avoid mark-to-market treatment on properties by investing through an intermediary or through the use of another financial instrument (such as a derivative). (footnote 1)

The tracking property rules provide for a "look through" to determine whether the tracked property, if held directly by the taxpayer, would be mark-to-market property. Therefore, when determining if a property is a tracked property, the test is whether the property would be a mark-to-market property if it were held directly by the taxpayer.

Does "property" mean a single property or one or more properties?

You asked us if the reference in the definition of tracking property to "in respect of property" refers to a single tracked property or if it can refer to multiple tracked properties?

The phrase "in respect of property" refers to one or more tracked properties. The word property can mean either the singular or the plural. An example of the use of the word property to include multiple properties can be found in the preamble to subsection 85(1), "...where a taxpayer has ... disposed of any of the taxpayer's property that was ..." Further, subsection 33(2) of the Interpretation Act, which applies to the Act, states, "Words in the singular include the plural, and words in the plural include the singular."

Finally, the Supreme Court of Canada has stated that "the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament." (footnote 2) To interpret the phrase "in respect of property" as referring to only a single property would mean that the tracking property rules would only apply to situations where a single tracked property made up more than half of the property in question. This would render the tracking property provisions virtually meaningless.

Linkage between the tracking property and the tracked property

You asked us whether a direct mechanism linking the value of a property to particular tracked properties is required in order to find that the property is a tracking property.

The definition of tracking property states, "... the fair market value of which is determined primarily by reference to one or more criteria..." and "(d) any other similar criteria in respect of the tracked property." (emphasis added) Reading the language of the provision in a contextual and purposeful manner, in our view it is clear that a direct mechanism is not required. The words "primarily by reference" and "any other similar criteria in respect of the tracked property" suggest that there be a correlation between the criteria and the fair market value of the subject property, not necessarily a direct mechanism.

What is fair value property?

In order for tracking property to be mark-to-market property, it must be fair value property of the taxpayer for the year. Fair value property is defined in subsection 142.2(1) to mean "property ... that is - or it is reasonable to expect would, if the taxpayer held the property at the end of the taxation year, be - valued in accordance with generally accepted accounting principles, at its fair value (determined in accordance with those principles) in the taxpayer's balance sheet as at the end of the taxation year". In our view, this means the determination must be made in accordance with Canadian GAAP (which includes IFRS as applicable) applied on a non-consolidated basis, not on some other basis.

Determining significant interest

When determining if a property is tracking property, it is necessary to determine if the tracked property would be mark-to-market property if held directly by the taxpayer. Where the tracked property is shares, it is necessary to determine if the taxpayer would have a significant interest in the corporation if the shares were held directly.

Pursuant to subsection 142.2(2):

Significant interest - For the purposes of the definitions "excluded property", "mark-to-market property" and "specified debt obligation" in subsection (1) and subsections (5) and 142.6(1.6), a taxpayer has a significant interest in a corporation at any time if

(a) the taxpayer is related (otherwise than because of a right referred to in paragraph 251(5)(b)) to the corporation at that time; or
(b) the taxpayer holds, at that time,

(i) shares of the corporation that give the taxpayer 10% or more of the votes that could be cast under all circumstances at an annual meeting of shareholders of the corporation, and
(ii) shares of the corporation having a fair market value of 10% or more of the fair market value of all the issued shares of the corporation.

In order to determine whether a tracked property would be a mark-to-market property of the taxpayer if held directly, we agree that it is necessary to determine if the taxpayer would have a significant interest in the corporation if it held the shares directly. In order to make that determination, it is our view that the taxpayer's percentage interest in the tracking property must be applied to the tracked property to determine the percentage that would be directly held by the taxpayer.

For example, the taxpayer owns a 40% interest in ABC, a mutual fund trust (a fair value property of the taxpayer), whose only asset is 20% of the shares of ACO. Through its interest in ABC, the taxpayer owns 8% of ACO (40% of 20%). These shares would be mark-to-market property of the taxpayer pursuant to paragraph (a) of that definition if they were held directly and, because the taxpayer does not hold a significant interest in ACO, the shares would not be excluded property. In our view, the fair market value of the taxpayer's interest in ABC would be determined entirely by reference to the FMV of the underlying shares in ACO. Therefore, the taxpayer's interest in ABC is a tracking property that is a fair value property and is a mark-to-market property.

Must a property be mark-to-market property at the time of disposition to be treated as a mark-to-market property?

The definition of mark-to-market property and excluded property apply to the determination of whether property is tracking property in the same way that they apply to shares or specified debt obligations held directly.

This means that a property that is both a tracking property and a fair value property at any time in the year is a mark-to-market property for the year unless the property is excluded property. If a property is excluded property at any time in the taxation year, it is excluded property for the year and, therefore, is not mark-to-market property for the year.

Therefore, a property does not have to meet the requirements of the definition of tracking property at the time of its disposition in order to be a mark-to-market property for the year as long as it was a tracking property and a fair value property at some point in the year, and not an excluded property at any time in the year.

We also note that, even if a property is not mark-to-market property, it could still be taxed on an income basis. Whether a property is held on account of income or capital is a question of fact. Just because a property is not mark-to-market property does not necessarily mean that it is a capital property.

Are warrants tracking property?

Whether a warrant is considered "tracking property" of a taxpayer will generally depend on whether its fair market value is determined primarily by reference to the fair market value of the referenced property (i.e., the share). Although, the change in fair market value of a warrant may not correlate 100% with changes in the fair market value of the share to which it relates, in our view, the change in share price generally is the primary driving factor in the fair market value of warrants. Consequently, a warrant generally would be a tracking property. We note that a warrant is a derivative security and the Department of Finance technical notes on tracking property specifically refer to financial instruments such as derivatives.

Other comments

You asked us to comment on a number of other scenarios or properties (for example, whether credit default swaps could be tracking properties). We are not in a position to address these questions without having actual specific fact situations on which to comment.

We trust that our comments will be of assistance.

Yours truly,

Jenie Leigh
Manager
Charitable and Financial Institutions Sectors
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Department of Finance Technical Notes, February 2009.
2 65302 British Columbia Ltd. v. Canada, [1999] 3 S.C.R. 804, paragraph 50 and reaffirmed in Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, paragraph 10.