2014 Ruling 2014-0518521R3 - Issuance of a new class of units - Hedged Class

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 issuance of a new class of units, being the hedged class of a mutual fund trust, would result in:
(1) a disposition by the existing unitholders of their beneficial interest in the fund; (2) a disposition by the fund of its assets; and, (3) the application of subsection 104(7.1).

Position: (1) No. (2) No. (3) No.

Reasons: (1) The existing unitholders will not receive any cash or other consideration for the issuance of the new class of units; (2) The issuance of the new class will not result in any significant change to the fund so as to cause a resettlement of the fund. Further, it is assumed that there will be no legal resettlement as a matter of provincial law. (3) Consistent with our position in earlier rulings.

XXXXXXXXXX
2014-051852

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Taxpayer") – BN: XXXXXXXXXX

This is in response to your letter dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the Taxpayer. To the best of your knowledge and that of the Taxpayer, none of the issues involved in the ruling request is:

(i) in an earlier return of the Taxpayer or a related person,

(ii) 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,

(iii) under objection by the Taxpayer or a related person,

(iv) before the courts, or

(v) the subject of a ruling previously considered by the Directorate in respect of the Taxpayer or a related person.

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 except as expressly referred to herein, and any references thereto are otherwise provided solely for the convenience of the reader.

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:

a. "Canadian Hedging Contracts" means the currency forward contracts which Fund 1 intends to enter into in respect solely of the Hedged Class in order to minimize the effect of currency movements between the net foreign assets held by such fund attributable to such Hedged Class and the Canadian dollar;

b. "Class" in respect of a Fund means one or more classes of Units of that Fund designated by the Trustee from time to time, and except where the context requires otherwise, includes the Hedged Class;

c. "Class Expenses" means, in respect of any particular Class of a Fund, the expenses of that Fund for the relevant period that are referable specifically to that Class;

d. "Class Liabilities" means in respect of any particular Class of a Fund, the liabilities of that Fund for the relevant period that are referable specifically to that Class;

e. "Class Net Asset Value" as determined pursuant to section XXXXXXXXXX of the Master Declaration of Trust means, as of any Valuation Date (the "Relevant Date") (i) the Class Net Asset Value calculated in respect of that Class on the immediately preceding Valuation Date (the "Previous Date"); (ii) plus or minus the Class' Proportionate Share of Net Change in Working Capital determined in respect of the Relevant Date; (iii) plus the increase in Fund assets due to Unit issuances in respect of Units of that Class issued immediately after the Valuation Time on the Previous Date; (iv) minus the decrease in Fund assets due to redemptions of Units of that Class redeemed immediately after the Valuation Time on the Previous Date; (v) minus the aggregate of additional Class Expenses; (vi) minus any amounts to be paid on the Relevant Date by way of distributions to the Unitholders of that Class; (vii) plus or minus that Class' Proportionate Share of market appreciation or depreciation (excluding any impact due to foreign exchange gains or losses) of the portfolio assets of such Fund on the Relevant Date from the Previous Date.

f. "Common Expenses" means all expenses of a Fund, excluding, without duplication, any Class Expenses, provided that for purposes of calculating the Net Asset Value of a Fund and the Class Net Asset Value of a Class, expenses resulting from the Canadian Hedging Contracts shall not constitute Common Expenses;

g. "Common Liabilities" means all the liabilities of a Fund other than, without duplication, Class Liabilities and other liabilities relating to redemption or reclassification of Units and distributions to Unitholders, provided that for purposes of calculating the Net Asset Value of a Fund and the Class Net Asset Value of a Class, liabilities resulting from the Canadian Hedging Contracts shall not constitute Common Liabilities;

h. "CRA" means the Canada Revenue Agency;

i. "Fund" means each individual trust established and governed by the Master Declaration of Trust;

j. "Funds" means collectively each of the Funds, established and governed by the Master Declaration of Trust as listed from time to time in Schedule XXXXXXXXXX to the Master Declaration of Trust including for greater certainty, Fund 1;

k. "Fund 1" means XXXXXXXXXX;

l. "Hedged Class" means the proposed new Class of a Fund, where the net foreign assets of the Class are hedged against one or more foreign currencies back to the Canadian dollar as further described in 19 to 22 below;

m. "Hedged Class Net Asset Value" of a Hedged Class of a Fund, as determined pursuant to section XXXXXXXXXX of the Master Declaration of Trust means, as of the Relevant Date, (i) the Hedged Class Net Asset Value calculated in respect of that Hedged Class on the Previous Date; (ii) plus or minus that Hedged Class' Proportionate Share of Net Change in Working Capital determined in respect of the Relevant Date; (iii) plus the increase in Fund assets due to Unit issuances in respect of Units of that Hedged Class issued immediately after the Valuation Time on the Previous Date; (iv) minus the decrease in Fund assets due to redemptions of Units of that Hedged Class redeemed immediately after the Valuation Time on the Previous Date; (v) minus the aggregate of additional Class Expenses of the Hedged Class; (vi) minus any amounts to be paid on the Relevant Date by way of distributions to the Unitholders of the Hedged Class; (vii) plus or minus that Hedged Class' Proportionate Share of market appreciation or depreciation (excluding any impact due to foreign exchange gains or losses) of the portfolio assets of such Fund on the Relevant Date from the Previous Date, and, (viii) adjusting the result for the change in value at the Valuation Time of the currency forward hedges entered into in respect solely of such Hedged Class in order to minimize the effect of currency movements between the net foreign assets held by the Fund attributable to such Hedged Class and the Canadian dollar (the "Canadian Hedging Contracts") and for any monies paid or received in excess of the value of any Canadian Hedging Contracts settled since the Previous Date;

n. "Hedged Class Net Asset Value per Unit" in respect of any particular Hedged Class of Units of a Fund means the Hedged Class Net Asset Value in effect at that time divided by the number of Units of that Hedged Class outstanding at that time;

o. "Hedged Unit" means an equity interest in the Hedged Class, with such designation, rights, privileges, restrictions and conditions attached thereto as determined by the Trustee and which are issued from time to time in accordance with the provisions of the Master Declaration of Trust;

p. "Hedged Unitholder" means the holder of a Hedged Unit;

q. "Manager" means the Taxpayer, acting as the investment fund manager of the Funds, including Fund 1;

r. "Master Declaration of Trust" means the Amended and Restated Master Declaration of Trust in respect of the XXXXXXXXXX;

s. "Net Asset Value of a Fund" as determined pursuant to section XXXXXXXXXX of the Master Declaration of Trust means, as of any Valuation Time, the fair value of the Fund's assets as of that Valuation Time, less an amount equal to Common Liabilities and Total Class Liabilities of a Fund (without duplication) as of that Valuation Time;

t. "Proportionate Share" means, at the Valuation Time on any Valuation Date, the share of a particular Class of Units as a whole, determined by the Trustee by taking into account changes to the Class Net Asset Value and Hedged Class Net Asset Value applicable to Units of the particular Class and to the Net Asset Value of the Fund as a whole, in both cases as at the immediately preceding Valuation Date;

u. "Proposed Transactions" means the transactions described in 17 to 25 below;

v. "Reclassification Ratio" means the quotient obtained when the Net Asset Value of a Unit of the Class of a Fund into which a Unit is being reclassified is divided by the Net Asset Value of a Unit of the Class of that Fund that is being reclassified, in each case, at the relevant time;

w. "Taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;

x. "Total Class Liabilities" means the aggregate of the Class Liabilities in respect of each Class;

y. "Trustee" means the Taxpayer, acting as trustee of the Funds, including Fund 1;

z. "Unit" means a unit of interest in a Fund;

aa. "Unitholder" means a holder of Units;

bb. "Valuation Date" means any day determined by the Trustee; and

cc. "Valuation Time" means the particular time on a Valuation Date at which the Net Asset Value of a Fund, the Class Net Asset Value and the Hedged Class Net Asset Value of a Fund are determined, as prescribed by the Trustee from time to time.

Facts

1. Fund 1 is resident in Canada for the purposes of the Act.

2. Fund 1 is a "unit trust" within the meaning of paragraph 108(2)(a) of the Act and a "mutual fund trust" within the meaning of subsection 132(6) of the Act.

3. Fund 1's investment objective is to generate a high level of current income, primarily through investment in senior floating rate loans and other floating rate debt instruments, as well as lower-rate debt securities of issuers located anywhere in the world.

4. Fund 1 was established on XXXXXXXXXX. It has not applied in advance for a tax account number with CRA and expects to be assigned one at the time of filing its first tax return.

5. The Taxpayer is a taxable Canadian corporation XXXXXXXXXX.

6. The Taxpayer's head office and registered office is XXXXXXXXXX.

7. The Taxpayer's tax account number is XXXXXXXXXX.

8. Each Class of a Fund is divided into equal interests referred to as whole Units, and fractions thereof. Pursuant to section XXXXXXXXXX of the Master Declaration of Trust (XXXXXXXXXX), Units of a particular Class of a Fund participate pro rata in the distributions made by the Fund based on the respective net asset values of each Class except with respect to Management Fee Distributions, Expense Distributions and Return of Capital Distributions (as such terms are defined in the Master Declaration of Trust) and participates pro rata in the net assets of the Fund based on the respective net asset values of each Class upon termination of the Fund.

9. Pursuant to sections XXXXXXXXXX of the Master Declaration of Trust (XXXXXXXXXX), the Trustee in its discretion, may authorize the creation of classes of a Fund. Each Class of a Fund shall be designated, as determined by the Trustee from time to time, and the Classes of Units authorized from time to time shall be set out in Schedule XXXXXXXXXX to the Master Declaration of Trust. Section XXXXXXXXXX of the said document provides that each Fund has the Classes of Units set forth in Schedule XXXXXXXXXX.

10. Pursuant to section XXXXXXXXXX of the Master Declaration of Trust (XXXXXXXXXX), the Net Asset Value of a Fund and the Class Net Asset Value of a Class of a Fund are determined by the Manager as at the Valuation Time on each Valuation Date (generally on each business day).

11. Where a Class has identifiable expenses properly allocated to the Class, then expenses are charged to and borne by the Class pursuant to section XXXXXXXXXX of the Master Declaration of Trust. The bearing of expenses solely by a Class may be appropriately reflected in the calculation of the Class Net Asset Value of a Fund which may cause differences in the Class Net Asset Values of a Fund relative to other Classes of a Unit of the Fund, and the distribution, redemption and liquidation rights of the Units of such Class.

12. However, where Units of a Fund are divided into more than one Class, no Class of the Fund may in a particular taxation year, have either a loss, computed in accordance with the provisions of the Act, or net capital loss, when another Class has net income or net capital gains in that particular year because pursuant to section XXXXXXXXXX of the Master Declaration of Trust, the net income of a Fund is determined without regard for Classes and the entitlement of a particular Class to receive income distributions is restricted to the income of a particular Fund taken as a whole.

13. Pursuant to section XXXXXXXXXX of the Master Declaration of Trust, each Fund will declare as due and payable to its Unitholders by the end of each calendar year (or such other date determined by the Trustee, as permitted by the Act), the amount per Unit, if any, by which the net income and net realized capital gains of a Fund, determined by the Trustee in accordance with section XXXXXXXXXX of the Master Declaration of Trust, exceeds the aggregate of:

(i) any such net income and net realized capital gains payable in the year pursuant to sections XXXXXXXXXX of the Master Declaration of Trust, as applicable;

(ii) any non-capital losses for prior years that the Fund is permitted by the Act to deduct in computing its taxable income for the year;

(iii) in the event that the amount of taxable dividends received by the Fund in the year on shares of the capital stock of taxable Canadian corporations exceeds the net income of the Fund for the year, the amount determined by the Trustee, and

(iv) that part of the net realized capital gains of the Fund for the year as determined by the Trustee.

14. Notwithstanding the above allocation, section XXXXXXXXXX of the Master Declaration of Trust states the total amount due and payable by a Fund on the last business day of any year, or such other date to be determined by the Trustee as permitted by the Act, shall not be less than the amount necessary to ensure that a Fund will not be liable for income tax under Part I of the Act for the year, after taking into account any entitlement to a capital gains refund.

15. Pursuant to section XXXXXXXXXX of the Master Declaration of Trust (XXXXXXXXXX), the Net Asset Value of a Fund and any Class Net Asset Value shall be determined in Canadian currency (XXXXXXXXXX) and, in addition, may be determined in any other currency at the discretion of the Manager. If the Manager determines that the Net Asset Value of a Fund, and any Class Net Asset Value are to be determined in any currency other than Canadian currency, the Manager shall give an appropriate written notice of such determination to Trustee.

16. There is currently no currency hedging in Fund 1.

Proposed Transactions

17. Pursuant to section XXXXXXXXXX of the Master Declaration of Trust, the Trustee proposes to amend the Master Declaration of Trust to provide for the ability of a Fund to establish an additional Class that is hedged as described below. The Trustee proposes to establish and designate an additional Class, the Hedged Class, in respect of Fund 1.

18. The proposed XXXXXXXXXX amendment to the Master Declaration of Trust will include the following revisions specific to the Hedged Class in respect of Fund 1:

(i) Pursuant to section XXXXXXXXXX of the Master Declaration of Trust, each Fund may issue unlimited number of units. Each whole Unit of a Fund will have an equal and ratable undivided share of the assets and liabilities of a Fund based on the respective net asset values of each Class and will participate pro rata in the distributions of the Fund based on the respective net asset values of each Class except with respect to Management Fee Distributions, Expense Distributions and Return of Capital Distributions (as such terms will be defined in the Master Declaration of Trust) and will participate pro rata in the net assets of the Fund based on the respective net asset values of each Class upon termination of the Fund.

(ii) Pursuant to section XXXXXXXXXX of the Master Declaration of Trust, the Trustee, in its discretion, may authorize the division of Units of a Fund into an unlimited number of Classes. Each Class of a Fund shall be designated, as determined by the Trustee from time to time, and the Classes of Units authorized from time to time shall be set out in Schedule XXXXXXXXXX to the Master Declaration of Trust. There may be variations between Classes of Units of a Fund with respect to Class Expenses, Class Liabilities, the right to have net foreign assets hedged in the case of Hedged Classes, and Return of Capital Distributions. No Class of Units of a Fund issued in Canadian dollars shall constitute a Hedged Class unless specifically designated as such when the Class is established. Each Fund shall have the Classes of Units set forth in Schedule XXXXXXXXXX to the Master Declaration of Trust.

(iii) Pursuant to section XXXXXXXXXX of the Master Declaration of Trust, the Net Asset Value of a Fund, the Class Net Asset Value of a Class of a Fund and the Hedged Class Net Asset Value of a Hedged Class of a Fund are determined by the Manager as at the Valuation Time on each Valuation Date (generally on each business day).

(iv) Pursuant to section XXXXXXXXXX of the Master Declaration of Trust, the Net Asset Value of a Fund, any Class Net Asset Value and any Hedged Class Net Asset Value shall be determined in Canadian currency (XXXXXXXXXX) and, in addition, may be determined in any other currency at the discretion of the Manager. If the Manager determines that the Net Asset Value of a Fund, any Class Net Asset Value or any Hedged Class Net Asset Value are to be determined in any currency other than Canadian currency, the Manager shall give an appropriate written notice of such determination to Trustee.

19. The Hedged Class is intended for those investors who have Canadian dollar holdings that they intend to invest indirectly in foreign currency securities on a currency neutral basis so as to isolate the performance of the underlying assets of Fund 1 from fluctuations in the Canadian dollar relative to the relevant foreign currency.

20. The only difference between the Hedged Units and the other existing Classes of Units of Fund 1 is that the return for the existing Classes of Units is based on the performance of Fund 1's portfolio of investments including the performance, either positive or negative, attributable to changes in value of the relevant foreign currency relative to the Canadian dollar. The Hedged Class, in contrast, will have a return that is based on the performance of Fund 1's portfolio of investments without regard for the performance, either positive or negative, attributable to changes in value of the relevant foreign currency relative to the Canadian dollar because the foreign currency exposure of the portion of Fund 1 that is attributable to the Hedged Class will be substantially hedged using the Canadian Hedging Contracts.

21. The Hedged Class Net Asset Value of the Hedged Class of Fund 1 will be computed in the same way as the Class Net Asset Value of a Class of a Fund, except that the Hedged Class Net Asset Value of the Hedged Class otherwise determined will be adjusted by the cost of and performance of the Canadian Hedging Contracts held by Fund 1 in relation to the Hedged Class portion of the Fund.

22. Similarly, the amount of distributions of net income and net realized capital gains of Fund 1 payable to Hedge Unitholders will be determined in the same way as for holders of Units of other Classes of Fund 1, except by taking into account the performance of the Canadian Hedging Contracts held by Fund 1 and by taking into account the Class Expenses and any liabilities of Fund 1 in respect of the Canadian Hedging Contracts.

23. Existing Unitholders will not receive any financial compensation or proceeds of any kind, what so ever, as consideration for the issuance of Hedged Units, nor will Units be redeemed or cancelled as a result of the issuance of Hedged Units.

24. Unitholders (who are not Hedged Unitholders) will continue to receive their pro rata share of distributions of Fund 1 calculated before the effects of the Canadian Hedging Contracts. The costs or benefits sustained from the Canadian Hedging Contracts will only be allocated to those investors who hold the Hedged Class.

25. For greater certainty, however, losses, if any, from the Canadian Hedging Contracts will first be allocated against income attributable to the Hedged Class and, in circumstances where losses exceed such income, the losses will then be applied against income of all other Classes of Units within the Fund consistent with Article XXXXXXXXXX of the Master Declaration of Trust.

Purpose of the Proposed Transactions

26. The purpose of the Proposed Transactions is to enable Fund 1 to offer the Hedged Units as a new Class to investors who wish to invest in Fund 1 but on a basis that their investment return is the foreign market return neutral to fluctuations in the Canadian dollar compared to the relevant foreign currency.

Additional Information

27. The constating documents of Fund 1, including its Simplified Prospectus and Annual Information Form, will be amended to introduce the Hedged Class and describe it as having a currency neutral strategy pursuant to which it intends to maintain an effective hedge between its investments and a particular currency to isolate the real rate of return of the investment from the specified currency fluctuation. The investment objective of Fund 1, as described in 3 above, will not be changed to accommodate this new investment strategy.

28. The currency neutral hedge involves purchasing Canadian Hedging Contracts for a specified currency with a significant correlation or linkage between the Canadian Hedging Contracts and the securities that are being hedged.

29. Fund 1 will consistently maintain the hedge. The proportion hedged will be constant. As each contract terminates, it will be replaced with another similar contract for the next period (subject to fluctuations in the value of Fund 1's securities and any dispositions or acquisitions in the period).

30. A hedge will be maintained regardless of the strength of the reference currency against the Canadian dollar. Thus protection will be achieved against both appreciation and depreciation of the relevant currencies to each other.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, Proposed Transactions and the purpose of the Proposed Transactions, the Proposed Transactions are completed in the manner described above and there are no other transactions that may be relevant to the rulings given, our rulings are as follows:

A. The execution by the Trustee of the proposed XXXXXXXXXX amendment to the Master Declaration of Trust in order to establish and thereafter designate the Hedged Class in respect of Fund 1 will not result, in and by itself, in a disposition by any Unitholder of all or part of his, her or its beneficial interest in Fund 1 provided the rights, privileges, restrictions and conditions attaching to the Hedged Class are based on current market conditions at the time of the offering.

B. The execution by the Trustee of the proposed XXXXXXXXXX amendment to the Master Declaration of Trust in order to establish and thereafter designate the Hedged Class in respect of Fund 1 will not result, in and by itself, in a disposition by Fund 1 of its property or in a resettlement of Fund 1 for purposes of the Act.

C. The implementation of the Proposed Transactions will not, in and by itself, cause subsection 104(7.1) of the Act to deny the deduction by Fund 1 of any amount it is otherwise entitled to deduct under paragraph 104(6)(b) of the Act in respect of amounts paid or payable to its Unitholders and Hedged Unitholders.

Opinions/Caveats

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or Proposed Transactions described herein. For greater certainty, the CRA has not considered, confirmed or made any determination in respect of:

a) whether any specific changes or amendments to the Master Declaration of Trust before the present time would impact on the specific rulings given;

b) the potential tax consequences should a Unitholder reclassify or exchange a Unit, that is not a Hedged Unit, for a Hedged Unit; however, in this regard, it is our preliminary view that at the time of reclassification or exchange of the said Unit for a Hedged Unit, or vice versa, the event would likely result in a taxable disposition;

c) whether any Fund is, at any particular time, a mutual fund trust within the meaning of subsection 132(6) or a unit trust within the meaning of subsection 108(2) of the Act;

d) whether there has been a legal resettlement of any trust under provincial law;
e) whether subsection 104(7.1) may apply in respect of any Return of Capital Distributions, as defined in section XXXXXXXXXX of the Master Declaration of Trust;

f) whether the attributes associated with the Hedged Unit represent current market conditions; and,

g) the potential tax consequences associated with the hedging arrangements described in the Additional Information in 27 to 30 above and more specifically, whether these arrangements represent hedging for income tax purposes.

Further to item (g) above, nothing in this advance income tax ruling should be construed as implying that we are confirming any income tax implications related to the recognition of any currency hedge gain or loss in any particular period and in particular, whether the resulting currency hedge gain or loss is on account of income or capital for tax purposes.

The above advance income tax rulings, which are based on the Act and Income Tax Regulations to the Act in their present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 Advance Income Tax Rulings, dated May 17, 2002, and are binding on the CRA provided that the proposed transactions are completed within six months of the date of this letter.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch