14 July 1986 Income Tax Severed Letter 5-1378 - [Mortgage as Qualified Investment]

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.

Revenue Canada Taxation Head Office

B. C. Dodd (613) 995-0051

July 14, 1986

Dear Sirs:

We are writing in reply to your letter of April 2, 1986 wherein you requested our opinion in respect of the provisions of the Income Tax Act (the "Act") concerning the circumstances in which a mortgage would be a qualified investment for a registered retirement savings plan (RRSP) as described in subsection 4900(4) of the Income Tax Regulations (the "Regulations").

You have outlined a situation which involves the possible development by your client of a real estate project in Canada for a corporation whose shares would be sold to the public by way of a confidential offering memorandum (an exemption from the provisions of the Saskatchewan Securities Act would be obtained limiting the investment to "sophisticated investors"). You indicate that the number of investors would be approximately fifty. of which 80% would not be related to each other and would not have business connections with each other. The proposal would involve an investor contributing $10,000 to acquire shares of the corporation and lending $40,000 to the corporation secured by a mortgage or a portion of a mortgage on the real estate owned by the corporation. Your concern is whether such a mortgage would be a qualified investment within the meaning of subsection 4900(4) of the Regulations in view of that provision's requirement that the investor (who we assume would be the annuitant under the RRSP which would hold the mortgage) deal at arm's length with the corporation, i.e. the mortgagor.

We note initially that this is not a matter of general interpretation of tax law but is one in which the proper application of the law would hinge largely on the particular facts. Accordingly, your proposed transaction should normally be the subject of an advance income tax ruling request following the procedures outlined in Information Circular 70-6R. In any event, we offer the following general comments on the issues raised in your letter which, you will appreciate, are not binding on the Department.

The requirement that the mortgagor deals at arm's length with the RRSP annuitant and thus whether the corporation and a particular investor in this case would deal at arm's length is determined by the application of section 251 of the Act. Paragraph 251(l)(a) of the Act provides that related persons shall be deemed not to deal with each other at arm's length. It must, therefore, be determined whether the corporation and an investor would be related. Paragraph 251(2)(b) of the Act provides that a corporation is related to:

(i) a person (and any person related thereto) who controls the corporation, if it is controlled by one person; and

(ii) a person (and any person related thereto) who is a member of a related group that controls the corporation.

The fact that the shares of the corporation would be owned equally by all of the investors suggests that no one investor would control the corporation. In the event that the corporation and a particular investor are not related pursuant to paragraph 251(1)(a) of the Act, paragraph 251(l)(b) of the Act provides that it is a question of fact whether unrelated persons were, at a particular time, dealing with each other at arm's length. In circumstances involving a shareholder and corporation (where they are not related as discussed above), there is a general presumption that they deal at arm's length. However, the facts in a particular situation may dictate otherwise. Among other things in this case the conduct of the parties with respect to the terms and administration of the mortgage might have a bearing on the question. Interpretation Bulletin IT-419 on the meaning of arm's length discusses shareholders and corporations in paragraph 19 and 20.

In view of the foregoing, we are unable to express an opinion on the question of whether a mortgage in the circumstances described above would be a qualified investment under subsection 4900(4) of the Regulations for an RRSP. With respect to your other questions, we comment as follows.

1. In an alternative situation where the investor group would consist of a small number (e.g. two to six persons) of unrelated investors, the same comments as those made hereinabove would be in order. Again it would be a question of fact in each situation.

2. In our view, the fact that a shareholder is a "specified shareholder" as defined in subsection 248(1) of the Act does not in and by itself give rise to a non-arm's length relationship with the corporation.

3. With respect to the relationship between a limited partnership and its members, we refer you to the comments in paragraphs 15 and 16 of IT-419 .

4. In a situation where a mortgage is given by a partnership comprised of 50 partners, you ask whether: (a) one partner would be the mortgagor; (b) one partner would be the mortgagor of 1/50 portion of the mortgage; or (c) one partner would be a mortgagor of that specific portion of the mortgage held by that partner's RRSP. In our view, this is essentially a legal question. It is possible that the finding might be that a partner (who is also the RRSP annuitant) would be the mortgagor of his undivided interest in the partnership property and to that extent the mortgage would not be a qualified investment under subsection 4900(4) of the Regulations.

We trust that the foregoing will be of assistance.

Yours truly,

for Director Financial Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch