12 April 1995 External T.I. 9417135 - CANADIAN MUTUAL FUND TRUST-NON-RESIDENT

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

5-941713
XXXXXXXXXX (613) 957-8953

April 12, 1995

Dear Sirs:

This is in response of your letter dated December 10 1993, wherein you ask the tax treatment of investments in Canadian mutual funds. More specifically, you ask the following questions concerning such an investment for a non-resident investor:

1- What is the tax treatment of:

- interest income generated by and automatically re- invested in a mutual fund;

- interest expenses generated by buying funds "on margin" through a broker;

- any realized or unrealized capital gains;

- unused net expenses or capital losses.

2-You understand that the Federal government is considering the taxation of 80% of capital gains. You would like to know to effect of such legislation on the answers to question 1.

3-You would like know the effect on the answers to question 1 if you became a resident of Canada. You inquire how and when the tax treatment would change and how it would be calculated.

4-As a non-resident, you ask if you can claim, in reducing any taxable income or taxable capital gains, contributions to Canadian charitable organizations and capital losses carried forward (incurred while a resident of Canada).

5-Finally, you would like to know the impact of the Double Taxation Treaty with Germany.

Our comments

We will answer your questions on the assumption that your investments are represented by units in a mutual fund trust as defined in subsection 132(6) of the Income Tax Act (the "Act") that is, a unit trust whose only undertaking is the investing of funds of the trust.

Question #1

a)Trust Income

As a non-resident unitholder of a Canadian mutual fund trust, any amount of the income of the trust as was paid or became payable to you as the beneficiary of the trust (the "distribution") will generally be subject to a withholding tax under paragraph 212(1)(c) of the Act at the rate of 25%, or such lower percentage as set by treaty. The distribution will be deemed income of a trust by virtue of subsection 212(11) of the Act, whatever source from which the trust derived the income. This tax treatment may apply even though the income of the trust is automatically re-invested. As long as the income of the trust is payable to a unitholder and that unitholder is entitled in the year to enforce the payment, the amount will be deemed paid or credited to the non-resident (paragraph 214(3)(f)) and thus subject to withholding tax pursuant to paragraph 212(1)(c)) of the Act. Such an income distribution by the trust does not require you to file a Canadian income tax return, as the tax is withheld at source.

An exception to paragraph 212(1)(c) of the Act is made for taxable capital gains of a trust where the trust has made a designation under subsection 104(21) of the Act. The designated gains so distributed by a mutual fund trust to a non-resident unit holder are not taxable in Canada.

Other exemptions from paragraph 212(1)(c) of the Act could apply and we refer you to paragraph 9, 10 and 11 of Interpretation Bulletin IT-465R enclosed.

b)Gains and losses from holding units of a Canadian Mutual Fund Trust

A capital gain from the disposition of a unit in a mutual fund trust would only be taxable if the unit is a taxable Canadian property of the non-resident, as provided in subparagraph 115(1)(b)(viii) of the Act. A unit is a taxable Canadian property of a person only if in the period of 5 years preceding the disposition, not less than 25% of the issued units of the mutual fund trust belonged to the non-resident or to persons with whom the non-resident person did not deal at arm's length. If the units are taxable Canadian property, you would be required to file a Canadian income tax return to report any gain or disposition of the units. We assume that you own a relatively modest percentage of the units issued by a mutual fund trust (less than 25% of the issued units of any one trust). If this assumption is correct, the units would not represent "taxable Canadian property" to you within the meaning assigned by paragraph 115(1)(b) of the Act, and you would not be subject to tax on any gain realized on a disposition of a mutual fund trust unit.

The interest expense incurred by you to invest in a mutual fund trust is not deductible against your income from the trust that is subject to withholding tax (subsection 214(1) of the Act). The unused capital losses of a non-resident from other taxation years will be deductible in any particular year against his taxable capital gains from the disposition of taxable Canadian property only if the losses were also incurred from the disposition of taxable Canadian property . Such a loss can be carried forward without any limit and carried back to the three previous years.

Question #2

Since 1990, only 75% of the capital gains realized by a taxpayer are taxable in Canada. We are not aware of any proposed legislation to increase that rate to 80%. Capital gains are only taxable in the year of disposition of the capital property. Unrealized capital gains are generally not taxable.

Question #3

Generally, residents of Canada are taxable on their world income (from all sources, whether domestic or foreign). The distribution of income from the trust would have to be included in your Canadian income tax return as income from an interest in a trust by virtue of subsection 108(5) of the Act. Such inclusion would be required as of the date of you becoming a resident of Canada. The interest expense could be deductible against such income, subject to the usual rules regarding the deduction of interest (the interest must be incurred for the purpose of earning income to be deductible, pursuant to paragraph 20(1)(c) of the Act). Subject to certain restrictions, losses in a year from a business or property of a Canadian resident are generally deductible against other income of the year, if any, or can be applied against the income for tax purposes of the person in the seven following years or the three preceding years, if applicable.

As noted above, 75% of the capital gains realized by a Canadian resident have to be included in income for tax purposes. As a resident of Canada, your capital losses of a year could be applied against your capital gains of other years, subject to certain restrictions.

As a general comment, were you to immigrate to Canada, you would be deemed to acquire your mutual fund units at their fair market value at the time you arrived in Canada, assuming they are not for you taxable Canadian property as defined above. If you dispose of the units after you have established Canadian residency, you will be taxable on 75 % of your capital gain on the disposition, and in general, the capital gain would be the difference between the selling price of the properties and their fair market value at the time you immigrated to Canada.

Question #4

Based on the earlier assumption that your investments in Canadian mutual funds do not constitute taxable Canadian property to you, you would be subject to tax at the rate of 25% in respect of the trust income distributed. As noted earlier, no deductions can be claimed against this withholding tax. If however you have other income sources that are taxable in Canada (salary, business income or taxable capital gains), you may be entitled to claim in very limited circumstances a non-refundable credit in the calculation of your income tax payable (section 118.94). In order to be able to reduce your income tax payable in Canada as a non-resident with such a credit, you would have to demonstrate that all or substantially all of your world income for the year is included in computing your taxable income earned in Canada for the year. The term "all or substantially all" is considered by the Department to be 90%.

Any capital losses incurred while formerly a resident of Canada cannot be carried forward to be applied against capital gains realized by a non-resident.

Question #5

Any income distribution from a mutual fund trust to a resident of Germany will be subject to the withholding rate of 25% referred to in question 1 since the Canada-Germany Income Tax Agreement (the "Agreement") does not provide for a reduced of rate of withholding in respect of income from a trust (Article 21(1)). The basic right to tax, however, is given to the country of residence by virtue of the Agreement. Normally, the gross amount of the income (including the amount withheld in Canada) is required to be reported as income in the state of residence, with that state giving some form of tax credit in respect of the taxes paid in the foreign jurisdiction. You should consult your local tax authorities in this regard.

Capital gains realized on the disposition of taxable Canadian property in the situation you presented would generally be exempt from the tax treatment referred to in question 1 by virtue of Article 13 the Agreement since the right to tax is given to the state in which the author of the disposition is resident. There would be no taxation in Canada in respect of a capital gain by a resident of Germany on the disposition of a unit in a mutual fund trust that qualifies as a taxable Canadian property. An exception to this would occur if the value of the interest in the mutual fund trust so disposed is derived principally from immovable property situated in Canada. In such a case, the capital gain from the disposition of the unit would remain taxable in Canada by virtue of the treaty.

We trust the present information will be of assistance to you.

We apologize for the lengthy delay in responding.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch