7 July 1996 Income Tax Severed Letter 9618493 - Mutual fund partnership

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.

SUMMARY: Advance income tax ruling—Tax implications for a mutual fund partnership and mutual funds where sales commissions are paid in a particular manner.

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.

XXXXXXXXXX 961849

Attention: XXXXXXXXXX

XXXXXXXXXX, 1996

Dear Sirs:

Re: XXXXXXXXXX

This is in reply to your letters dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-named taxpayers and Partnership. We understand that to the best of your knowledge and that of the taxpayers involved, none of the issues described herein is:

(a) being considered by a Tax Services Office or a Taxation Centre in connection with any tax returns already filed, or

(b) the subject of any notice of objection or is under appeal.

Our understanding of the relevant facts, proposed transactions and the purpose of the proposed transactions is as follows:

FACTS

1. XXXXXXXXXX

Both corporations are "private corporations" in accordance with the definition of the term under subsection 89(1) of the Income Tax Act (the "Act").

2. XXXXXXXXX

Each of the Funds qualifies as a unit trust and a mutual fund trust within the meaning of subsections 108(2) and 132(6) of the Act, respectively. In addition, XXXXXXXXXX are "registered investments" within the meaning of section 204.4 of the Act.

3. XXXXXXXXXX

4. XXXXXXXXXX 5. XXXXXXXXXX

6. The capital of each of the Funds is divided into units ("Units") which are offered for sale to the public at a price (the "Unit Price") equal to the Net Asset Value per Unit as of the date of purchase. Units are also redeemable by the holders thereof at a price (the "Redemption Price") equal to the Net Asset Value per Unit as of the date of redemption.

7. The Trust Deeds of the Funds provide for the method of valuing the assets of the Funds and for the computation of the net asset value ("Net Asset Value") of the Funds, which is in turn used to calculate the Net Asset Value per Unit. In determining the Net Asset Value of a Fund, assets of the Fund are valued at market value determined by the Manager as being the most recent value established on the market at which the asset held by the Fund trades. Liabilities of the Fund are deducted from the aggregate asset value so determined. In general, the Net Asset Value per Unit is obtained by dividing the Net Asset Value of the Fund by the number of Units of the Fund outstanding.

8. Since the date of the Funds' formation, Units have been sold at a cost to the purchaser (the "Unit Price") equal to the aggregate Net Asset Value per Unit of all Units purchased plus a sales commission that is paid by the purchaser to the sales agent who sold the Units. The amount of the sales commission is negotiable but in no event may the sales commission exceed XXXXXXXXXX% of the Unit Price. Accordingly, the aggregate cost to the purchaser (the "Purchase Amount") equals the aggregate of the Unit Price and the negotiated sales commission.

9. XXXXXXXXXX is a subsidiary wholly-owned corporation of XXXXXXXXXX and is the sponsor and promoter of the Funds. XXXXXXXXXX is a "private corporation" in accordance with the definition of the term under subsection 89(1) of the Act and is a diversified financial services organization which provides, through its subsidiaries, management, administrative, marketing and distribution services.

10. Pursuant to the Trust Deeds governing each of the Funds, XXXXXXXXXX was appointed manager of each of the Funds. As manager of a Fund, XXXXXXXXXX is responsible for the management and administration of the Fund, including arranging the distribution of the Units and subcontracting the sale of Units of the Funds to persons who are registered under the securities legislation of the applicable jurisdictions to sell such Units. 11. In consideration of the management services provided by XXXXXXXXXX, the Funds pay management fees calculated as a percentage of the Net Asset Value of the Funds. The management fee for each Fund is paid monthly by the respective Funds. XXXXXXXXXX pays portfolio management fees to persons engaged to provide investment portfolio management advice to the Funds.

12. The Partnership was formed as a Limited Partnership under the Partnership Act (XXXXXXXXXX) by filing under the XXXXXXXXXX a declaration of partnership on XXXXXXXXXX with XXXXXXXXXX as general partner ("General Partner"), and XXXXXXXXXX as the initial limited partner, of the Partnership.

PROPOSED TRANSACTIONS

13. Units of the Funds are offered for sale on a continuous basis by registered dealers selling through the Manager or by other distribution agent appointed by the Manager. Pursuant to a pro forma simplified prospectus and a pro forma annual information form, Units of the Funds will be offered for sale to the public under either the "Initial Sales Charge Option" or the "Deferred Sales Charge Option".

14. Under the Initial Sales Charge Option, investors will pay the Unit Price of the Unit, plus a sales commission payable at the time of purchase. The amount of the sales commission will be paid by the investor to the sales agent by whom the Unit is sold and is negotiable but in no event may the sales commission exceed XXXXXXXXXX% of the Unit Price and XXXXXXXXXX% of the Purchase Amount, as described in paragraph 8 above.

The Manager will be entitled to charge a redemption fee in respect of redemption of Units purchased under the Initial Sales Charge Option in an amount of up to XXXXXXXXXX% of the value of each Unit to be redeemed, if the redemption occurs within XXXXXXXXXX days from the date of issue. This redemption charge will not apply to Units purchased through the automatic reinvestment of distributions from a Fund. Such redemption charge will be deducted from the price of the Units being redeemed ("Redemption Price") and will be retained by the Manager.

15. For Units purchased under the Deferred Sales Charge Option, the investor is not required to pay any sales commission at the time of purchase. The Partnership will be responsible for paying the sales commission for Units purchased under the Deferred Sales Charge Option. Under certain circumstances a redemption fee (the "Deferred Sales Charge") may be charged at the time of redemption of Units purchased under the Deferred Sales Charge Option and of Units acquired on the automatic reinvestment of income or capital gain distribution to holders, as a result of their ownership of such Units. All Units purchased under the Deferred Sales Charge Option and any Units owned by the investor that are derived, whether from the reinvestment of distributions or otherwise, from the ownership of Units originally purchased under the Deferred Sales Charge Option are hereinafter referred to as "Deferred Sales Charge Units".

16. The amount of the Deferred Sales Charge payable on redemption of Deferred Sales Charge Units will be based upon a percentage of the original purchase price of the Units being redeemed, and depends upon how long the investor has held such Units, as set out in the following table:

If Units are Redeemed During Deferred Sales Charge the Following Period after as a Percentage of Date of Original Purchase or Original Unit Price

Deemed Original Purchase

XXXXXXXXXX

The Deferred Sales Charge will be deducted from the total Redemption Price of each Unit redeemed and will be paid to the Manager or, at the request of the Manager, to the Partnership, for the Partnership's services as the distribution agent for the Deferred Sales Charge Units as described in paragraph 21 below.

17. No Deferred Sales Charge is payable upon the redemption of Deferred Sales Charge Units if:

(a) the Deferred Sales Charge Units are redeemed pursuant to XXXXXXXXXX exchange program pursuant to which the proceeds of the redemption are immediately used to purchase Deferred Sales Charge Units of one or more of the other Funds under the Deferred Sales Charge Option;

(b) the Deferred Sales Charge Units are redeemed under XXXXXXXXXX free redemption program pursuant to which investors may redeem each year, through an automatic withdrawal plan on a monthly or quarterly basis, without Deferred Sales Charge, Deferred Sales Charge Units which have an aggregate Net Asset Value up to the sum of (i) XXXXXXXXXX% of the aggregate original Unit Price of all of the Deferred Sales Charge Units in that Fund held by the investor as at XXXXXXXXXX of the prior year plus (ii) XXXXXXXXXX% of the aggregate original Unit Price of all of the Deferred Sales Charge Units acquired by the investor during the current year.

If Deferred Sales Charge Units of one Fund are exchanged for Deferred Sales Charge Units of another Fund, any unexercised free redemption right will also be transferred on a proportionate basis. Rights under the free redemption program are not cumulative and will not be carried forward to future years.

18. The following rules will govern the calculation of the Deferred Sales Charges levied against an investor on the redemption of Deferred Sales Charge Units:

(a) An investor who owns Deferred Sales Charge Units and other Units shall, when redeeming or exchanging such Units, specify which Units are to be redeemed. If an investor fails to specify which Units are to be redeemed or exchanged, Units that are not Deferred Sales Charge Units shall be redeemed or exchanged in priority to Deferred Sales Charge Units.

(b) Except as otherwise provided, Deferred Sales Charge Units will be redeemed or exchanged in the order in which they were purchased or deemed to be purchased.

(c) Deferred Sales Charge Units which are issued on an exchange from one Fund to another Fund will be deemed to have been issued on the date of issue of the original Deferred Sales Charge Units at the cost of such original Deferred Sales Charge Units.

(d) Deferred Sales Charge Units which are issued upon the automatic reinvestment of distributions will be deemed to have been issued on the date of issue of the Deferred Sales Charge Units on which such distribution was made. The original cost of such Units will be the Net Asset Value of such Units determined immediately following such distribution.

19. An investor may transfer all or any part of his Units between Funds if those Units were purchased under the same purchase option. A negotiable commission, which may not exceed XXXXXXXXXX% of the value of the Units exchanged, may be charged by the investor's dealer, regardless of the purchase option selected by an investor.

20. The Partnership will enter into an agreement (the "Distribution Agreement") with the Manager, whereby the Manager will grant to the Partnership the exclusive right to arrange for the distribution of Deferred Sales Charge Units of the Funds through registered dealers, XXXXXXXXXX (the "Distribution Agreement"). The period in which such distribution will be made shall commence on the date on which this ruling letter is issued and end on XXXXXXXXXX (the "Distribution Period"). Under the Distribution Agreement, the Partnership will be responsible for paying sales commissions payable to registered dealers in respect of the sale of Deferred Sales Charge Units distributed by the Partnership ("Sales Commissions"). These Sales Commissions will not exceed XXXXXXXXXX% of the Unit Price of Deferred Sales Charge Units sold.

21. In return for arranging for the distribution of Deferred Sales Charge Units and paying the Sales Commissions in respect thereof, the Partnership will receive a distribution fee, payable quarterly at an annual rate of XXXXXXXXXX% on the average daily Net Asset Value per Unit of the outstanding Deferred Sales Charge Units distributed by the Partnership. The distribution fee represents a portion of the fee payable to XXXXXXXXXX by each of the Funds. Pursuant to the Distribution Agreement, XXXXXXXXXX will unconditionally and irrevocably assign and transfer such portion of its fee to the Partnership. The distribution fee will be payable to the Partnership commencing XXXXXXXXXX and, subject to earlier termination of the Partnership, will continue thereafter until XXXXXXXXXX. Notwithstanding, the Partnership will accrue a proportionate amount of distribution fee income in respect of its fiscal year ending XXXXXXXXXX, and will report such income for tax purposes. The amount to be accrued by the Partnership will be calculated in accordance with generally accepted accounting principles.

In addition, the Partnership will be entitled to receive any Deferred Sales Charges paid upon the redemption of Deferred Sales Charge Units. The amount of such Deferred Sales Charges is payable to the Partnership on a quarterly basis commencing with the first quarter following the date upon which the requested ruling is issued.

22. A limited partnership agreement (the "Partnership Agreement") will be entered into between the General Partner of the Partnership and the initial limited partner which has contributed $XXXXXXXXXX to the capital of the Partnership for one limited partnership unit ("Partnership Unit") in the Partnership. Upon subscription of a Partnership Unit under the offering described in paragraphs 23 and 24 below, the initial limited partner's Partnership Unit shall be redeemed and the capital contribution made in respect thereof shall be returned.

23. Pursuant to a Prospectus to be prepared and filed under the provisions of the Securities Act (XXXXXXXXXX), the Partnership will offer Partnership Units to the public in the Province of XXXXXXXXXX. An investor will become a "Limited Partner" of the Partnership upon acceptance, by the General Partner, of the investor's subscription for Partnership Units and the inclusion in the Partnership's books and records of the relevant information in respect of the investor.

24. The offering will consist of a minimum of XXXXXXXXXX Partnership Units and a maximum of XXXXXXXXXX Partnership Units at a price of $XXXXXXXXXX per Partnership Unit. Partnership Units will be offered for sale only to persons resident in Canada. It is expected that the first closing of the offering of the Units will take place on or about XXXXXXXXXX and subsequent closings will occur no later than XXXXXXXXXX. The subscription price for Partnership Units will be payable in full in one instalment at the time of closing of the particular offering.

25. The Partnership will use the proceeds of the offering to pay to the "Agent", as described in paragraph 26 below, a commission, expenses incurred in relation to the offering, Sales Commissions on Deferred Sales Charge Units, other operating expenses and to repay amounts borrowed and expenses related to such borrowings.

26. The Partnership has entered into an agreement with XXXXXXXXXX (the "Agent") pursuant to which the Agent will distribute Partnership Units in XXXXXXXXXX on a best efforts basis. The Partnership will pay to the Agent a commission of XXXXXXXXXX% of the aggregate subscription amount in respect of all Partnership Units sold. No Partnership Units will be issued prior to the date of this ruling letter, although subscriptions for Partnership Units may be solicited, conditional upon the rulings requested being obtained.

27. Offering expenses of approximately $XXXXXXXXXX to be incurred in connection with issuing or selling Partnership Units will be paid by the Partnership. Such expenses will include advertising and marketing costs, legal and accounting costs related to the offering and the costs of preparing and printing prospectuses.

28. The Partnership Agreement provides that the General Partner will be entitled to XXXXXXXXXX% of the net income or loss of the Partnership and that XXXXXXXXXX% of such net income or loss will be allocated among Limited Partners of record at the end of each fiscal year in proportion to the number of Partnership Units held by each of them.

29. Pursuant to the Partnership Agreement, the general partner of the Partnership will have exclusive authority to manage the business and affairs of the Partnership and to make all decisions regarding the business of the Partnership.

30. Under the Partnership Agreement, any portion of the Limited Partners' capital contributions received by the Partnership that has not been expended on or prior to XXXXXXXXXX will be returned to the Limited Partners in proportion to the number of Partnership Units owned by each of them.

31. Commencing in XXXXXXXXXX, provided all borrowings of the Partnership, if any, have been repaid, the Partnership shall make quarterly cash distributions ("Cash Distributions"), as defined below, to the General Partner and Limited Partners on record, in proportion to the number of Partnership Units held by each of them, for each calendar quarter or such other period as may be determined (the "Distributable Period").

Cash Distributions means the amount by which cash receipts by the Partnership in respect of the distributable period and the amount of any reserves retained at the end of such previous period, if any, exceed the expenses of the Partnership for the distributable period, amounts used to repay borrowings in such period and any reserves established by the General partner for the ensuing distributable period. In the case of a Distributable Period ending on XXXXXXXXXX, such Cash Distributions will be made within XXXXXXXXXX days of the end of such Distributable Period and for other Distributable Periods, Cash Distributions will be made within XXXXXXXXXX days of the end of the particular Distributable Period. 32. The Partnership will be terminated and the procedures for dissolution will be commenced upon the first occurring of the following events or dates:

(a) XXXXXXXXXX;

(b) the first day after XXXXXXXXXX on which there remains outstanding no Deferred Sales Charge Units in respect of which the Partnership is entitled to receive distribution fees;

(c) the removal or deemed removal of the General Partner unless the General Partner is replaced in accordance with the provisions of the Partnership Agreement; or

(d) the date upon which an extraordinary resolution is passed to dissolve the Partnership.

33. The General Partner has full authority, for and on behalf of and in the name of the Partnership, to borrow funds from time to time from financial institutions selected by the General Partner or from XXXXXXXXXX or its affiliates, including the General Partner, but only to pay operating expenses of the Partnership, including Sales Commissions and the cost of issuing Partnership Units. The rate of interest and any other expenses related to such borrowings shall not exceed that which the Manager pays in relation to borrowings from its principal lenders on loans to finance the Partnership plus XXXXXXXXXX% per annum, and shall never exceed that which the Partnership could obtain from a Canadian chartered bank with respect to similar borrowings.

34. On behalf of the Partnership, the General Partner will enter into an administrative services agreement with its affiliate, XXXXXXXXXX. XXXXXXXXXX is a subsidiary wholly-owned corporation of XXXXXXXXXX and is a "private corporation" in accordance with the definition of the term under subsection 89(1) of the Act. XXXXXXXXXX will provide administrative services to the Partnership which will include:

- maintaining financial accounts in connection with the business of the Partnership;

- preparing and filing all necessary reports and filings required by applicable corporate, partnership and securities legislation;

- paying distributions to Limited Partners;

- arranging for the payment of Sales Commissions to dealers in connection with the distribution of Units by the Partnership; and

- providing all other general day-to-day activities as may be required for the purpose of maintaining the business and operation of the Partnership.

Commencing XXXXXXXXXX is to be reimbursed by the Partnership for all expenses incurred by it on behalf of the Partnership and to receive an annual fee equal to XXXXXXXXXX% of ongoing expenses of the Partnership, other than interest or other expenses related to borrowings by the Partnership and Sales Commissions payable by the Partnership. The aggregate of all such fees and expenses to be reimbursed for the period ending XXXXXXXXXX is limited to $XXXXXXXXXX which amount may increase by XXXXXXXXXX% per year thereafter.

35. The Partnership's annual financial statements, as reported on by the auditors, will account for Sales Commissions paid on unredeemed Deferred Sales Charge Units by amortizing the Sales Commissions based on revenue over a XXXXXXXXXX year period.

36. The Partnership Units will be a tax shelter within the meaning assigned by subsection 237.1(1) of the Act. The General Partner will obtain an identification number in respect of the Partnership pursuant to subsection 237.1(2) of the Act. The General Partner will file annual tax shelter information returns and provide copies to the Limited Partners pursuant to subsection 237.1(7) of the Act.

37. The fiscal period of the Partnership will end on XXXXXXXXXX

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Partnership is to pay the Sales Commissions on sales of Deferred Sales Charge Units of the Funds, to facilitate the sale of such Deferred Sales Charge Units to investors in the Funds and to allow such investors to earn income based on distribution fees earned by the Partnership and Deferred Sales Charges payable to the Partnership on the redemption of Deferred Sales Charge Units, including such Units issued upon the automatic reinvestment of distributions on Deferred Sales Charge Units of the Funds.

RULINGS GIVEN

Provided that the above statements of fact and proposed transactions are accurate and constitute complete disclosure of all of the relevant facts and proposed transactions, the proposed transactions are carried out as herein described and the Partnership is a partnership at law, our rulings in respect of the proposed transactions are as follows:

A. The Sales Commissions, as described in paragraph 20 above, paid or payable by the Partnership to registered dealers on the distribution of the Deferred Sales Charge Units during the Distribution Period, will be amortized and deductible by the Partnership in computing its income or loss for tax purposes in the following manner:

- 33 1/3% thereof for each of the fiscal periods ending XXXXXXXXXX

B. Provided they are reasonable, expenses, as described in paragraphs 26 and 27 above, incurred in a particular fiscal period or preceding fiscal period by the Partnership in the course of issuing or selling Partnership Units pursuant to the public offering, described in paragraph 23 and 24 above, will, to the extent of the lesser of:

(i) that proportion of 20% of the expenses that the number of days in the fiscal period is of 365; and

(ii) the amount, if any, by which the expenses exceeds the aggregate of all amounts each of which is an amount deductible by the Partnership in respect of these expenses in computing its income for a preceding fiscal period,

be deductible in computing the income or loss of the Partnership for the particular fiscal period pursuant to paragraph 20(1)(e) of the Act.

C. The Partnership will be entitled to deduct, in computing its income or loss for a fiscal period for income tax purposes, interest of a reasonable amount paid or payable in the period under a legal obligation to pay interest (depending on the method to be regularly followed by the Partnership in computing its income) on money borrowed by the Partnership to fund the payment of Sales Commissions and other expenses, as contemplated by paragraph 33 above, pursuant to subparagraph 20(1)(c)(i) of the Act.

D. A limited partner who owns Partnership Units at the end of a fiscal period of the Partnership will, subject to the provisions of subsection 96(2.1) and subsection 237.1(6) of the Act, be entitled to deduct the amount of losses of the Partnership for the fiscal period allocated to the Limited Partner in accordance with the Partnership Agreement, as described in paragraph 28 above, in computing the Limited Partner's income or loss for income tax purposes for the taxation year in which that fiscal period ends.

E. The provisions of paragraph 96(2.2)(d) of the Act will not apply to reduce a Limited Partner's "at-risk" amount in respect of the Partnership at the end of a fiscal period thereof, by reason of:

(i) the Partnership's entitlement to the fees and charges pursuant to the Distribution Agreement as described in paragraph 21 above;

(ii) the limitation of the amount payable by the Partnership to XXXXXXXXXX for its services under the administrative services agreement, as described in paragraph 34 above; and

(iii) the Limited Partnership Agreement, providing for the distribution to Limited Partners by the General Partner of the Partnership of any amount of net proceeds of the offering of Partnership Units remaining unexpended by the Partnership on XXXXXXXXXX as described under paragraph 30, as such distribution will reduce the adjusted cost base of the Limited Partner's Partnership Units by virtue of subparagraph 53(2)(c)(v) of the Act.

F. The distribution fee payable by XXXXXXXXXX to the Partnership under the Distribution Agreement, as described in paragraph 21 above, will be deductible by XXXXXXXXXX in computing its income for its taxation year in which such fees are incurred, provided that such distribution fee is reasonable and incurred for the purpose of gaining or producing income from a business or property with a reasonable expectation of profit.

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R2 issued by Revenue Canada, Taxation on September 28, 1990 (as amended by Special Release dated September 30, 1992) and are binding provided the first closing of the offering of Partnership Units described in paragraph 24 is made by XXXXXXXXXX, and the Partnership commences its operations by XXXXXXXXXX. These rulings are based on the Act and Regulations to the Act in force as of the date of this letter, without taking into account any future amendments thereto, whether currently proposed or not. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly: (a) the reasonableness of any of the expenses of the Partnership; and (b) the existence of a reasonable expectation of profit of the Partnership or any partner of the Partnership. Also, these rulings are not to be construed as confirming, in any way, the implications of the goods and services tax in respect of any of the proposed transactions.

OPINION

(1) Notwithstanding the rulings given in this letter, if the provisions of section 143.2 of the Act are enacted into law as proposed, the amount of any expenditures made by the Partnership, including, but not limited to, Sales Commissions referred to above in rulings A., would be reduced by the total of

(i) the "limited-recourse amounts" of

(A) the Partnership, and

(B) all taxpayers not dealing at arm's length with the Partnership that can reasonably be considered to relate to the expenditures,

(ii) the Partnership's "at-risk adjustment" in respect of the particular expenditures, and

(iii) the limited-recourse amounts and at-risk adjustments of each taxpayer who deals at arm's length with and holds an interest in the Partnership, that can reasonably be considered to relate to the particular expenditures.

This would also alter the amount available to be deducted by a Limited Partner, as referred to above in ruling D.

In accordance with paragraph 22 of Information Circular 70- 6R2, the comments in (1) above are only expressions of opinion on the application of the particular proposed legislation and, as such, should not be construed as advance income tax rulings, nor are they binding on the Department.

Yours truly,

for Director Resources, Partnerships and Trusts Division Income Tax Rulings and Interpretations Directorate Policy and Legislation Branch