15 July 1996 External T.I. 9620115 - MUTUAL FUND CAPITAL PAYOUTS

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.

Principal Issues:

Effect of principal payouts on cost amount of mutual fund units

Position:

Explained provisions on adjusting ACB (cost amount) of units

Reasons:

Routine explanation of provisions

XXXXXXXXXX							5-962011

Attention: XXXXXXXXXX

July 15, 1996

Dear Sirs:

Re: Mutual Fund Units held in a Registered Retirement Savings Plan

This is in reply to your letter of May 30, 1996, in which you asked us to clarify the calculation of the book value of mutual fund trust units where there has been a distribution of capital in respect of the units. You are concerned that this return of capital could reduce the book value of units held in a registered retirement savings plan (an "RRSP") and thereby expose the plan to taxation under Part XI of the Income Tax Act (the "Act").

While you have used the term "book value", for the purposes of Part XI of the Act, property held in an RRSP is measured in terms of its "cost amount". This term is defined in subsection 248(1) of the Act and, in general, means a property's cost for tax purposes at any particular time. While there may be some exceptions, in most cases, units of a mutual fund trust are held by an RRSP as capital property. As a consequence, they generally have a cost amount equal to their "adjusted cost base" or "ACB" at any particular time.

In our previous telephone conversation of May 13, 1996, (XXXXXXXXXX-Gillman) we discussed how changes in the market value of units of a fund do not affect the calculation of a mutual fund unit's cost amount or ACB. We also clarified that where income of a fund is distributed in the form of additional units of the fund, an RRSP will generally increase its holdings of the fund as well as the total cost amount of all its property by an amount equal to the value of the additional units at the time of the distribution. Accordingly, the calculation of any Part XI tax payable will be affected.

In this conversation we did not discuss the consequences of a change in the ACB of such units. However, if the ACB of any units that are foreign property were to increase or the ACB of units that are not foreign property were to decrease, the cost amount of the foreign units and the total cost of all of the property held by the RRSP would likewise increase or decrease and the RRSP could be exposed to Part XI taxation.

A property's "ACB" is defined in paragraph 54(a) of the Act and means the cost of the property adjusted in accordance with section 53 of the Act. Section 53 of the Act then provides for a number of possible adjustments. For example, along with several provisions applicable to capital property in general, section 53 specifically provides that the ACB of the units in a mutual fund trust must be adjusted:

-by virtue of paragraph 53(1)(d.2) and subsection 132.1(2) of the Act in respect of amounts designated by the mutual fund trust in order to allocate amounts to particular units of a fund for such items as the potential recapture of capital cost allowance;

-by virtue of paragraph 53(1)(p) after 2004 with respect to the flow through of exempt capital gains; and

-by virtue of subparagraphs 53(2)(h)(i) and (i.1) in respect of certain distributions of capital from the fund.

Subparagraph 53(2)(h)(i.1) of the Act is also of particular note to your question. In relation to mutual fund trusts, it provides that any amount that becomes payable to a taxpayer by a trust after 1987 in respect of a unit otherwise than as proceeds of disposition of the unit, must be deducted from the ACB of the unit unless the amount is:

-included in the taxpayer's income as income from the trust; or

-if the trust was resident in Canada throughout the year,

-equal to 1/3 of any capital gains designated by the trust under subsection 104(21) of the Act in respect of the RRSP; or

-designated by the trust under subsection 104(20) of the Act.

Finally, subsection 52(6) of the Act has specific application to mutual fund trusts. Basically, subsection 56(2) provides that any income or capital gains earned by a mutual fund trust must be added to the units' ACB when the unit holders obtain the right to enforce payment of such amounts and must be deducted once the amounts are actually paid. Accordingly, the ACB and cost amounts of the units would be increased by the amount payable. For more information please refer to the Department's Interpretation Bulletin IT-390 and the special release to it dated June 21, 1995 (enclosed).

In our opinion, a distribution of trust capital cannot be converted to a distribution of trust income subject to subsection 56(2) of the Act where the right to enforce payment of the income arises subsequent to the payment of the capital. Instead, the amount of the payment must be deducted in computing the ACB of the trust units in accordance with the provisions of subsection 53(2)(h)(i) or (i.1) of the Act.

We trust these comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch