2 July 1998 External T.I. 9728675 - MUTUAL FUND TRUSTS

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:

Will the words "investing of its funds in property (other than real property)" in subparagraph 132(6)(b)(i) cease to be met where a mutual fund:

1) makes secured loans of its securities (which may not be viewed as “qualified securities” in section 260 of the Act - i.e listed on prescribed stock exchanges) or enters into repurchase agreements,
2) makes short sales of securities,
3) writes naked call options, and
4) invests in all manner of derivatives (including swaps), whether to take a position or to hedge, and whether they constitute "permitted derivatives" under National Policy # 39 of the Canadian Securities Regulators.

Position: No, the provision will not cease to be met.

Reasons:

The words in the provision are broad enough to include these activities and they are not specifically prohibited. The leveraged activities form an integral part of the investing activities of the fund. In each type of transaction described above, the trust acquires a contractual right, security or other property for the purpose of gaining a financial return or financial advantage or benefit therefrom.

The fact that a trust may loan funds does not change the fact the trust is “investing its funds in property”. There is no distinction between lending funds on security and investing in debt instruments or other securities. The fact that the underlying securities involved in these transactions may not be “qualified securities” (i.e. securities listed on a prescribed stock exchange) does not change the fact that the trust is “investing its funds in property”. The fact that the trust enters into these transactions for hedging purposes does not change the fact that the trust is “investing its funds in property”. There is nothing in this wording that prohibits a trust from being involved in a speculative/risky investment business. There is no requirement that investments be free of risk. “Hedging transactions” are generally made by a trust to counteract potential negative price or interest rate fluctuations in its assets. By doing that, the trust is in fact able to reduce its risk of loss. Finally, it was not the intent to narrow the type of investments that would qualify under 132(6)(b)(i) by adding the word “property”.

972867
XXXXXXXXXX M. Lemire
(613) 957-4363

Attention: XXXXXXXXXX

July 2, 1998

Dear Sirs:

Re: Investing of funds in property

This is in reply to your letter dated February 16, 1998 in which you requested our views as to whether the activities of a trust described in your letter would satisfy the undertaking specified in subparagraph 132(6)(b)(i) of the Income Tax Act (the “Act”).

Subsection 132(6) of the Act sets out the definition of “mutual fund trust”. For a trust to qualify as a mutual fund trust, subparagraph 132(6)(b)(i) of the Act requires the trust’s only undertaking be the investing of its funds in property (other than real property or an interest in real property). However, that phrase is not defined in the Act.

We have previously stated that buying, selling, or otherwise taking a position in futures contracts, forward contracts and options on futures contracts (based on, among other things, a commodity, a commodity index, a foreign currency, a stock index or a bond index) are activities that will generally fall within the meaning of that phrase.

In these instances, the fund acquires a contractual right, security or other property for the purpose of financial return, financial advantage or benefit therefrom. The fact that the fund’s only undertaking for purposes of subparagraph 132(6)(b)(i) of the Act must be the investing of its funds in property (other than real property or an interest in real property) does not mean that a fund would cease to meet that phrase if it were to engage in activities such as making loans of securities, entering into repurchase agreements, making short sales of securities, writing naked call options or entering into swap agreements. In other words, while the undertaking must be the investing of funds in property, generally, activities involving the use of leverage or the borrowing of funds to achieve that undertaking are acceptable.

Also, the fact that: (1) the securities may not be qualified securities, (2) the fund is not subject to National Policy No. 39, and (3) the activities are undertaken for hedging or non-hedging purposes, would not generally have an impact on whether the fund’s only undertaking is the investing of funds in property (other than real property or an interest in real property).

This opinion is provided in accordance with the comments in paragraph 22 of the Information Circular 70-6R3 dated December 30, 1996.

We trust our comments will be of assistance to you.

Yours truly,

T. Murphy
Chief
Trusts Section
Resources, Partnerships and
Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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