1999 Ruling 9817583 - MUTUAL FUND TRUST - CAPITAL GAINS ALLOCATION

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:

1) Will the proposed amendments to the trust agreement which will allow the Trustee, at year end, to allocate capital gains to unitholders who redeemed their units during the year be legally effective?

2) On the redemption of a unit will the Proceeds of Disposition equal the amount paid less the allocable capital gains allocated in respect of that unit?

3) Will subsection 104(7.1) apply to the proposed transactions?

4) Will subsection 245(2) apply to the proposed transactions?

Position: 1) Yes; 2) Yes; 3) No; 4) No.

Reasons: XXXXXXXXXX, the proposed amendments to the trust agreement in respect of the allocation of capital gains to unitholders who have redeemed their units will be legally effective and subsection 104(7.1) will not apply to the proposed transactions. It was also their view that there was a good argument that Proceeds of Disposition on the redemption of a unit equals the amount paid less any capital gains allocated in respect of that unit. Also, see Doc # 32954. As there are good business reasons for undertaking the proposed transactions, the proposals are not avoidance transactions and GAAR should not be applied.

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XXXXXXXXXX 3-981758
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Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers and your subsequent correspondence of XXXXXXXXXX, in respect of the income tax consequences arising out of the proposed transactions described below.

We understand that to the best of your knowledge, and that of the taxpayers involved, none of the matters considered in this ruling request are:

(a) in an earlier return of the taxpayers or related persons;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or related persons;

(c) under objection by the taxpayers or related persons;

(d) before the courts; or

(e) the subject of a ruling previously issued by this Directorate to the taxpayers or related persons.

In this letter, unless otherwise indicated, all statute references are to the Income Tax Act (Canada) (R.S.C. 1985, 5th Supplement, c.1, as amended) (the "Act"), and the following terms have the meanings specified:

"ICo" means XXXXXXXXXX.

"Fund" means each XXXXXXXXXX fund listed in Appendix A.

"Funds" means, collectively, the XXXXXXXXXX funds listed in Appendix A.

"Fund A" means XXXXXXXXXX Fund.

"Fund B" means XXXXXXXXXX Fund.

The Funds and ICo deal with the XXXXXXXXXX Tax Services Office. ICo files its return at the XXXXXXXXXX/Tax Centre and the Funds file or will file their returns at the XXXXXXXXXX Tax Centre.

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

FACTS

1. Each Fund is a trust established by a declaration of trust under the laws of Canada, is a resident of Canada for purposes of the Act, and will qualify as a mutual fund trust within the meaning of subsection 132(6) throughout the XXXXXXXXXX taxation year.

2. ICo is a corporation formed under the laws of XXXXXXXXXX and is the trustee and investment manager of each Fund.

3. The Funds were formed principally for the purpose of providing individual investors (the "unitholders" of the Funds) with professional money management and portfolio diversification on a cost effective basis. Each Fund invests the unitholders' subscription monies in various financial instruments, including stocks and bonds, according to the specified investment objectives of the Fund. Consequently, the Funds earn ordinary income (dividends, interest, other income) and/or realize capital gains and capital losses from the disposition of capital property.

4. The current declaration of trust (the "Current Agreement") provides that net income and net realized capital gains of the Fund for the year will be allocated to and made payable to its unitholders. XXXXXXXXXX the Current Agreement defines "net income" to be the net income of the Fund determined in accordance with the provisions of the Act (other than paragraph 82(1)(b) and subsection 104(6)), but it excludes capital gains and capital losses. "net realized capital gains" are defined to be the amount, if any, by which the aggregate of the capital gains of the Fund exceed the aggregate of the capital losses of the Fund and an amount in respect of any net capital losses deducted in computing taxable income for the year.

5. XXXXXXXXXX the Current Agreement requires that the trustee compute the amount of such net income and net realized capital gains, if any, for the year that should be allocated to the unitholders. The purpose of such computation and allocation is to ensure that the unitholders, rather than the Fund, include such amount in their income for the purposes of the Act. In determining the amount to allocate, the trustee can take into account factors such as any non-capital losses from prior years and the amount of net realized capital gains of the Fund that can be retained without giving rise to a tax liability in excess of the refund available under section 132. Such allocation of net income and net realized capital gains to particular unitholders is not done until the end of the year as the trustee cannot practically determine precisely the amount of net income and net realized capital gains to allocate to the unitholders until the last week of the taxation year. In any event, the trustee will only allocate to unitholders that amount of net income and net realized capital gains that would otherwise be subject to tax in the Fund.

6. Each of the Funds is authorized, under the Current Agreement, to have two or more classes of units issued and outstanding. The principal differences between the classes of units relate to the management fees or other expenses charged to the Fund in respect of the various classes. The Current Agreement provides that the allocation of net income and net realized capital gains as described in 5 above be made among each class of units in such manner as the trustee considers to be fair and equitable. The Current Agreement also sets out certain principles that should be taken into account by the trustee in making this determination.

7. The trustee, in accordance with XXXXXXXXXX the Current Agreement, determines a record date for the allocation of net income and net realized capital gains to the unitholders of the Fund that will not be later than the last day of the calendar year in which the taxation year of the Fund ends. The net income and net realized capital gains of a Fund are allocated pro rata to unitholders on the record date. This pro rata allocation is based upon the number of units the unitholder owns on the record date relative to the number of units issued and outstanding.

8. XXXXXXXXXX the Current Agreement provides that the unitholder shall have a legal right on the record date to enforce payment of any amount of net income or net realized capital gains which is allocated to the unitholder.

9. Pursuant to XXXXXXXXXX the Current Agreement, any net income or net realized capital gains which are allocated and payable to a unitholder (as described in paragraphs 5 to 8 above) will be satisfied by the Fund issuing additional units having a value equal to the amount allocated. However, some Funds allow a unitholder to elect to receive cash instead of additional units of the Fund.

10. The trustee of each Fund has, under XXXXXXXXXX the Current Agreement, the discretion to make other allocations of income to the unitholders. For example, some unitholders may negotiate a management fee that is lower than the fee otherwise payable by the Fund XXXXXXXXXX. The amount of such management fee reductions will be allocated to the applicable unitholders of the Fund XXXXXXXXXX.

11. XXXXXXXXXX the Current Agreement provides that the trustee may make such designations under the Act as are reasonable in the circumstances with respect to the amounts allocated to unitholders in the year. The purpose of such designations is to ensure that the character of certain income of the Fund is retained in the unitholders' hands. The designations are made in respect of dividends from taxable Canadian corporations, taxable capital gains and foreign source income and taxes under subsections 104(19), (21) and (22) respectively.

12. XXXXXXXXXX is the value of a Fund's assets less its liabilities.

13. Where units of a Fund are redeemed, XXXXXXXXXX the Current Agreement provides that the trustee shall pay out of the assets of a Fund an amount equal to the XXXXXXXXXX per unit multiplied by the number of units redeemed plus the proportionate share of any distribution of net income or net realized capital gains of the Fund attributable to such units which has been declared and not yet paid, and any XXXXXXXXXX attributable to such units which the Fund has credited to the unitholder but not yet distributed, less any redemption or other fees payable by the unitholder.

14. Each XXXXXXXXXX Fund's XXXXXXXXXX taxation year XXXXXXXXXX ends on December 15.

15. The trustee prepares such information slips as are required under the Act and the Income Tax Regulations to report the amount of income and taxable capital gains allocated to the unitholders of each Fund.

PROPOSED TRANSACTIONS

16. It is proposed that the Current Agreement governing each Fund will be amended to change the method of allocating the Fund's net income and net realized capital gains for a taxation year to the unitholders. To implement the proposals, XXXXXXXXXX the Current Agreement for each Fund will be amended XXXXXXXXXX.

17.

XXXXXXXXXX.

18. The terms "net income", "net realized capital gains", "XXXXXXXXXX", "XXXXXXXXXX" and the "XXXXXXXXXX" will be defined in XXXXXXXXXX of the amended declaration of trust (the "Amended Agreement"). "Net income" will be the net income of the Fund determined in accordance with the provisions of the Act (other than paragraph 82(1)(b) and subsection 104(6)), but it excludes capital gains and capital losses. "Net realized capital gains" will be the amount, if any, by which the aggregate of the capital gains of the Fund exceeds the aggregate of the capital losses of the Fund in the year. "XXXXXXXXXX" will be the amount by which the net income of the Fund for the particular taxation year exceeds the total of: (1) any amounts payable in the year out of the net income of the Fund as "other distributions" (XXXXXXXXXX); (2) the non-capital losses the Fund may be permitted to deduct; and (3) where the amount of taxable dividends received by the Fund from taxable Canadian corporations exceeds net income, such amount as the trustee may determine. "XXXXXXXXXX" will be the amount by which net realized capital gains of the Fund for the particular taxation year exceed the total of: (1) such part of the net realized capital gains of the Fund as would, if retained, give rise to a tax liability not in excess of the capital gains refund (section 132); (2) the net capital losses which the Fund would be permitted to deduct; (3) the non-capital losses which the Fund may be permitted to deduct; (4) the net income loss for such year; and (5) the amount of the Fund's net realized capital gains which are allocated to unitholders as "other distributions" XXXXXXXXXX. The "XXXXXXXXXX" will be such day or days in the calendar year which, in the discretion of the trustee, unitholders of record on that day will be allocated a portion of the XXXXXXXXXX and XXXXXXXXXX of the Fund for the year.

Allocation of Capital Gains to Redeeming Unitholders

19. Under the proposals, an allocation of capital gains will XXXXXXXXXX be made to unitholders who redeemed units of the Fund at any time during the taxation year.

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XXXXXXXXXX

20.

XXXXXXXXXX

Allocation of Capital Gains on XXXXXXXXXX

21. The XXXXXXXXXX capital gains of the Fund which are not allocated to redeeming unitholders as described in 19 above (i.e., the remaining XXXXXXXXXX capital gains or "Amount C"), will be allocated to unitholders of record on XXXXXXXXXX. The amount to be allocated to a particular unitholder on XXXXXXXXXX will be determined as follows:

a)

XXXXXXXXXX

b) The allocation methods described in 19 and 21(a) above will generally be used to allocate all of a Fund's XXXXXXXXXX capital gains for a particular year. However, it will be possible that XXXXXXXXXX will be an inappropriate allocation method in a particular year

XXXXXXXXXX

Therefore, pursuant to XXXXXXXXXX the Amended Agreement, the amount of the XXXXXXXXXX capital gains to be allocated to unitholders will be determined XXXXXXXXXX.

(i) XXXXXXXXXX

(ii) XXXXXXXXXX

Allocation of Income on XXXXXXXXXX

22. Under the proposals, XXXXXXXXXX income of the Fund XXXXXXXXXX allocated to unitholders of record on XXXXXXXXXX. XXXXXXXXXX. The amount of XXXXXXXXXX income to be allocated to a particular unitholder will be determined as follows:

a) The net income of a Fund for the taxation year will no longer be allocated pro rata to the unitholders on the record date. Instead, a unitholder's share of the XXXXXXXXXX income of the Fund will be determined under XXXXXXXXXX the Amended Agreement. This provision provides that the amount of XXXXXXXXXX income of the Fund to be allocated to a particular unitholder of record on XXXXXXXXXX will be determined XXXXXXXXXX.

b) The allocation method described in 22(a) above will generally be used to allocate all of a Fund's XXXXXXXXXX for a particular taxation year. However, there may be circumstances where it is not possible to allocate XXXXXXXXXX other than XXXXXXXXXX circumstances, pursuant to XXXXXXXXXX the Amended Agreement, XXXXXXXXXX will be allocated to unitholders using a XXXXXXXXXX method XXXXXXXXXX.

Designation of Amounts Allocated

23.

XXXXXXXXXX

Payment of Income or Capital Gains Allocation

24.

XXXXXXXXXX

25.

XXXXXXXXXX

PURPOSE OF PROPOSED TRANSACTIONS

26.

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

RULINGS GIVEN

Provided that the above statements are accurate and constitute complete disclosure of all the relevant facts, proposed transactions and purpose thereof and the proposed transactions are legally effective and are carried out as described herein, our advance income tax rulings are as follows:

A. With respect to the amount of the XXXXXXXXXX capital gains of a Fund allocated to a unitholder who redeemed units during the year as described in 19 above:

(i) For the purposes of paragraph 104(6)(b), the Fund may deduct from its income for a taxation year the taxable portion of the XXXXXXXXXX capital gains that were payable in the year to such a unitholder.

(ii) Pursuant to subsection 104(13), the taxable portion of the XXXXXXXXXX capital gains of a Fund that became payable in the taxation year to such a unitholder will be included in computing that unitholder's income for the year. To the extent that the Fund makes the proper designations in its return of income for a taxation year, the amount of the XXXXXXXXXX capital gains of a Fund determined to be the unitholder's taxable capital gain will be the unitholder's taxable capital gain in accordance with subsection 104(21).

(iii) In computing such a unitholder's gain in respect of the units which were redeemed, the proceeds of disposition for those units will be the amount by which the XXXXXXXXXX of the units redeemed exceeds the amount of XXXXXXXXXX capital gains allocated to the unitholder in respect of those units.

(iv) In accordance with subsection 52(6) and subparagraph 53(2)(h)(i.1), that portion of the XXXXXXXXXX capital gains of a Fund that were paid to such a unitholder and not included in the unitholder's income under subsection 104(13), is not taxable and will not reduce the adjusted cost base of any units owned by the unitholder before, on or after the redemption.

B. With respect to the amount of the XXXXXXXXXX income and/or XXXXXXXXXX capital gains of a Fund allocated to a unitholder of record on XXXXXXXXXX as described in 21 and 22 above:

(i) For the purposes of paragraph 104(6)(b), the Fund may deduct from its income for a taxation year that portion of the XXXXXXXXXX income and the taxable portion of the XXXXXXXXXX capital gains that were payable in the year to such a unitholder.

(ii) Pursuant to subsection 104(13), that portion of the XXXXXXXXXX income and the taxable portion of the XXXXXXXXXX capital gains of a Fund that became payable in the taxation year to such a unitholder will be included in computing that unitholder's income for the year. To the extent that the Fund makes the proper designations in its return of income for a taxation year, the amount of the XXXXXXXXXX income or XXXXXXXXXX capital gains of a Fund determined to be the unitholder's taxable dividend, taxable capital gain or foreign source income will be the unitholder's taxable dividend, taxable capital gain or foreign source income in accordance with subsections 104(19), (21) and (22).

C. In computing the amount of the "capital gains refund" for the year under subsection 132(1) in respect of the capital gains of a Fund which are subject to tax in the Fund, amount A in the calculation of the "capital gains redemptions" of a Fund for a taxation year in subsection 132(4) will be equal to XXXXXXXXXX.

D. The implementation of the proposed transactions described herein, will not, in and by themselves, cause subsection 104(7.1) to apply so as to deny the Funds a deduction under paragraph 104(6)(b) in computing their income.

E. Subsection 245(2) will not be applied to redetermine the tax consequences of Rulings A to D above solely as a result of the implementation of the proposed transactions described herein.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3, Advance Income Tax Rulings, and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed within six months of the date of this letter. Also, these rulings are based on the Act presently in effect and do not take into account any proposed amendments thereto.

COMMENTS

After the proposed transactions are implemented, a Fund's continued entitlement to a capital gains refund under subsection 132(1) may not be consistent with policy intent of this provision. As a result, the Department of Finance has been advised of our concerns in this regard.

Yours truly,

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

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