1999 Ruling 9914303 - CONVERSION TO OPEN END UNIT TRUST

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. whether adding a redemption feature to a unit trust and expanding its investment objectives constitutes a disposition of either trust property or the units of the trust
2. Whether the trust will qualify as an open end unit trust under 108(2)(a) after the redemption feature is added
3. Whether the trust will qualify as a unit trust throughout the taxation year if more than 10% of the shares of a singled corporation are acquired after it becomes an open-ended trust

Position:

1. no 2. yes 3. no

Reasons:

1.similar to past positions taken, recognizing that the addition of the redemption feature and the expansion of the investment objectives will not result in any entitlement to proceeds of disposition nor will the units be redeemed, cancelled or acquired
2. the documentation provided and representations made supports this finding
3. 108(2)(b) requires certain conditions to be met throughout the taxation year - as a result, the acquistion of additional assets could result in the trust not qualifying as a unit trust, and thus a mutual fund trust, for the part of the year preceding the addition of the redemption right

XXXXXXXXXX
XXXXXXXXXX 991430
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in your reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted trust and unitholders thereof in respect of the income tax consequences arising out of the proposed transactions described below. We also acknowledge your submissions of XXXXXXXXXX.

We understand that, to the best of your knowledge, none of the issues involved in this ruling request are:

a) in an earlier return of the taxpayer or a related person;

b) being considered by a tax services office and/or a tax centre in connection with a tax return previously filed by the taxpayer or a related person;

c) under objection by the taxpayer or a related person;

d) before the courts; or

e) the subject of a ruling previously issued by this Directorate to the taxpayer or a related person.

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

a) "Board of Directors" means the board of directors of Investco, the majority of who are elected by the unitholders of the Trust. The directors are not the agents of, and are not bound by instructions or orders of, either the Trust or its unitholders and there is no shareholder's agreement with respect to the shares of Investco;

b) "Current Investment Objective" means the current investment objective of the Trust. At this time, it is to achieve long-term growth in the value of the Trust and to maintain stable income available for distribution through the investment in a royalty (the Investco Agreement) representing an entitlement to XXXXXXXXXX% of the royalty income earned by Investco from various XXXXXXXXXX;

c) "Distributable Income" currently means XXXXXXXXXX;

d) "Investco Agreement" means the royalty agreement between the Trust and Investco dated XXXXXXXXXX as amended and restated effective XXXXXXXXXX;

e) "Investco" means XXXXXXXXXX;

f) "Manager" means XXXXXXXXXX, a corporation which provides management services to both Investco and the Trust;

g) "Registered Plans" means registered retirement savings plans, registered retirement income funds, deferred profit sharing plans and registered education savings plans as such terms are defined in the Act;

h) "Subsequent Investments" means investment in other royalties in respect of XXXXXXXXXX;

i) "Trust" means XXXXXXXXXX;

j) "Trustee" means XXXXXXXXXX; and

k) "Unit" means an equal fractional undivided interest in the Trust. The Units are listed on XXXXXXXXXX Stock Exchange.

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

Facts

1. The Trust is a closed-end "unit trust" as defined in paragraph 108(2)(b) and a "mutual fund trust" as defined in subsection 132(6) of the Act. It was established under the laws of XXXXXXXXXX pursuant to a trust indenture dated XXXXXXXXXX, as amended and restated. The principal office of the Trust is located at XXXXXXXXXX. The Trust's tax account number is XXXXXXXXXX and it files its income tax returns at the XXXXXXXXXX Tax Centre.

2. The Trust is a registered investment pursuant to paragraph 204.4(2)(c) of the Act and as such, the units are qualified investments for Registered Plans. The unitholders of the Trust include both taxable investors and Registered Plans.

3. The trust indenture of the Trust provides that no conversion, redemption or pre-emptive rights attach to the Units. The Trustee is scheduled to commence to wind-up the affairs of the Trust on XXXXXXXXXX, unless the term of the Trust is extended by special resolution at any meeting of the unitholders. Unitholders may also vote to terminate the Trust prior to its expiry date by special resolution at any meeting of the unitholders.

4. In order to meet the Trust's Current Investment Objective, the Trustee, the Manager and Investco have entered into two management agreements, one dated XXXXXXXXXX, which relates to the management of the Trust (the "Trust Management Agreement"), and another dated XXXXXXXXXX as amended and restated effective XXXXXXXXXX, which relates to the management of Investco (the "Investco Management Agreement").

5. Any cash not invested pursuant to the Current Investment Objective is invested in Canadian government bonds, guaranteed investment certificates or other highly rated short-term debt and deposits. The Trust may also invest in Subsequent Investments.

6. Unitholders of the Trust are entitled to receive monthly cash distributions of Distributable Income. As well, the Trust will distribute sufficient income and net capital gains so that it will not be liable for Part I income tax.

7. The Manager has determined that certain amendments to the trust indenture would facilitate the efficient administration of the Trust and would allow the Trust and Investco greater flexibility in undertaking acquisitions of property. Article 9 of the trust indenture provides the mechanism for the amendment of the Trust.

Proposed Transactions

8. The Trust's status will be changed from a closed-end unit trust to an open-end "unit trust" as defined in paragraph 108(2)(a) of the Act by introducing a redemption right for the Units. Voting rights, distribution rights and all other rights attached to the Units will not change.

9. A unitholder will be granted the right to require the Trust to redeem his or her Units at any time on demand. Upon such redemption, all the unitholder's rights attached to the Units tendered for redemption will be surrendered and the unitholder will be entitled to receive a price per Trust Unit (the "Redemption Price") equal to the lesser of:

(i) 95% of the "market price" of the Trust Units on XXXXXXXXXX Stock Exchange during the ten trading day period commencing immediately after the date on which the Trust Units are surrendered for redemption; and

(ii) 95% of the "closing market price" of the Trust Units on XXXXXXXXXX Stock Exchange on the date that the Trust Units are surrendered for redemption.

"Market price" will be an amount equal to the simple average of the closing price of the Trust Units for each of the ten trading days on the principal market on which the Trust Units are quoted for trading and on which there was a closing price; provided that if the applicable exchange or market does not provide a closing price but only provides the highest and lowest prices of the Trust Units traded on a particular day, the "closing price" shall be an amount equal to the simple average of the highest and lowest prices for that trading day if there was a trade; and provided further that if there were a trade on the applicable exchange or market for fewer than five of the ten trading days, the "market price" shall be the simple average of the "closing market price" on each of the ten trading days. The "closing market price" on a particular day shall be an amount equal to:

(i) the closing price of the Trust Units if there was a trade on that day;

(ii) an amount equal to the average of the highest and lowest prices of Trust Units if there was trading and the exchange or other market provides only the highest and lowest prices of Trust Units traded on that day; and

(iii) the average of the last bid and last ask prices of the Trust Units if there was no trading on that day.

10. The aggregate cash Redemption Price payable by the Trust in respect of any Trust Units surrendered for redemption during any calendar month shall be satisfied by way of a cash payment on the last day of the following month except that the entitlement of unitholders to receive cash upon the redemption of their Trust Units is subject to a general limitation that the total amount payable by the Trust in respect of such Trust Units and all other Trust Units tendered for redemption in the same calendar month shall not exceed $XXXXXXXXXX and, in a six month period shall not exceed $XXXXXXXXXX. This limitation will not apply to the redemption of Units held by a Registered Plan. In addition, this limitation may be waived by Investco at its sole discretion in any other circumstance. Because the majority of the Trust's assets are normally held in illiquid investments, the Trust requires until the end of the following month to arrange for a cash payment of any redemption proceeds.

11. If a unitholder is not entitled to receive cash upon the redemption of Trust Units as a result of the foregoing limitation, then the Redemption Price for such Trust Units shall be the unitholder's share of the proportionate underlying fair market value of the Trust's assets as at the date upon which such Trust Units were tendered for redemption and shall, subject to any applicable regulatory approvals, be paid and satisfied by way of a distribution in specie of the Trust's assets. To the best of the knowledge of the Trustee and the Manager, regulatory approval has not previously been denied in similar situations. No fractional interest in any security owned by the Trust (other than an interest in the Investco Agreement) will be distributed and where the number of securities to be received by a unitholder (other than an interest in the Investco Agreement) includes a fraction such number shall be rounded to the next lowest whole number. In the event that regulatory approval is required for an asset that is to be distributed as part of the in specie distribution and the appropriate regulatory approval is not obtained, the limitation described in 10 will be waived in any case where no other asset is available for distribution. The Trust shall be entitled to all interest paid, or accrued and unpaid, and to all dividends paid or declared payable on any such securities on or before the date of the in specie distribution. The unitholders who receive any such securities will be subject to the provisions of any material agreements that relate to those securities.

12. The trust indenture will be amended to permit the Trust to use the proceeds of an offering of Trust Units for such purposes as the Board of Directors may determine to facilitate an acquisition or which would otherwise be in the best interests of the unitholders. The definition of distributable income will be modified to include any income derived from such acquisitions. It will also be amended to modify the definition of trust expenses as found in the trust indenture to include repayments of amounts borrowed by the Trust in order to provide the Trust with greater flexibility in structuring and financing acquisitions of property.

13. The Board of Directors will be granted the authority to negotiate and execute management agreements respecting assets (other than the Investco Agreement) and entities owned from time to time by the Trust. The terms of the Investco Agreement, the Investco Management Agreement and the Trust Management Agreement will not be amended to effect the proposed transactions.

14. As with most other open-end trusts, it is anticipated that trading on a stock exchange and not the right of redemption will continue to be the primary mechanism for unitholders to dispose of their Units. Any assets of the Trust that are distributed in specie to unitholders in connection with a redemption may not be listed on a stock exchange and there may be no market for such assets. Any securities so distributed may be subject to resale restrictions under applicable securities laws.

15. Notwithstanding the expectation that unitholders will usually prefer to dispose of their units on XXXXXXXXXX Stock Exchange rather than to redeem their units, the Trustee and the Manager are of the view that it is reasonable to expect unitholders to redeem their Units in certain circumstances. In support of this view, the Trust has received a report from an investment dealer that states that it is reasonable to expect that unitholders will choose to exercise the redemption right in certain circumstances.

16. Subsequent to the change in the Trust's status to an open-end unit trust, the Current Investment Objective of the Trust will be expanded to include the acquisition and holding of various assets and the securities of entities holding such assets. The Trust's only undertaking will remain the investing of its funds in property described in paragraph 132(6)(b) of the Act.

17. The introduction of the redemption right and the expansion of the Current Investment Objective, in and by themselves, will not entitle a unitholder to proceeds of disposition and the Units will not be redeemed, acquired or cancelled upon such changes.

Purpose of Proposed Transactions

18. The purpose of the proposed transactions is to allow the Trust to expand its Current Investment Objective by permitting it to acquire more than 10% of the capital stock of any particular corporation. In addition, the introduction of a redemption right will give unitholders another means of realizing their investment. For example, if a unitholder who maintains a large investment in the Trust wants to dispose of his or her investment, the redemption right would provide liquidity without risking a significant reduction in the market price of the Trust's Units. The redemption right will also be of value when buyers cannot be found because of an illiquid market.

Rulings Given

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

A. Existing unitholders of the Trust will not be considered to have disposed of their units by virtue only of the introduction of the redemption right described in 8 above and the expansion of the Current Investment Objective described in 16 above.

B. The property of the Trust will not be considered to have been disposed of by the Trust and resettled on a new trust by reason only of the introduction of the redemption right described in 8 above and the expansion of the Current Investment Objective described in 16 above.

C. At the time immediately after the trust indenture is modified to add the redemption right, the Trust will be a unit trust by virtue of paragraph 108(2)(a) of the Act.

D. Provided that the Trust is a mutual fund trust as defined in subsection 132(6) of the Act prior to the implementation of the proposed transactions, then at the time immediately following the introduction of the redemption right described in 8 above but prior to the acquisition of any additional assets pursuant to the expanded Current Investment Objective described in 16 above, it will be a mutual fund trust.

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 Revenue Canada provided that the trust indenture is amended in substantially the same form as the draft amended trust indenture submitted XXXXXXXXXX and modified on XXXXXXXXXX, and that the proposed transactions other than those described in 16 above are completed and effective within six months of the date of this letter.

Comments

In addition to the rulings above we provide the following comments:

You asked us to rule that the Trust would be a mutual fund trust throughout the taxation year in which the proposed transactions take place. In order to qualify as a mutual fund trust throughout a particular taxation year, the Trust must be a unit trust as defined in subsection 108(2) throughout the taxation year. In order to qualify as a unit trust for the portion of the taxation year in which paragraph 108(2)(a) did not apply to the Trust, the following conditions must be met throughout the taxation year in which the proposed transactions occur:

(a) the Trust remains resident in Canada for purposes of the Act;

(b) the Trust's only undertaking remains the investing of its funds in the types of property described in subparagraph 108(2)(b)(ii) of the Act;

(c) at least 80% of the Trust's property consists of property of the type described in subparagraph 108(2)(b)(iii) of the Act;

(d) not less than 95% of the Trust's income (determined without reference to subsections 49(2.1) and 104(6) of the Act) for that year will be derived from, or from the disposition of, investments described in subparagraph 108(2)(b)(iii) of the Act; and

(e) not more than 10% of the Trust's property consists of bonds, securities or shares in the capital stock of any one corporation or debtor other than Her Majesty in right of Canada or a province or a Canadian municipality.

For greater certainty it is a question of fact whether any property, or interest therein, is a property described in subparagraph 108(2)(b)(iii) of the Act. No comment is expressed with respect to whether any asset of the Trust so qualifies or whether any activity of the Trust constitutes the "investing of funds in property" as used in paragraph 132(6)(b) of the Act.

The above noted rulings are based on the law presently in effect and do not take into account any amendments to the law which may be proposed or enacted in the future. Accordingly, the rulings are subject to the possible application of any subsequent enacted or proposed legislation. In this respect we have examined the proposed transactions in view of the proposed repeal of section 54 and the proposed amendment to include the definition of "disposition" in subsection 248(1) of the Act as set out in the draft legislation released December 23, 1998. We are of the opinion that the addition of the redemption right described in paragraph 8 above and the expansion of the Current Investment Objectives as described in paragraph 16 would not, in and by itself, result in a disposition as defined in the proposed amendment to subsection 248(1) of the Act.

Yours truly,

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

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