1999 Ruling 9917743 - RRSP MUTUAL FUND TRUST WITH DERIVATIVES

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: Does the use of derivatives by one mutual fund trust to mimic the return of another mutual fund trust that holds foreign property qualify to be a registered investment and if so, would such a transaction be subject to GAAR?

Position: Yes and GAAR is not applicable.

Reasons: The cost amount of the forward contract will be based on legal fees, brokerage fees and any similar fees related to the entering into of the forward contract (expected to be nominal). Thus it is not significant to the rulings that this forward contract is foreign property based on the fact that the counterparty is non-resident and the contract is to be settled in foreign currency which means that the contract entitles the Fund to property that is foreign property (notwithstanding that a deposit held in Canada which is denominated in foreign currency is not foreign property). Provided that the mutual fund trust limits its investments in foreign property to 20%, the mutual fund trust will qualify as a registered investment.

XXXXXXXXXX 991774

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

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 taxpayers in respect of the income tax consequences arising out of the proposed transactions described below. We also acknowledge your correspondence of XXXXXXXXXX.

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

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

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

d) before the courts; or

e) the subject of a ruling previously issued by this Directorate to the taxpayers 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:

"Basket of Shares" with respect to a particular Forward Contract means securities of corporations listed in the Forward Contract; such Basket of Shares will consist of the number and kind of shares specified in the appendix to the contract and will generally match the securities held by the Underlying Fund at that time and may include common shares, preferred shares and warrants to acquire such shares;

"Cost amount" means the cost amount of property as defined in subsection 248(1) of the Act;

"Counterparty" means XXXXXXXXXX, a non-resident of Canada; however, the Fund may enter into similar Forward Contracts with other counterparties which may or may not be resident of Canada and may or may not be related to the Manager;

"Dividend Amount" means the total of all cash dividends payable in respect of the relevant number of shares contained in the Basket of Shares where the ex-dividend date for such dividends occurs after the date the Forward Contract is entered into and on or before the date the contract matures for a particular Forward Contract;

"Final Price" with respect to a Forward Contract means the market value of the Basket of Shares on the maturity of the Forward Contract;

"Forward Contract" has the meaning set out in paragraph 7;

"Forward Price" with respect to a Forward Contract means an amount determined by formula and is based on the market value of the Basket of Shares on the date the Forward Contract is entered into, adjusted to reflect an interest component and sales commission component; XXXXXXXXXX;

"Fund" means XXXXXXXXXX;

"Manager" means XXXXXXXXXX, the manager and trustee of both the Fund and the Underlying Fund; its business number is XXXXXXXXXX and its Tax Services Office is XXXXXXXXXX;

"Money Market Securities" means securities offered in the Canadian money market such as treasury bills of the Government of Canada, bankers' acceptances of chartered Canadian banks and short-term debt obligations of Canadian corporations, the Government of Canada, a province or a municipality;

"Payment Date" means the date on which a Forward Contract is settled and will normally occur on the third business day following the maturity of the particular Forward Contract; and
"Underlying Fund" means XXXXXXXXXX.

Facts

1. The Manager is a taxable Canadian corporation under the Act. Its business includes the management of mutual fund trusts.

Proposed Transactions

2. The Manager will establish the Underlying Fund as an inter vivos trust pursuant to a declaration of trust. The Underlying Fund will, at all relevant times, be a mutual fund trust as defined in section 132 of the Act. The Underlying Fund will not be a registered investment under the Act and units of the Underlying Fund will be "foreign property" as defined in subsection 206(1) of the Act.

3. The Manager will establish the Fund as an inter vivos trust pursuant to a separate declaration of trust. The only activity of the Fund, as described further below, will be the investing of its funds in property (other than real property or an interest in real property).

4. The Fund will apply to become a "registered investment" under subsection 204.4(2) the Act immediately after it is established.

5. Units will be offered to the public by the Fund pursuant to the terms of a prospectus filed by the Fund with the securities regulatory authorities of each province of Canada (the "Offering"). The units will be sold to residents of Canada and as such, it is reasonable to consider that the Fund will not be established or maintained primarily for the benefit of persons who are not residents of Canada. The Fund intends to comply with the conditions prescribed in section 4801 of the Income Tax Regulations necessary to qualify as a mutual fund trust for the purposes of paragraph 132(6)(c) of the Act. It is expected that the Fund will comply with such conditions before the filing date for the Fund's 1999 income tax return and, pursuant to subsection 132(6.1) of the Act, will elect in its return of income under Part I of the Act for 1999 to be deemed to have been a mutual fund trust from the time of its establishment.

6. From time to time, the Fund will invest its funds, including the proceeds of the Offering, any amounts received under a Forward Contract and income earned on its investments, net of the expenses incurred by the Fund, primarily in Money Market Securities. From time to time the Fund may also invest its funds temporarily in short term deposits ("Cash Deposits") with Canadian financial institutions pending the investment of such funds in Money Market Securities. The Money Market Securities and Cash Deposits will not be foreign property as defined in the Act. The Fund may also invest in units of the Underlying Fund provided that the cost amount of such investment and any other foreign property held by the Fund does not exceed 20% of the cost amount of all the property of the Fund at the end of any month.

7. The Fund will enter into one or more separate Forward Contracts with a Counterparty. The Forward Contracts between a Counterparty and the Fund will relate to a Basket of Shares. The sample Forward Contract which was submitted for our review will be settled by means of a cash payment in U.S. dollars and is subject to any risks of default by the Counterparty. This Forward Contract will be foreign property for the purposes of the Act. Each Forward Contract will provide for a payment of an amount either by the Fund to the Counterparty, or by the Counterparty to the Fund, which payment will be determined by reference to the increase or decrease in the Final Price from the Forward Price. In particular, on each Payment Date, the Fund will be obligated to pay to the Counterparty the amount by which (a) exceeds (b), or the Counterparty will be obligated to pay to the Fund the amount by which (b) exceeds (a), where

(a) is the amount, if any, by which the Final Price is less than the Forward Price, and

(b) is the sum of any Dividend Amount and the amount, if any, by which the Final Price is greater than the Forward Price.

Each Forward Contract will be for a term of 30 days and will be subject to renewal at the option of the parties. A Forward Contract may be terminated before its maturity in certain circumstances set out in the Forward Contract, including a decision by the Fund to alter the composition of the Basket of Shares in the event that the Underlying Fund makes changes in its holdings.

8. The Fund will be required to maintain an initial and variation margin with the Counterparty in connection with each Forward Contract held by that Counterparty. The property to be held by the Counterparty in such margin deposits will consist of Cash Deposits or Money Market Securities and will be held at a location in Canada.

9. When it is considered appropriate, the obligations of the Counterparty under the Forward Contract will be guaranteed by another person who may or may not be resident in Canada. The Fund will not incur any cost in connection with such a guarantee and thus, the cost amount to the Fund of the guarantee will be nil.

10. The Fund will earn interest on its Cash Deposits and Money Market Securities and will pay or receive an amount on each Payment Date under a Forward Contract.

11. As a result of the Fund entering into the Forward Contracts, the return on the investment in units of the Fund will approximate the investment return on units in the Underlying Fund plus the income derived from the Fund's Cash Deposits and Money Market Securities less any amount required to be paid to the Counterparty under the Forward Contract and any expenses of the Fund. As it is expected that the income derived from the Fund's Cash Deposits and Money Market Securities will be less than the amount required to be paid to the Counterparty under the Forward Contract, the public documents relating to the Offering will state that the rate of return on units of the Fund is expected to be less than the rate of return on units of the Underlying Fund. The public documents relating to the Offering will state that the units of the Fund are suitable for investment by investors that are subject to the foreign property limits under Part XI of the Act.

12. At the end of any month, the aggregate cost amount for purposes of the Act of Cash Deposits and Money Market Securities and any other assets held by the Fund that are not foreign property will exceed 80% of the cost amount of all the property of the Fund.

Purpose of Proposed Transactions

13. The purpose of the proposed transactions is to provide investors that are subject to foreign property limits under Part XI of the Act an opportunity to realize investment returns that are linked to the returns realized on units of the Underlying Fund without increasing the amount of foreign property held by the investors.

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. Provided that the Fund is accepted by the Minister as a registered investment as set out in subsection 204.4(2) of the Act and has not been notified of a revocation of such status under subsection 204.4(3) of the Act, the units of the Fund will not be foreign property as defined in subsection 206(1) of the Act.

B. Provided that the cost amount at the end of a particular month of the Fund's Money Market Securities, Cash Deposits and any other property of the Fund that is not foreign property is not less than 80% of the cost amount of all property of the Fund, the Fund will not be liable for tax under subsection 206(2) of the Act for that month.

C. For the purposes of subsection 248(1) of the Act and section 5000 of the Income Tax Regulations, the cost amount to the Fund of its investments in Forward Contracts which are substantially the same as the draft contract submitted will be equal to the brokerage fees, legal fees and other costs incidental to entering into or acquiring the investment and will not include an amount in respect of the Forward Price or Final Price or the amount of any initial or variation margin deposit in respect of the Forward Contract.

D. Subsection 245(2) of the Act will not apply to redetermine the tax consequences arising from the above rulings.

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 with respect to forward contracts as described in paragraphs 7 and 8 above which are entered into or acquired by the Fund within six months of the date of this letter. Ruling A is also subject to the proviso that the Fund is accepted by the Minister as a registered investment within six months of the date of this letter.

The above rulings should not be construed as providing the Department's views on whether the Funds will qualify as unit trusts, mutual fund trusts or registered investments for purposes of the Act.

Yours truly,

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