2000 Ruling 9922883 - DERIVATIVES USED TO MIMIC CLONE FUNDS

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: Is the use of derivatives by one mutual fund trust to mimic the return of another mutual fund trust that holds foreign property subject to GAAR?

Position: GAAR is not applicable.

Reasons: The effect of the transaction does not increase the amount of foreign property held by the Fund.

XXXXXXXXXX
XXXXXXXXXX 992288
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 2000

Dear Sirs/Mesdames:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
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 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:

"Canadian Investments" means deposits with Canadian chartered banks and money market investments, such as treasury bills, and for greater certainty does not include any property included in the definition of "foreign property" in subsection 206(1) of the Act;

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

"Counterparty" means the XXXXXXXXXX, a party that XXXXXXXXXX is resident in Canada; however, the Fund may enter into similar Forward Contracts with other persons resident in Canada;

"Forward Contract" has the meaning set out in paragraphs 7 to 9;

"Forward Settlement Date" means the date as of which either a Fund or the Counterparty pays the Settlement Amount to the other in respect of a Forward Contract;

"Forward Start Date" means the date on which a Forward Contract commences;

XXXXXXXXXX

"Fund" means any of XXXXXXXXXX individually;

"Funds" means XXXXXXXXXX collectively;

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

"Settlement Amount" has the meaning set out in paragraph 9;

"Underlying Fund" with respect to XXXXXXXXXX means XXXXXXXXXX, individually; and

"Underlying Funds" means XXXXXXXXXX collectively.

Facts

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

2. The Manager has established each Underlying Fund as an inter vivos trust pursuant to a declaration of trust. The Underlying Funds are and will be, at all relevant times, mutual fund trusts as defined in section 132 of the Act. The Underlying Funds are not and will not be registered investments for the purposes of the Act and units of the Underlying Funds are and will continue to be "foreign property" as defined in subsection 206(1) of the Act.

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

4. Each Fund has applied to become a "registered investment" under subsection 204.4(2) of the Act.

Proposed Transactions

5. Units will be offered to the public by each Fund pursuant to the terms of a prospectus filed with the securities regulatory authorities XXXXXXXXXX (the "Offering"). The units will be sold to residents of Canada and as such, it is reasonable to consider that no Fund will be established or maintained primarily for the benefit of persons who are not residents of Canada. It is intended that each Fund will 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 each of the Funds will comply with such conditions before the filing date for its XXXXXXXXXX income tax return and, pursuant to subsection 132(6.1) of the Act, each Fund will elect in its return of income under Part I of the Act for XXXXXXXXXX to be deemed to have been a mutual fund trust from the time of its establishment.

6. From time to time, each 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 Canadian Investments. Each 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. Each Fund will enter into one or more separate Forward Contracts with the Counterparty. The Forward Contracts will have a term of XXXXXXXXXX and will require XXXXXXXXXX deposits XXXXXXXXXX held by the Counterparty as margin. The amounts so held on deposit will be Canadian Investments held by the Counterparty in Canada. XXXXXXXXXX Payments will be made under each Forward Contract as of the Forward Settlement Date, XXXXXXXXXX. The Forward Contracts will be appropriately adjusted for any distributions made by the Underlying Funds to their unitholders. A draft Forward Contract was included with your submission.

8. Each Forward Contract will be executed in Canada, will be governed by the laws of Canada and both parties to the contract will be resident in Canada. No such Forward Contract will be listed on any stock exchange or traded over-the-counter. None of the Forward Contracts will be convertible into, exchangeable for, or provide the Funds with any right to acquire property that is foreign property. Each Forward Contract will be settled by means of a cash payment and is subject to any risks of default by the Counterparty.

9. A Forward Contract entered into by a Fund will commence on a Forward Start Date and will terminate on a Forward Settlement Date. On the Forward Settlement Date, the Settlement Amount will be paid by either the Fund to the Counterparty, or by the Counterparty to the Fund, as is applicable. The Settlement Amount under a Forward Contract will generally be determined as:

(a) the sum of:

• the net asset value per unit of the Underlying Fund on the Forward Settlement Date, and
• the distributions per unit made by the Underlying Fund from the Forward Start Date to but excluding the Forward Settlement Date;

minus

(b) the sum of

• the net asset value per unit of the Underlying Fund on the Forward Start Date, and
• an amount in respect of the Counterparty's notional funding costs plus an interest component to compensate the Counterparty for entering into the Forward Contract in respect of the period from the Forward Start Date to the Forward Settlement Date;

multiplied by the number of units of the Underlying Fund that are the subject of the Forward Contract.

If the Settlement Amount as determined above is a positive amount, it will be payable by the Counterparty to the Fund and if it is a negative amount, it will be payable by the Fund to the Counterparty.

10. The Funds will incur legal fees, but not brokerage fees, in entering into the Forward Contracts.

11. The Funds will earn interest on the Canadian Investments and will pay or receive amounts under the Forward Contracts.

12. As a result of a Fund entering into Forward Contracts, the unitholders of that Fund will realize generally the same amount by way of investment return as holders of units in the relevant Underlying Fund less the difference between

(a) the costs borne by the Fund in respect of the Forward Contracts and the Fund's operating expenses, and

(b) the income earned by the Fund on its Canadian Investments.

13. It is expected that the interest earned on the Canadian Investments will be less than the costs borne by the Fund in respect of the Forward Contracts and as a result the public documents relating to the Offering will state that the performance of each of the Funds will be less than the performance of the relevant Underlying Fund. The public documents relating to the Offering will state that the units of the Funds are suitable for investment by investors that are subject to the foreign property limits under Part XI of the Act.

14. At the end of any month, the aggregate cost amount of the Canadian Investments and Forward Contracts held by each Fund that are not foreign property for purposes of the Act will not be less than 80% of the cost amount of all the property of the Fund.

Purpose of Proposed Transactions

15. 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 Funds 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 a 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. A Forward Contract described in paragraphs 7 to 9 above, and which is substantially similar to the draft Forward Contract submitted will not be considered to be foreign property as defined in subsection 206(1) of the Act.

C. Provided that the cost amount at the end of a particular month of a Fund's Canadian Investments, Forward Contracts, 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.

D. For purposes of subsection 248(1) of the Act and section 5000 of the Income Tax Regulations, the cost amount to a Fund of its investment in a Forward Contract which is substantially similar to the draft Forward Contract submitted will be equal to the legal fees and other similar costs incidental to entering into or acquiring the investment and will not include an amount in respect of the Settlement Amount, or any margin deposits in respect of the Forward Contract.

E. 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 the Canada Customs and Revenue Agency (the CCRA) with respect to Forward Contracts as described in paragraphs 7 to 9 above which are entered into or acquired by a Fund within six months of the date of this letter.

The above rulings should not be construed as providing the CCRA'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