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 units of a mutual fund trust (the "Fund"), which holds units of another mutual fund trust (the "Reference Fund") and which also uses derivative investments to mimic the return of the Reference Fund, be "foreign property" as defined in subsection 206(1). Under the proposals, the cost amount to the Fund of all its foreign property will not exceed 20% of the cost amount to the Fund of all the property held by it.
2) Will subsection 245(2) apply to the proposed transactions.
Position: 1) No 2) No.
Reasons:
Paragraph 206(1)(i) provides that except as prescribed by regulation, any interest in a trust (other than a registered investment), is foreign property. However, subsection 5000(1) provides that an interest in a mutual fund trust will not be foreign property provided that the cost amount to the trust of foreign property held by it does not exceed 20% of the cost amount to the mutual fund trust of all property held by it. As set out in the proposed transactions, the cost amount to the Fund of its foreign property will not exceed the 20% limitation, therefore, as long as the Fund qualifies as a mutual fund trust under subsection 132(6), its units will not be foreign property.
The application of subsection 245(2) to similar transactions was previously considered by the GAAR Committee and it was their view that GAAR was not applicable to the proposed transactions. See 9914583, 991395, 991774, 992288, 992304, and 992307.
XXXXXXXXXX
XXXXXXXXXX 3-992831
XXXXXXXXXX
Attention: XXXXXXXXXX
XXXXXXXXXX, 1999
Dear Sirs:
Re: Advance Income Tax Ruling
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 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:
"MCo" means XXXXXXXXXX.
"PCo" means XXXXXXXXXX.
"Fund A" means XXXXXXXXXX.
"Fund B" means XXXXXXXXXX.
"Fund C" means XXXXXXXXXX.
"Fund X" means XXXXXXXXXX.
"Fund Y" means the XXXXXXXXXX.
"Fund Z" means the XXXXXXXXXX.
"Cost amount" means the cost amount of property as defined in subsection 248(1).
MCo deals with the XXXXXXXXXX Tax Services Office and files it returns with the XXXXXXXXXX/Tax Centre. Funds X to Z file, and Funds A to C will file, their returns at the XXXXXXXXXX Tax Centre and deal, or will deal with, the XXXXXXXXXX Tax Services Office.
FACTS AND PROPOSED TRANSACTIONS
1. MCo is a mutual fund management company engaged in the promotion, management and distribution of XXXXXXXXXX open-end mutual fund trusts within the meaning of subsection 132(6).
2. MCo will establish three new unit trusts, Fund A, Fund B and Fund C (collectively, the "Funds", individually, the "Fund"), by way of amendment and restatement of a declaration of trust that provides for the creation of additional trusts from time to time.
3. The capital of each Fund will be represented by two classes of redeemable units of beneficial interest in the Fund (the "XXXXXXXXXX" and the "XXXXXXXXXX"), the terms and conditions of which are essentially identical except that the XXXXXXXXXX Class will not bear any management fees charged to the Fund in respect of the assets of the Fund.
4. Units will be offered for sale to the public in Canada by way of simplified prospectus filed with the applicable securities regulators in Canada. MCo has filed a preliminary Simplified Prospectus and Annual Information Form dated XXXXXXXXXX for the Funds with all securities regulators in Canada. It is expected that the final documents will be filed on or about XXXXXXXXXX.
5. MCo intends the Funds to qualify as "unit trusts", as defined in paragraph 108(2)(a), and expects that the Funds will qualify as mutual fund trusts for purposes of subsection 132(6) and will make the election provided under subsection 132(6.1) on or before XXXXXXXXXX. Also, MCo will apply in prescribed form to have each Fund accepted as a "registered investment" pursuant to section 204.4.
6. Each Fund will hold XXXXXXXXXX Class units of another MCo mutual fund trust with a cost amount up to but not exceeding the prescribed percentage of the aggregate cost amount of all property held by the Fund as stipulated in paragraph 5000(1)(e) of the Income Tax Regulations. Such other mutual fund trust for Fund A, Fund B and Fund C will be Fund X, Fund Y, and Fund Z, respectively, (collectively, the "Reference Funds", individually, the "Reference Fund"). Units of each of the Reference Funds are foreign property for purposes of Part XI of the Act.
7. In addition to units of the Reference Fund, each Fund will also invest in cash deposits with Canadian financial institutions, bankers acceptances of chartered Canadian banks, Canadian money market instruments with a weighted average duration of not more than 90 days, and other securities of Canadian issuers, or any combination thereof (such investments, excluding the cash deposits, being referred to herein as the "Canadian Instruments"). The cash deposits and the Canadian Instruments will not be foreign property for purposes of Part XI of the Act.
8. The Funds will also enter into forward contracts with one or more Canadian financial institutions (the "Counterparty"). Each forward contract will be executed in Canada, will be governed by the laws of Canada, and both parties to the forward contract will be resident in Canada. No such forward contract will be listed, or traded over the counter, on any stock exchange. The forward contract will not 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. As such the forward contracts will not be foreign property.
9. In particular the Funds will enter into a "XXXXXXXXXX" (the "Program") with PCo, the terms and conditions of which will be set out in a master agreement and will govern forward contracts entered into between the Funds and PCo. The Program will have an "initial" term of XXXXXXXXXX years but it may be terminated by either party at any time on XXXXXXXXXX days' prior written notice.
It is intended that if the Funds enter into forward contracts with other Counterparties, then such contracts will have substantially similar terms and conditions as those contemplated under the Program. A draft sample forward contract was included with your submission.
10. Each forward contract will have a fixed term of XXXXXXXXXX days, will be settled in cash by a payment by the Fund to the Counterparty or by a payment by the Counterparty to the Fund at the end of the term of the forward contract and will be automatically renewed (subject to termination of the Program as described in 9 above). Under the forward contract, a Fund and the Counterparty agree to make payments to each other determined by reference to the change in net asset value of a XXXXXXXXXX Class unit (the "XXXXXXXXXX NAV") of the Reference Fund. That is, a payment will be made by the Fund to the Counterparty (if the XXXXXXXXXX NAV of the Reference Fund has decreased in value) and a payment will be made by the Counterparty to the Fund (if the XXXXXXXXXX NAV of the Reference Fund has increased in value). However, each such forward contract payment is subject to the payment of a "Funding Amount" and "Fee Amount" in favour of the Counterparty. The Funding Amount is determined by multiplying the average yield to maturity of a one month banker's acceptance expressed as a percentage rate per annum (the "Base Rate") by the notional forward contract amount. The notional forward contract amount is the amount in respect of which the Counterparty is expected to hedge its risk (see 14 below) on the forward contract (and generally will be equal to the cash funds the Fund has on deposit with the Counterparty on which it will earn interest at XXXXXXXXXX). The Fee Amount is XXXXXXXXXX basis points multiplied by the notional forward contract amount, calculated daily. The Funding Amount and the Fee Amount reflect the particular arrangement between the parties relating to the Counterparty's cost of hedging and the Counterparty's compensation.
11. Interim settlement payments may also be made when the accrued amount of the payment to be made under the forward contract exceeds, or is exceeded by, XXXXXXXXXX% of the notional forward contract amount and in certain other circumstances such as a breach of the contract or "force majeure" type events as stipulated in standard ISDA (International Swaps and Derivatives Association) Agreement, a copy of which was also included with your submission.
12. Subscriptions for and redemptions of units of the Fund adjust the notional forward contract amount. Distributions made by a Reference Fund to its unitholders, and any consequential decrease in the XXXXXXXXXX NAV, are taken into account in the payments made by the parties under the forward contract.
13. The Simplified Prospectus and Annual Information Form related to the Funds will advise potential investors that the taxation of taxable investors in a Fund will compare adversely to the taxation of taxable investors in a Reference Fund in that investment returns earned from the Funds will be primarily characterized as income, rather than capital gains. Also, returns earned by a Fund are expected to be lower than the returns earned by a Reference Fund primarily because the Fund has expenses that a Reference Fund does not have. That is, in addition to its usual operating expenses, a Fund has additional costs related to the forward contracts (the Funding Amount and the Fee Amount). These costs will reduce the returns of the Fund but will be partially offset by the interest earned on a Fund's cash deposits as discussed in 15 below.
14. The Counterparty may and is expected to invest in XXXXXXXXXX Class units of a Reference Fund to hedge its forward contract obligations to a Fund. MCo will not charge any sales or redemption fee in respect of such investment by the Counterparty. The Counterparty will not pay any commission in respect of its investment in Retail Class units of the Reference Fund.
15. Each Fund will deposit its cash with the Counterparty or maintain its Canadian Instruments in an amount approximately equal to the aggregate notional forward contract amount of any forward contracts between the Fund and the Counterparty. A portion of the cash deposits and/or Canadian Instruments will be pledged to the Counterparty as security for the Fund's payment obligations to the Counterparty under the forward contracts. Cash deposits with the Counterparty will earn a rate of interest equal to the XXXXXXXXXX.
16. If a Fund's cash deposit held by the Counterparty at any time during the month in any particular month exceeds the Counterparty's costs at the time to acquire units of the relevant Reference Fund to hedge its risk under the forward contract by an amount greater than $XXXXXXXXXX, then the Counterparty will pay an amount to the Fund equal to the XXXXXXXXXX applied to the amount of such excess. If these costs of the Counterparty at any time during the month exceed the amount of the cash deposit held by the Counterparty by an amount greater than $XXXXXXXXXX, the Fund will pay to the Counterparty an amount equal to the XXXXXXXXXX applied to the amount of such excess.
PURPOSE OF PROPOSED TRANSACTIONS
17. The purpose of the proposed transactions is to permit the Funds to invest in properties that will allow it to achieve their investment objectives, namely, to provide investors with a return measured by reference to the performance of a specific foreign property, while at the same time ensuring that units of the Funds are not foreign property, as defined in section 206 of the Act, to taxpayers listed in paragraphs 205(a) to (f) of the Act. The proposed transactions also will permit MCo to offer a product that is similar to products currently being offered by its mutual fund competitors.
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 carried out as described herein, our advance income tax rulings are as follows:
A. Provided that each Fund limits it investments, as described in 6 to 9 above, and at all relevant times qualifies as a "mutual fund trust" as defined subsection 132(6), the units of the Fund will not be "foreign property" as described in subsection 206(1).
B. Subsection 245(2) will not be applied to redetermine the tax consequences of the ruling given 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 (CCRA) with respect to forward contracts as described in 8 to 12 above which are entered into or acquired by a Fund within six months of the date of this letter. These rulings are based on the law as it currently reads and do not take into account any proposed amendments to the Act, which if enacted into law, could have an effect on the rulings provided herein.
The above rulings should not be construed as providing the CCRA's views on whether the Funds qualify as 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
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