2000 Ruling 9928733 - DERIVATIVE BASED MUTUAL FUND 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: 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 992873
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 2000

Dear Sirs/Mesdames:

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 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:

"Contract Net Asset Value" means the net asset value of the notional units of the Underlying Fund as determined at the maturity of the Forward Contract;

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

"Counterparty" means a XXXXXXXXXX which is not related to XXXXXXXXXX or the Fund within the meaning of the Act; 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;

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 the XXXXXXXXXX Taxation Services Office;

"Money Market Securities" means securities offered in the Canadian money market and cash deposits with major Canadian financial institutions, XXXXXXXXXX, but for greater certainty, does not include any property included in the definition of "foreign property" in subsection 206(1) of the Act;

"Notional Forward Amount" means the net asset value of the notional units of the Underlying Fund as determined on the date the Forward Contract commences, adjusted to reflect any increase or decrease made during the course of the Forward Contract and any distributions made by the Underlying Fund;

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

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

"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. None of the Underlying Funds is or will be a registered investment for the purposes of the Act and the 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 XXXXXXXXXX declaration of trust. The only activity of each Fund, as described below, 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 of the Funds pursuant to the terms of a prospectus filed by the Funds 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 none of the Funds 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 under the Act. It is expected that each Fund will comply with such conditions before the filing date for its 2000 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 to be deemed to have been a mutual fund trust from the time of its establishment.

6. Each Fund will invest its funds, including the proceeds of the Offering and any amounts received pursuant to a Forward Contract, net of the expenses incurred by the Fund, in Money Market Securities. Each Fund may also invest some of its funds 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, or such other limit as may be stipulated in paragraph 5000(1)(e) of the Income Tax Regulations.

7. The Manager will enter into an agreement with the Counterparty under which each Fund will enter into one or more separate Forward Contracts with the Counterparty. The Forward Contracts between the Counterparty and each Fund will relate to the units of the Underlying Fund. In no event will a Fund acquire a unit of an Underlying Fund pursuant to a Forward Contract. Each Forward Contract will be for a term of XXXXXXXXXX. A Forward Contract may be terminated before its maturity date in certain circumstances. A draft copy of the Forward Contract and the agreement 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. Each Forward Contract will provide for a Payment Amount to be made by either the Fund to the Counterparty or the Counterparty to the Fund. In particular, on each Payment Date,

(a) the Fund will be obligated to pay to the Counterparty the amount, if any, by which the Notional Forward Amount and an amount representing the Counterparty's cost of funding the Forward Contract and the Counterparty's fee for entering into the Forward Contract exceeds the Contract Net Asset Value, or

(b) the Counterparty will be obligated to pay the Fund the amount, if any, by which the Contract Net Asset Value exceeds the Notional Forward Amount and an amount representing the Counterparty's cost of funding the Forward Contract and the Counterparty's fee for entering into the Forward Contract.

10. In connection with a Forward Contract, each Fund will be required to maintain initial and variation margin deposits XXXXXXXXXX. The margin deposits will consist of Money Market Securities and will be held at a location in Canada. XXXXXXXXXX

11. The Funds will incur legal fees, XXXXXXXXXX, in entering into the Forward Contracts.

12. As a result of a Fund entering into the Forward Contracts, unitholders of the Fund will realize generally the same amount by way of investment return as holders of units in the Underlying Fund, plus the income derived from the Fund's Money Market Securities and less the costs borne by the Fund in respect of the Forward Contracts and any expenses of the Funds. It is expected that the income derived from a Fund's Money Market Securities will be less than the costs borne by the Fund under the Forward Contracts. The public documents relating to the Offering will state that the rate of return on units of each Fund is expected to be less than the rate of return on units of the Underlying Fund and 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.

13. At the end of any month, the aggregate cost amount for purposes of the Act of Money Market Securities held by each Fund, and any other assets of 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

14. 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 costs incidental to entering into or acquiring the investment and will not include an amount in respect of the Payment Amount, or any initial or variation 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 Directorate
Policy and Legislation Branch