Allocation-to-redeemer rulings (p. 12)
- The allocation-to-redeemer methodology for allocating capital gains to a redeemed unitholder is supported by 9817583; see also 2000-0041363, 2001-009107A, 2007-0224201R3 and 2007-0257551R3.
Abuse prompting s. 132(5.3)(b) (p. 14)
- S. 132(5.3)(b) addressed in part the potential for abuse arising from a unitholder of an MFT being indifferent to how much capital gains was allocated to it (the more allocated, the larger an offsetting capital loss), but with the result that the remaining unitholders receiving a reduced or no capital gains allocation.
Purpose test applies at time the terms are established (p. 10)
- The original Explanatory Notes referenced “one of the main purposes for the creation of an interest in the trust”, which supports the better reading of the s. 104(7.1) words, which is that they refer to the purposes at the time the particular term was created, and not the purposes when the trustee determines to apply the particular term.
Abuse addressed by s. 132(5.3)(a), and response in practice (pp. 6-8)
- S. 132(5.3)(a) addressed in part the potential for abuse arising from a unitholder of an MFT which held its units on income account being indifferent to the quantum of income that was allocated to it on redeeming its units, so that a pro rata portion of such income might not be allocated to other unitholders who held their units on capital account.
- Strategies for dealing with s. 132(5.3)(a) include distributing income regularly through the year (although the MFT’s income may be unpredictable) and distributing income to all unitholders once a redemption request has been received from a large unitholder (which may create practical difficulties, e.g., stock exchanges which required at least five trading days’ notice of a distribution.
Potential to not receive a full refund (p. 13)
- Where the amount of an MFT’s realized capital gains throughout a taxation year divided by the amount paid to redeeming unitholders in the year is greater than the unrealized gains in the MFT at the end of the year divided by the NAV of the units of the MFT at the end of the year (e.g., when the portfolio has declined in value throughout the year), the capital gains refund mechanism (“CGRM”) will result in the MFT paying more tax on its capital gains than the CGRM refund.
Background to s. 132(5.31) (p. 16)
- S. 132(5.3)(b) produced an inappropriate result for exchange-traded funds (ETFs) where a market maker, in order to avoid the units trading at a significant discount to NAV, would purchase units on the exchange and redeem them, and also subscribe for units, so that effectively all the redemption proceeds were paid to a unitholder (the market maker) with full cost for its redeemed units, without account being taken of the gains of the unitholders selling their units to the market maker.
- Under the s. 132(5.31)(a) formula directed to ETFs, provided that the total amount paid by the ETF in the year for redemptions is less than its NAV at the end of the year, and at the end of the previous year, it is permitted to deduct an amount not exceeding its net taxable capital gains for the year multiplied by the total amount paid for redemptions of its units in the taxation year divided by the sum of its NAV at the end of the year and total amount paid by it for redemptions in the year.
Advantages and limitations of s. 132(5.31) formula (pp. 18-19)
- In contrast to s. 132(5.3), a market downturn will not affect the amount of gains that can be distributed by the ETF to redeemed units if the downturn causes the amount paid on the redemptions to exceed the NAV of the ETF at the end of the applicable taxation year (by virtue of variable (ii)(A) exceeding variable (i)).
- An April 4, 2022 submission of IFIC and CETFA to Finance pointed out that if a significant portion of an ETF’s capital gains related to satisfying units redemptions rather than from ordinary course trading activities, and the amount paid to redeeming unitholders was small relative to the aggregate NAV of all ETF units, then the ETF would only be able to allocate a small portion of those capital gains to redeemed unitholders and referred inter alia to a July 29, 2020 submission that the ETF should be allowed to allocate to redeemed unitholders a proportionate amount of the ETF’s unrealized gains at the beginning of the day on which the redemptions occurred.
ETF difficulty in detecting whether a unitholder has become a majority-interest beneficiary (pp 25-26)
- A fund can conclude that it did not experience a loss restriction event in a year (with a resulting deemed taxation year) by virtue of being an investment fund - or by virtue of monitoring unit acquisitions by its unitholders (which may not be practicable for an ETF since the requirement under NI 62-104 to provide early warning of an acquisition of 10% or more of a class of securities of a reporting issuer generally does not apply to ETFs, and most ETFs generally rely on exemptive relief from NI 62-104 requiring disclosure of securities subject to an offer plus existing securities which constitute 20% or more of the securities of a class).
Permanent tainting if momentary breach of any condition (p. 26)
- A trust breaching any of the conditions in paras. (a) or (b) of the definition of investment fund, even momentarily, will permanently lose its investment fund status.
Need under para. (a) to qualify units in year of trust creation (pp. 26-27)
- By virtue of the para. (a) requirement that a post-2013 trust must have a class of units that are qualified for distribution to the public in accordance with Reg. 4801(a) in the same calendar year in which it was created, a trust created in December in order to file a final prospectus in December, but whose units are not distributed until January will not meet that requirement and, therefore, be permanently disqualified from investment fund status.
Additional requirements where already an MFT (p. 27)
- In practice, if a trust which (leaving aside the 150 beneficiary requirement) qualified as a mutual fund trust, failed to qualify as an investment fund, this would likely occur under s. (b)(iii) or (b)(vi)(D).
Investment diversification test in s. (b)(iii) (p. 27)
- Regarding the requirement in s. (b)(iii) of following “a reasonable policy of investment diversification,” a fund should be able to satisfy this test by investing in a bottom fund that itself satisfies this test and should be evaluated in the context of the fund’s objectives - for example, in the case of a long federal bond fund, it could mean holding a portfolio of 15 different federal bonds.
Concentration test in s. (b)(vi)(D) (p. 28)
- In practice, it is possible for funds to violate the concentration test in (b)(vi)(D) by investing in a bottom fund that is a partnership, a Canadian resident trust that is not an investment fund, or a non-resident trust or corporation, given that the fund might have obtained exemptive relief in this regard from the application of NI 81-102.
Timing of applying tests under ss. (c)(ii) to (iv) (p. 30)
- Although ss. (c)(ii) and (iii) do not expressly address when eligible entity status is to be tested, it is suggested that a corporation or trust should be included in the maximum amount tests only at such times within the taxation year that it is an eligible group entity.
- S. (c)(iv) does not expressly address when eligible group entity status is tested, and refers to “an eligible group entity in respect of the taxpayer for the taxation year” even though the eligible group entity definition provides a point-in-time test – perhaps an interest payment made by an entity is relevant under s. (c)(iv) only if it is an eligible group entity in respect of the taxpayer at that time.
Canadian undertaking test in s. (c)(i) (p. 33)
- The phrase “if any” was added to s. (c)(i) in response to an industry request for confirmation that a taxpayer need not have a business to satisfy the test.
- There may be a concern that there is a foreign business or undertaking if, for example, a fund engages a non-resident sub-advisor to make investment decisions on behalf of the fund, or it used a non-resident custodian for trades outside Canada.
Eligible group entity status in bank-controlled ETF group (pp. 31-32)
In the scenario where the asset manager for a mutual fund corporation (MFC) is a Canadian bank subsidiary, and an exchange-traded mutual fund trust (the Fund) has the same asset manager and another bank subsidiary is the Fund’s designated broker and market maker:
- If the voting shares of the MFC are held by the asset manager, the MFC will be related to the asset manager and bank, so that they will be eligible group entities.
- Per s. 18.2(16)(a), the Fund will not be related for eligible group entity to the asset manager or bank by virtue only of the asset manager being its trustee.
- If either the asset manager (by virtue of providing seed capital) or the broker-dealer (by virtue of its market-maker function) owns more than 50% of the FMV of the Fund units, then it will be a majority-interest beneficiary, and thereby affiliated so as to generate eligible group entity status.
Payment and allocation discretion consistent with fixed interest status (p. 32)
- The discretion of pay distributions at different times (e.g., to make a special distribution in advance of a large redemption), allocating capital gains to redeeming unitholders and paying management fee distributions to particular unitholders should not cause units of an investment fund to not be fixed interests.
Issues with computing trust ATI (p. 36)
- The adjusted taxable income (ATI) definition in relation to a trust requires adding back (under Variable B(g)) the s. 104(6) deductions of the trust except to the extent of any portion designated under s. 104(19) in respect of taxable dividends, and Variable C(h) deducts any s. 104(13) inclusion to the trust except to the extent of the portion designated under s. 104(19).
- A trust with interest and financing expenses of $30 (e.g., loan interest) which invested in Canadian equities, received $100 of taxable dividends and distributed $70 to its unitholders which it designated under s. 104(19) would have an ATI of $30 (reflecting the add-back of the IFE, but not the add-back of the $70 under B(g) because of the s. 104(19) designation) so that the trust could deduct no more than $9 of interest in the year, thereby requiring a further distribution of $21 of income.
- A trust receiving all of its income (being $100 of ordinary income) from a trust investment would have an ATI of nil - since, although it would have an addback of its $30 of IFE under B(a) and of $70 under B(g) for its s. 104(6) deduction, the $100 of income received from the subtrust and included in its income under s. 104(13) would be deducted under C(h), so that the IFE could not be deducted.
Email this Content