Section 107.4

An individual resident in Canada settles and contributes capital property to a trust governed by the Civil Code of Québec (the "C.C.Q.") under which the settlor is one of the two trustees and under the terms of which no person other than the settlor can, before that individual’s death, receive any part of the income or capital, but with discretion accorded to the trustees as to whether or not to distribute the income and capital to the beneficiary, and with any undistributed income reinvested in the trust. On death, the trust property would go to the settlor's estate by virtue of the terms of the C.C.Q.

Does the according by the trust indenture to the trustees of the discretion to distribute income and capital to the beneficiary prevent s. 107.4(1)(a) from being satisfied? CRA responded:

Having regard to paragraph 248(3)(e) and subsection 248(25), it is reasonable to consider that the transfer of property to a trust governed by the C.C.Q. of which the transferor is the sole beneficiary does not result in a change in beneficial ownership for the purposes of paragraph 107.4(1)(a).

Thus, a discretion accorded to the trustees, under the terms of the trust indenture, as to when they may distribute capital and income to the beneficiary would not, in and of itself, affect the determination of whether or not there is a change in beneficial ownership as long as the individual is, as a result of the transfer of the property to the trust, the sole person beneficially interested in the trust within the meaning of subsection 248(25).

Current Structure

The units of the REIT (a real estate investment trust) are stapled to those of Finance Trust (a portfolio investment entity and a mutual fund trust), so that they trade on a stock exchange together. Finance Trust (along with the REIT) holds notes (the "US Holdco Notes") of the indirect U.S. commercial real estate subsidiary of the REIT (“U.S. Holdco”). Finance Trust qualifies as a fixed investment trust for Code purposes, so that its unitholders are treated as if they held such notes directly. The REIT holds US Holdco through a 2-tier subsidiary LP structure (i.e., holding Holdings LP which in turn holds US Portfolio LP.)

Purposes

As a result of US tax reform, Finance Trust no longer serves a purpose as adverse US tax consequences are no longer suffered by US Holdco on interest paid to the REIT. The proposed transactions allow for the US Holdco Notes to be transferred out of Finance Trust prior to its termination, and (in transactions not described below) also permit the US Holdco Notes to be refinanced to reflect current commercial arm’s length interest rates.

Proposed Transactions

A portion of the existing loans will be contributed by the REIT to Holdings LP, and by Holdings LP to US portfolio LP. An equity conversion option will be added to their terms and US portfolio LP will then convert them into equity on exercise of that option.

Finance Trust will transfer all of the US Holdco Notes held by it (being most of its property) to the REIT for no consideration (the “Disposition”). At the time of transfer, the beneficiaries of the REIT will be identical to, and will hold their units in the same proportions as, the beneficiaries of Finance Trust. The REIT will purchase all of the outstanding Finance Trust Units from the Finance Trust Unitholders for their nominal value, and Finance Trust will redeem all of the Finance Trust Units and will be terminated.

Ruling

The Disposition will constitute a “qualifying disposition” within the meaning of s. 107.4(1), such that the rules in s. 107.4(3) will apply to the REIT, Finance Trust and their respective unitholders in respect of the Disposition.

Current Structure

The units of the REIT (a real estate investment trust) are stapled to those of Finance Trust (a portfolio investment entity and a mutual fund trust), so that they trade on a stock exchange together. Finance Trust holds notes of the indirect U.S. commercial real estate subsidiary of the REIT (“U.S. Holdco”). Finance Trust qualifies as a fixed investment trust for Code purposes, so that its unitholders are treated as if they held such notes directly. This avoids the U.S. earnings stripping limitations on the level of permitted interest deductions by U.S. Holdco. However, subsequently to this structure being implemented, U.S. acquisitions by U.S. Holdco were funded with loans from REIT, which are subject to the earnings stripping rules. Each unit of the REIT and of Finance Trust (and of F17 Trust described below) represents an equal undivided beneficial interest in the property of the trust.

Proposed Transactions

In order that much of this additional debt can access the benefits of the stapled structure, the REIT and Finance Trust are proposing that Finance Trust first make a s. 107.4 transfer of its notes of U.S. Holdco to the REIT. Following the replacement of those notes and some of the newer debt with amended notes, and the transfer to the unitholders of units of a new fixed investment trust with nominal assets (the “F17 Trust”) in consideration for the nominal cash received by them for the transfer of their units of Finance Trust to the REIT (whose ACB will have been reduced under s. 107.4(3)(l)), the amended notes will be transferred by the REIT under s. 107.4 to the F17 Trust. Finance Trust then will redeem all its units. Thus, there will be a replacement stapled structure similar to what was there before, except that the new Finance Trust (F17 Trust) will hold more U.S. Holdco debt.

Ruling

The disposition of the Finance Trust loans to the REIT and of the amended loans to F17 Trust will constitute “qualifying dispositions” under s. 107.4(1), such that the rules in s. 107.4(3) will apply to the REIT, Finance Trust, F17 Trust, and their respective unitholders in respect such dispositions.

See also H&R REIT summary.

Two spouses (Mr. X and Ms. X) and their two adult children wish to contribute their jointly owned shares of Holdco to a newly-settled protective trust.

Can the transfer of the Holdco shares by the the four family members, to the extent that it cannot occur tax-free pursuant to subsection 73(1), be made pursuant to subsection 107.4(3)?

A "qualifying disposition" is defined in subsection 107.4(1) and in order for the transfer of property to be a qualifying disposition, the following conditions must be met:

i) there is a change in the legal title but not in the beneficial ownership of the property;
ii) the disposition is not made by a person resident in Canada to a non-resident trust;
iii) immediately after the disposition no person other than the contributor has an absolute or contingent right of any kind in the trust;
iv) the proceeds are not determined under any other provision of the Act (leaving aside sections 69 and 73);
v) subsection 73 (1) does not apply even if some of the conditions in subsection 73(1) are not satisfied.

[A] qualifying disposition of the trust would not be possible because conditions (i) and (iii) would not be met.

Proposed transactions

1. The Fund, which is an exchange-traded mutual fund trust, will for nominal consideration subscribe for one Trust Unit of a unit trust (the “Trust”) that was settled by a third party, and redeem the initial Trust Unit held by that third party for its cash subscription price.
2. The Fund will transfer all of the Partnership Units of a partnership to the Trust for one or more Trust Units. This transfer will occur in one day. The Fund will not make the election in s. 107.4(3)(a)(i) and the Trust will not make the election in s. 107.4(3)(c)(ii)(B). Following this transfer, the Fund will continue to directly own 100% of the Trust Units and will indirectly own 100% of the Partnership Units. The Partnership Units acquired by the Trust will not be used to fund a distribution by the Trust. The value of the beneficial ownership of each holder of a Fund Unit under the Fund in the Partnership Units at the commencement of the transfer this transfer will be the same as the value of such holder's beneficial ownership under the Fund and the Trust in the Partnership Units at the completion of the transfer.

Ruling

The transfer of the Partnership Units from the Fund to the Trust will be a "qualifying disposition" pursuant to s. 107.4(1).

Would s. 107.4(1)(a) be satisfied where a transferor transfers ownership of property to a Quebec trust of which he is the sole beneficiary? CCRA responded:

[T]he transferor of the property will therefore be considered, under paragraph 248(3)(f), to have beneficial ownership of the property immediately before its transfer to the trust. Since he is a beneficiary of the trust, the transferor will also be considered to have beneficial ownership of the property after its transfer, pursuant to paragraph 248(3)(f) and subsection 248(25). Consequently, to the extent that the transferor is the sole beneficiary of the trust within the meaning of subsection 248(25) when the property is transferred to the trust, the transfer will not have the effect of changing the beneficial ownership of the transferred property, thereby satisfying the condition set out in paragraph 107.4(1)(a).

A publicly-trade mutual fund trust (the "Fund") eliminated a corporate subsidiary ("Holdings") by incorporating a subsidiary ("MFC") with a modest value, distributing interests in MFC to its unitholders as a capital distribution in order that MFC would qualify as a mutual fund corporation, transferring Holdings to MFC on a s. 85(1) rollover basis in consideration for MFC shares, having MFC amalgamate with Holdings to form MFC Amalco, and then having MFC Amalco merge into the Fund in accordance with s. 132.2 so that the Fund acquired the assets of MFC Amalco, principally, units in a subsidiary LP.

Following these transactions, the Fund will transfer all of such LP units to a newly settled unit trust (the "Trust") for one or more Trust Units, so that following this transfer it will continue to own directly 100% of the Trust Units and indirectly own 100% of the LP units. The Trust will then use proceeds of a daylight loan to distribute cash proceeds to the Fund as a return of capital and the Fund will lend those proceeds to the Trust.

Ruling that the transfer of the LP units from the Fund to the Trust will be a “qualifying disposition” and that s. 245(2) will not apply. The CRA summary indicates that the refinancing of the Trust is not offensive as regards the qualifying disposition rules.

An individual resident in Canada settles and contributes capital property to a Quebec trust under which the settlor is one of the two trustees and under the terms of which no person other than the settlor can, before that individual’s death, receive any part of the income or capital, but with discretion accorded to the trustees as to whether or not to distribute the income and capital to the beneficiary, and with any undistributed income reinvested in the trust. On death, the trust property would go to the settlor's estate. Does the discretion of the trustees to distribute income and capital to the beneficiary result in the condition in s. 107.4(1)(i) being satisfied?

After noting that the relevant requirement was that in s. 73(1.01)(c)(ii) that, after transferring the capital property to the trust, the “individual is entitled to receive all of the income of the trust that arises before the individual’s death and no person except the individual may, before the individual’s death, receive or otherwise obtain the use of any of the income or capital of the trust,” CRA stated:

"[T]he right to receive" all of the trust income in subparagraph 73(1.01)(c)(ii) means that the right to require payment of trust income must belong solely to the beneficiary and that, under the terms of the relevant trust indenture, the trustees may not restrict the payment of all or part of the trust income.

…[W]here the Trust Indenture accords the Trustees the discretion as to the distribution of the income of the trust, the condition set out in paragraph 73(1.01)(c)(ii) would not be satisfied. Consequently, the requirement in paragraph 107.4(1)(i) would be satisfied … .

Overview

A Canadian REIT (the “Fund”) holds the units and notes of a subsidiary unit trust (“Sub-Trust”), whose principal asset is most of the partnership interests, other than exchangeable LP units, in a subsidiary LP (“Partnership”).

Steps relating to elimination of Sub-Trust

The Fund eliminates Sub-Trust by setting up a unit trust (“MFT”), transferring its assets to MFT under s. 107.4, distributing just enough units of MFT to its unitholders for MFT to qualify as a mutual fund trust, and then instigating a s. 132.2 merger of MFT into the Fund. In particular:

1. After the settling of MFT, which has redeemable retractable units, by a Canadian-resident third party, the Fund subscribes for MFT units for nominal cash consideration and the unit of the settlor is redeemed.
2. Sub-Trust will transfer all its assets including the Class A LP Units and the GP I shares of Partnership, to MFT for no consideration, with no s. 107.4(3)(a)(i) election being made and with MFT electing under (f)(v) of “disposition” in s. 248(1) that para. (f) thereof not apply.
3. Fund will distribute a certain number of its MFT Units to the Fund Unitholders in accordance with applicable securities’ laws (with s. 218.3(2) withholding being made) such that MFT will qualify as a mutual fund trust (and with a s. 132(6.1) election made before the winding-up of MFT in 7 below).
4. The Declaration of Trust of the Fund will be amended to provide for inter alia the consolidations in 6 below.
5. Pursuant to a transfer agreement between the Fund, MFT and an agent for the MFT Unitholders, MFT will transfer its assets to the Fund at the “MFT Transfer Time” in consideration for Fund Units being issued to the MFT Unitholders in payment of the redemption proceeds for their Units; and immediately after the MFT Transfer Time, MFT will redeem all of the MFT Units held by the Fund and the MFT Unitholders except for one MFT Unit which the Fund will continue to hold until the winding-up of MFT in 7 below. In due course, a joint s. 132.2 joint election will be filed.
6. Immediately thereafter the outstanding Fund Units are consolidated so as to result in the same number as before.
7. Ultimately, MFT will be wound up.

Ruling

The asset transfer in 2 will be a “qualifying disposition” within the meaning of s. 107.4(1), such that the rules in s. 107.4(3) will apply to Sub-Trust and MFT in respect of such transfer.

Current structure

The Fund, which is an exchange-listed mutual fund trust, holds shares and debt (the Corporation Shares and the Corporation Notes) of an operating subsidiary, and holds a general partnership interest through a sub trust (the trust).

Proposed transactions

The Fund will transfer the Corporation Shares and the Corporation Notes to the Trust for no consideration. This transfer will take place in one day. It will not make a s. 107.4(3)(a)(i) election and the Trust will not make a s. 107.4(3)(c)(ii)(B) election. There will be no transfer of property to the Trust as consideration for the acquisition of a capital interest in the Trust where the particular property can reasonably be considered to have been received by the Trust in order to fund a distribution. The value of each beneficiary's beneficial ownership under the Fund in the Corporation Shares and Corporation Notes at the commencement of this transfer will be the same as the value the beneficiary's beneficial ownership under the Fund and the Trust in the Corporation Shares and Corporation Notes at the completion of the transfer.

Ruling

S. 107.4(2)(a) will apply so that for purposes of s. 107.4(1)(a), and the transfer will not result in any change in beneficial ownership of the transferred Corporation Shares and the Corporation Notes.

The Fund, which is an exchange-traded mutual fund trust, will for nominal consideration subscribe for one Trust Unit of a unit trust (the “Trust”) that was settled by a third party, and redeem the initial Trust Unit held by that third party for its cash subscription price.

The Fund will transfer all of the Partnership Units of a partnership to the Trust for one or more Trust Units. This transfer will occur in one day. The Fund will not make the election in s. 107.4(3)(a)(i) and the Trust will not make the election in s. 107.4(3)(c)(ii)(B). Following this transfer, the Fund will continue to directly own 100% of the Trust Units and will indirectly own 100% of the Partnership Units.

CRA ruled that the transfer of the Partnership Units from the Fund to the Trust will be a "qualifying disposition" pursuant to s. 107.4(1). In its summary, CRA stated:

The Fund will acquire one or more units of the Trust in exchange for the limited partnership units and 107.4(3)(m) will deem the cost of the additional units to be the Fund's tax cost of the limited partnership units so transferred. If the Fund had not acquired any additional units … the contribution to the Trust would not increase the Fund's ACB of its capital interest in the Trust, notwithstanding that it would increase the FMV of its capital interest in the Trust.

On a transfer by a mutual fund trust (the "Fund") of shares and notes of a subsidiary to a subsidiary trust (the "Trust") of the Fund for no consideration, no amount would be added pursuant to s. 107.4(3) by virtue of such disposition to the cost of the Trust units owned by the Fund.