Words and Phrases - "offering memorandum"

In order that the taxpayer’s RRSP could indirectly invest in operating businesses in which he and/or two business colleagues had a management role, he instigated the formation of various unit trusts (the “Income Funds”) which were intended to be mutual fund trusts on the basis of 171 individuals (the “Investors”) - being immediate and extended family members, friends, employees of businesses run by him, business associates and others - each subscribing $750 for units. This distribution of units to such individuals was intended to be exempted from the requirement to qualify the distribution through filing a prospectus, by relying on an offering memorandum exemption.

The taxpayer’s RRSP then invested a large sum (e.g., over $150 million for one of the Income Funds) in subscribing for additional units. The Income Funds invested in the underlying businesses (sometime through a multi-tier “flow-through” structure under which the Income Fund held a sub trust, which held a master limited partnership, which held individual LPs that carried on the various businesses.)

Given that there were over 150 unitholders in each Income Fund holding a qualifying block of units, whether the units of the Income Funds qualified (under Reg. 4900(1)(d)) as units of mutual fund trusts turned principally on whether there had been a “lawful distribution in a province to the public of units of the trust and a prospectus … was not, under the laws of the province, required to be filed in respect of the distribution” (Reg. 4801(a)(i)(A)). In concluding that this requirement had not been satisfied because the distribution of the units had not been lawful, Smith J found that the RRSP had not displaced the Minister’s assumptions that many (over 30) of the Investors were minors and that many of the adult subscribers did not sign their own subscription documents (e.g., acknowledgements of risk) and did not pay for their own units. In this regard, Smith J found (at para. 266) that the subscribing “minors were not legally competent to sign the Risk Acknowledgement form” required to be given by them and that “the Alberta and BC securities commission intended that this document would only be signed by adult subscribers who had legal capacity,” that the minors’ subscriptions “were … unlawful” (para. 291) and (regarding over 25 of the subscriptions by adult Investors) the Minister’s unrebutted “assumption that these adults did not pay for their own units was sufficient to indicate that they had not purchased the units as principal for their own account” (para. 313). Furthermore, although it may have been possible to rely on other exemptions to establish a lawful distribution, this did not matter because in the reporting of the distribution to the Commissions, reliance had been placed only on the offering memorandum (OM) exemption (paras. 269-271).

After rejecting the taxpayer’s submission that there had been 171 distributions to the initial investors, so that the “lawful distribution” requirement would have been satisfied if as few as one of those distributions had been lawful, and instead finding that there had been only one distribution to that group, which was not lawful, as described above, Smith J stated obiter (at para. 207) that if, for example, there had been a lawful distribution to 50 investors relying on the “Friends, Family and Business Associates Exemption” and there had been a simultaneous second distribution to at least 100 investors, relying on the OM exemption, the first distribution might be sufficient to satisfy the lawful distribution requirement.

Furthermore, the OM had stated that the offerings were to a minimum of 160 investors. In this regard, Smith J stated (at paras. 208, 348):

[I]n this instance ... “a lawful distribution …under the laws of the province” required a distribution to no fewer than 160 investors. Anything less than that would not be “a lawful distribution” since it would be contrary to the precise terms of the OM. …

The Income Funds did not qualify as a “mutual fund trust” because they failed to satisfy the prescribed condition that there be “a lawful distribution …to the public of units” under the laws of the provinces of Alberta and BC to not fewer than 160 investors as required by the OM. Even if the Court considers for a moment that “a lawful distribution” should be interpreted to refer to a distribution to “no fewer than 150 beneficiaries of the trust”, as set out in paragraph (b) of Regulation 4801, the Income Funds have not met that bright-line test.