2016-0625301R3 Merger of two related segregated fund trusts

Principal Issues: Will the transfer of properties of one related segregated fund trust of the taxpayer to another related segregated fund trust of the taxpayer be a "qualifying disposition" pursuant to subsection 107.4(1)?

Position: In this case it will be.

Reasons: The underlying properties of the two funds are such that, in this case, the requirements to have the application rule in subsection 107.4(2) apply will be met, for the purpose of meeting the requirement in paragraph 107.4(1)(a).

Author: XXXXXXXXXX
Section: 107.4(1); 107.4(2); 107.4(3) and 138.1(1)

XXXXXXXXXX
                                                                                                                        2016-062530
XXXXXXXXXX, 2017

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling
        XXXXXXXXXX (the “Taxpayer”)
        Business Account Number - 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 Taxpayer.  We also acknowledge the information provided in your subsequent submissions.

You have advised that, to the best of your knowledge and that of the Taxpayer, none of the issues involved in the ruling request is:

(i)   in a previously filed tax return of the Taxpayer or a related person;

(ii)  being considered by a tax services office or a tax centre in connection with a previously filed tax return of the Taxpayer or a related person;

(iii) under objection by the Taxpayer or a related person;

(iv)  before the courts; or

(v)   the subject of a ruling previously considered by the Directorate in respect of the Taxpayer or a related person except in pre-ruling consultation 2015-060944 in respect of the Taxpayer.

This document is based solely on the facts and proposed transactions described below.  The documentation submitted with your request does not form part of the facts and proposed transactions except as expressly referred to herein, and any references thereto are otherwise provided solely for the convenience of the reader. Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended (the “Act”), and all terms and conditions used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated. Unless otherwise indicated, all references herein to monetary amounts are in Canadian dollars.

Definitions

The following terms and taxpayers referred to throughout this document will have the following meaning:

"Committed Cash" on the day of the proposed transactions in 11 below will include (i) cash that has been used to purchase MFT units in respect of Fund 1 and Fund 2 where the purchase has not yet settled, and (ii) cash that comes in on the day of the proposed transaction in 11 below for which there is a commitment to the policyholder that such cash will be used to purchase the MFT units but the actual purchase order will be forwarded to the manager of the MFT the next business day;

“CRA” means the Canada Revenue Agency;

“FMV” means fair market value;

“Fund 1” means XXXXXXXXXX which is a “segregated fund” for the purposes of section 138.1 of the Act and is the specified group of properties the FMV of which determines all or any portion of Taxpayer’s reserves for XXXXXXXXXX policies held by Fund 1 Policyholders;

“Fund 1 Policyholders” means holders of XXXXXXXXXX policies for which, prior to the proposed transaction described herein, all or any portion of the Taxpayer’s reserves vary in amount depending on the FMV of Fund 1;

“Fund 2” means XXXXXXXXXX which is a “segregated fund” for the purposes of section 138.1 of the Act and is the specified group of properties the FMV of which determines all or any portion of Taxpayer’s reserves for XXXXXXXXXX policies held by Fund 2 Policyholders;

“Fund 2 Policyholders” means holders of XXXXXXXXXX policies for which all or any portion of the Taxpayer’s reserves vary in amount depending on the FMV of Fund 2, and which will include Fund 1 Policyholders after the implementation of the proposed transaction described in paragraph 11 below;

“MFT” means the XXXXXXXXXX;

“MFT units” means units of MFT;

“Taxpayer” means XXXXXXXXXX;

“Trust 1” is, pursuant to paragraph 138.1(1)(a), the “related segregated fund trust” in respect of Fund 1 and a trust for the purposes of Part I of the Act, that was deemed to have been created at the time Fund 1 was created; and

“Trust 2” is, pursuant to paragraph 138.1(1)(a), the “related segregated fund trust” in respect of Fund 2 and a trust for the purposes of Part I of the Act, that was deemed to have been created at the time Fund 2 was created.

Facts

1.    The Taxpayer is a corporation established under the XXXXXXXXXX, resident in Canada and a XXXXXXXXXX corporation for the purposes of the Act.  The Taxpayer carries on a XXXXXXXXXX business in Canada which includes the XXXXXXXXXX and variable annuity segregated fund policies.

2.    The mailing address of the Taxpayer is XXXXXXXXXX.

3.    Taxpayer has a XXXXXXXXXX taxation year end, deals with the XXXXXXXXXX and files its tax return with the XXXXXXXXXX. The returns in respect of the related segregated fund trusts of the Taxpayer are filed with the XXXXXXXXXX.

4.    Fund 1 was established by the Taxpayer on XXXXXXXXXX and has CRA trust account number XXXXXXXXXX assigned to it.  As at XXXXXXXXXX, Fund 1 had a FMV of $XXXXXXXXXX and XXXXXXXXXX group annuity policyholders, representing the interests of XXXXXXXXXX members of those group plans.

5.    Fund 2 was established by XXXXXXXXXX on XXXXXXXXXX and has CRA trust account number XXXXXXXXXX assigned to it.  As at XXXXXXXXXX, Fund 2 had a FMV of $XXXXXXXXXX, representing XXXXXXXXXX group annuity policyholders and their XXXXXXXXXX plan members.  XXXXXXXXXX.

6.    The properties in each of Fund 1 and Fund 2 were funded with portions of the premiums paid by Fund 1 Policyholders and Fund 2 Policyholders, respectively, before that time under the terms of their policies.

7.    The investment objectives of Fund 1 are identical to the investment objectives of Fund 2. Both Fund 1 and Fund 2 seek long-term capital appreciation primarily through indirect investment in common shares and other equity securities of established Canadian issuers, by investing in MFT units, which are identical properties. MFT is managed by XXXXXXXXXX, a third party asset manager.

8.    Other than transitory cash, neither Fund 1 nor Fund 2 owns any other investments. The value of cash in each of Fund 1 and Fund 2 at the date of the transaction in 11 below, other than Committed Cash, will be less than XXXXXXXXXX% of the respective Fund assets.

9.    From a commercial law perspective, the Taxpayer is the legal and beneficial owner of each of the properties in Fund 1 and Fund 2, notwithstanding that the Taxpayer allocates such properties, for accounting and administrative purposes, to Fund 1 and Fund 2.  However, pursuant to paragraph 138.1(1)(b), for the purposes of Part I of the Act, property that has been allocated to Fund 1 or Fund 2 that remains part of Fund 1 or Fund 2, as the case may be, is deemed to be property of Trust 1 or Trust 2, as applicable, and not property of the Taxpayer.

10.   Pursuant to paragraph 138.1(1)(e), for the purposes of Part I of the Act, each Fund 1 Policyholder and Fund 2 Policyholder is deemed to own an interest in Trust 1 or Trust 2, as applicable, that is not in respect of any particular property or source of income.

Proposed Transaction

11.   The Taxpayer proposes to effect a transaction that will occur in one day and that will:

a.    combine the properties in Fund 1 with the properties in Fund 2 and enable Fund 1 to terminate; and

b.    transfer, for the purposes of Part 1 of the Act, the property held in Trust 1 to Trust 2 and cause Trust 1 to cease to exist.

12.   Trust 1 will not receive any consideration for the transfer of property to Trust 2 in 11(b) above.

13.   From a commercial law perspective, all of the properties in Fund 1 and Fund 2 will continue to be legally and beneficially owned by the Taxpayer. The Taxpayer will effect the transaction by changing the allocation of properties for accounting and administrative purposes, so that all of the properties in Fund 1 will be allocated to Fund 2.  No new contract will be entered into between the Taxpayer and any Fund 1 Policyholder, Fund 2 Policyholder or any sponsor of a group plan in connection with the transaction in 11 above.

14.   Given that Fund 1 and Fund 2 differ in size, the number of notional units held by a Fund 1 Policyholder and Fund 2 Policyholder before the transaction in 11 above may differ from the number of notional units that will be held by each such policyholder in Fund 2 following the transaction.

15.   However, each such policyholder will have the same economic entitlement after the completion of the transaction. In this regard, the manner in which income is allocated to each such policyholder, which was the same for both Fund 1 Policyholders and Fund 2 Policyholders prior to the transaction in 11 above, will remain the same following the transaction.

16.   The investment management fee applicable to a particular group plan in respect of Fund 1 and Fund 2 prior to the transaction in 11 above, will not be changed as a consequence of the transaction.

Purpose of the Proposed Transaction

17.   The purpose of the proposed transaction is to reduce the overall administrative costs and enhance administrative convenience by merging Fund 1 with Fund 2, in light of their identical investment objectives and property held.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the proposed transactions, the proposed transactions are completed in the manner described above, and there are no other transactions that may be relevant to the rulings given, our rulings are as follows:

A.    The reallocation of the properties in Fund 1 to Fund 2, as described in 11 and 13 above, will result in Fund 1 ceasing to exist and Fund 2 as continuing to exist for the purposes of paragraph 138.1(1)(a).

B.    The reallocation of the properties in Fund 1 to Fund 2, as described in 11 and 13 above, will be a transfer by Trust 1 of all of its property to Trust 2 for the purpose of section 107.4.

C.    After the transfer by Trust 1 of all of its property to Trust 2 referred to in Ruling B above, Trust 1 will cease to exist and will cease to be a related segregated fund trust pursuant to paragraph 138.1(1)(a).

D.    After the transfer by Trust 1 of all of its property to Trust 2 referred to in Ruling B above, Trust 2 will continue to be a related segregated fund trust that was deemed to be created on XXXXXXXXXX, pursuant to paragraph 138.1(1)(a).

E.    The transfer of property by Trust 1 to Trust 2 referred to in Ruling B above will be a “qualifying disposition”, within the meaning of subsection 107.4(1), such that the rules in subsection 107.4(3) will apply.

F.    Paragraph 107.4(3)(j) will apply to the proposed transactions in 11 to 16 above to deem each of the Fund 1 Policyholders to have disposed of their capital interests in Trust 1 for proceeds equal to the cost amount of such capital interests immediately before the disposition and to have acquired capital interests in Trust 2 at a cost equal to the amount determined by subparagraph 107.4(3)(j)(ii).

Policyholders who were Fund 2 Policyholders prior to the completion of the proposed transactions described herein will not be considered to have disposed of their capital interests in Trust 2 as a result of the transfer by Trust 1 of all of its property to Trust 2 referred to in Ruling B above.

Comments

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions described herein.

For greater certainty, the rulings herein are not provided on the basis of the technical position which you advanced in your submissions to CRA in pre-ruling consultation 2015-060944, and again in your initial submission of XXXXXXXXXX in respect of this advance income tax ruling. As was noted in our telephone discussion of XXXXXXXXXX (XXXXXXXXXX/XXXXXXXXXX), it is CRA’s view that the technical position advanced in those submissions would not support the rulings provided herein.

The above advance income tax rulings, which are based on the Act and Regulations in their present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R7 Advance Income Tax Rulings and Technical Interpretations, dated April 22, 2016, and are binding on the CRA provided that the proposed transactions are completed within six months of the date of this letter.

Yours truly,

XXXXXXXXXX
For Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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