2021-0889011R3 Redemption of MFT units held by registered plans

Principal Issues: Will a registered plan that holds units of a Canadian feeder fund/ mutual fund trust and that participates in the proposed transactions acquire a property that is a non-qualified investment?

Position: No.

Reasons: Consistency with past positions on short-term broker deposits and securities held in a central depository for the benefit of a registered plan. In this case the plan will exchange one type of qualified investment (units of a mutual fund trust) for another (money in a deposit account) under after a brief transit period.

Author: XXXXXXXXXX
Section: "qualified investment" definition in 204 and ITR 4900; 207.04(1)

XXXXXXXXXX
                                                                                         2021-088901

XXXXXXXXXX, 2021

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request –
      Redemption of Mutual Fund Trust Units Held by Registered Plans                          XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX requesting an advance income tax ruling (“Ruling”) on behalf of the above-named Taxpayer. We also acknowledge the information provided by email.

To the best of your knowledge and that of the taxpayers involved, none of the proposed transactions or issues involved in this Ruling request are the same as or substantially similar to transactions or issues that are:

i. in a previously filed tax return of the Taxpayer or a related person and:

A. being considered by the CRA in connection with such return;

B. under objection by the Taxpayer or a related person; or

C. the subject of a current or completed court process involving the Taxpayer or a related person; or

ii. the subject of a Ruling request previously considered by this Directorate.

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 definition unless otherwise indicated. Any reference in this letter to any action to be taken by or any agreement or transaction to be entered into by any trust participating in the Proposed Transactions shall be understood to be a reference to the trustees of that trust.

Definitions

In this letter, unless otherwise specified, the following terms have the meanings specified:

“Buyco” has the meaning assigned by paragraph 17;

“Buyco Direction” has the meaning assigned by paragraph 24;

“CDICA” means the Canada Deposit Insurance Corporation Act (Canada);

“CRA” refers to the Canada Revenue Agency;

“Funding Account” has the meaning assigned by paragraph 18;

“LLC 1” means XXXXXXXXXX;

“LLC 2” means XXXXXXXXXX;

“Notes” has the meaning assigned by paragraph 14;

“OP LP” means XXXXXXXXXX;

“Non-qualified Investment” has the meaning assigned by section 204 or subsection 207.01(1), as applicable;

“Proposed Transactions” means the transactions described in paragraphs 17 to 27;

“Qualified Investment” has the meaning assigned by subsection 146(1), 146.1(1), 146.3(1), 146.4(1), 204, or 207.01(1), as applicable;

“Redemption Time” has the meaning assigned by paragraph 22;

“Registered Plan” means a trust governed by a registered retirement savings plan, a registered disability savings plan, a registered education savings plan, a registered retirement income fund, a deferred profit sharing plan or a tax-free savings account;

“Repurchase Date” has the meaning assigned by paragraph 7;

“Repurchase Price” has the meaning assigned by paragraph 7;

“Sale Notice” has the meaning assigned by paragraph 19;

“Servicesco” means XXXXXXXXXX, a corporation XXXXXXXXXX resident in Canada;

“Settlement Date” has the meaning assigned by paragraph 7;

“Settlement Payment Time” has the meaning assigned by paragraph 22;

“Topco” means XXXXXXXXXX, together with its affiliates;

“Three-Party Agreement” has the meaning assigned by paragraph 20;

“Trust” has the meaning assigned by paragraph 9;

“Two Step Cash Redemption” has the meaning assigned by paragraph 15;

“USco” means XXXXXXXXXX; and

“USco Direction” has the meaning assigned by paragraph 25.

FACTS

The Topco Group

1. LLC 1 is a private limited liability company formed under the laws of XXXXXXXXXX that is not resident in Canada for purposes of the Act. LLC 1 is a subsidiary of LLC 2.

2. LLC 2 is a private limited liability company formed under the laws of XXXXXXXXXX that is not resident in Canada for purposes of the Act.

3. LLC 2 manages USco, a corporation formed under the laws of XXXXXXXXXX that qualifies as a XXXXXXXXXX for U.S. federal income tax purposes.

4. LLC 1 and LLC 2 are members of the XXXXXXXXXX of Topco, XXXXXXXXXX.

5. USco invests primarily in XXXXXXXXXX. USco shares are not listed on a designated stock exchange.

6. USco is the sole general partner of OP LP, a XXXXXXXXXX limited partnership that is managed by LLC 2. Substantially all of USco’s business is conducted through OP LP.

7. USco has a share repurchase plan establishing terms on which it will repurchase its shares for cancellation. Under the plan, USco will only repurchase shares as of the last calendar day of the month (a “Repurchase Date”), provided the shareholder makes a repurchase request and submits the required documentation by the second last business day of the month. Settlements of share repurchases will be made by USco on a date (the “Settlement Date”) occurring within three business days of the Repurchase Date. The repurchase will be made at a price generally equal to the net asset value per USco share at the end of the preceding month (the “Repurchase Price”). USco’s monthly financial statements and net asset value calculations are prepared after carving out the shares that have been repurchased as of the Repurchase Date and the cash or other assets applied to their repurchase.

8. Generally, under U.S. federal tax law, a share repurchase payment made by a corporation to a redeeming shareholder may be characterized as a U.S. source dividend subject to U.S. withholding tax. If, however, the redemption results in a meaningful reduction of the redeeming shareholder’s interest in the corporation, the redemption will not be treated as a dividend and U.S. withholding tax will not apply.

The Trust

9. Topco intends to establish a trust under the laws of XXXXXXXXXX (the “Trust”) that will own shares of USco directly. The Trust will act as a feeder fund and provide Canadian investors with an indirect interest in shares of USco. Trust units will be offered on a private placement basis (rather than their distribution being qualified for securities law purposes through the filing of a prospectus) and will be marketed to both taxable investors and to Registered Plans.

10. The settlor and sole trustee of the Trust will be an individual who is an officer of Servicesco and a resident of Canada. LLC 1 will wish for the Trust to have been established, albeit with nominal capitalization, so that it can be identified as the offeror in the offering memorandum for the initial offering of its units. Accordingly, the Trust will be settled before the offering memorandum is finalized with $XXXXXXXXXX in cash as the subscription price for one unit, which will form the Trust’s initial corpus. By the time at which the offering of Trust units to investors closes, the Trust will have at least XXXXXXXXXX trustees, a majority of whom will be resident in Canada. The Trust will deal at arm’s length (within the meaning of subsection 251(1)) with Topco and Servicesco from the time its board of trustees is formed. Central management and control of the Trust will be exercised by its trustees in Canada at trustee meetings held exclusively in Canada.

11. Immediately after the proceeds of the initial offering of Trust units are received and added to the corpus of the Trust, the initial Trust unit will be redeemed for $XXXXXXXXXX. The proceeds of the initial offering of Trust units will be used principally to subscribe for shares of USco and to pay Trust expenses.

12. All or substantially all of the Trust’s property will consist of USco shares and the Trust’s only undertaking will be the investment of its funds in property. The Trust will qualify as a “unit trust” for purposes of the Act. In particular, it is intended that the conditions of paragraph 108(2)(a) will be satisfied in that all of the issued units of the Trust will be subject to the requirement that the Trust accept the surrender of Trust units at the holder’s demand. It is also intended that the Trust will qualify as a “mutual fund trust” for purposes of subsection 132(6) and that the Trust will elect pursuant to subsection 132(6.1) to have been a mutual fund trust from the beginning of its first taxation year.

13. It is intended that a Trust unit will be a Qualified Investment for a Registered Plan. Were a Registered Plan to hold a USco share directly, the Plan would have acquired a Non-qualified Investment for purposes of subsection 207.04(1) and would also be required to file a U.S. tax return. It is intended that by investing in USco through the Trust, a Registered Plan will be able to participate in USco while avoiding these adverse tax consequences.

14. Units in the Trust will not be listed on a designated stock exchange. To facilitate liquidity, Trust unitholders will have the right to request that some or all of their Trust units be redeemed on the next occurring Settlement Date. The Trust will pay redemption amounts in cash to the greatest extent possible. On the occurrence of a market disruption event, the Trust may satisfy its redemption obligations by distributing notes (the “Notes”) XXXXXXXXXX.

15. But for the U.S. tax consequences described above, the Trust would fund redemption payments to unitholders by asking USco to redeem a number of the Trust’s USco shares of equivalent value (a “Two-Step Cash Redemption”). As all or substantially all of the Trust’s property will consist of USco shares, however, there is a substantial risk that the number of shares the Trust would need redeemed to fund redemption payments to its own Unitholders on a particular Settlement Date would not amount to a meaningful reduction in the Trust’s equity interest in USco.

16. The Trust could make an in-specie distribution of USco shares to redeeming unitholders who could in turn request a repurchase by USco. This redemption method would avoid adverse U.S. tax consequences because the unitholder would be redeeming all of its USco shares, thereby exceeding the meaningful redemption threshold. If the unitholder is a Registered Plan, however, an in-specie distribution of USco shares would result in the plan holding USco shares, which are a Non-qualified Investment, for a brief period of time.

PROPOSED TRANSACTIONS

17. Subject to the receipt of a favourable ruling from the CRA, Servicesco (which will at all relevant times deal with Topco and the Trust at arm’s length within the meaning of subsection 251(1)) will incorporate a corporation under XXXXXXXXXX law (“Buyco”) for the purpose of acquiring Trust units from redeeming unitholders that are Registered Plans. Buyco will fund these acquisitions by way of a Two-Step Cash Redemption, as set out in the following paragraphs. Servicesco will be Buyco’s sole shareholder.

18. To facilitate the payments described below, the Trust will open a U.S. dollar bank account (the “Funding Account”) with a Canadian branch of a Schedule I Canadian chartered bank. Money deposited in the Funding Account will qualify as a “deposit” within the meaning of the CDICA. The Trust will execute a declaration of bare trust providing that it holds the amounts in the Funding Account as bare trustee and agent for the beneficial owner of the funds, i.e., USco until such amounts are transferred pursuant to the Buyco Direction and the USco Direction.

19. When a Registered Plan that is a Trust Unitholder (the “Plan”) seeks redemption of its Trust units, the Plan will be required to give written notice to the Trust and to Buyco of the Plan’s intention to sell a specified number of units on the next Settlement Date (the “Sale Notice”). The deadline for providing any such Sale Notice will be no more than three business days before the deadline for making a repurchase request for a corresponding number of USco shares (5:00 p.m. on the last business day of the month).

20. The Sale Notice requirement will be set out in the Declaration of Trust for the Trust and in an agreement (the “Three-Party Agreement”) to be entered into by the Plan, the Trust and Buyco. The Three-Party Agreement will have been previously agreed to by Buyco and the Trust. The Sale Notice will require the Plan to acknowledge and accept the terms of the Three-Party Agreement such that the Three Party Agreement will become effective and contractually bind the Plan as of the time the Plan provides the Sale Notice.

21. The Three-Party Agreement will provide for a particular time at which the Plan will assign the Trust units that it wishes to have redeemed to Buyco in return for a cash payment to be made as set out in paragraph 25 below.

22. The Three-Party Agreement will also provide for a time (the “Redemption Time”) occurring on the Settlement Date. The Redemption Time will occur immediately before the time (the “Settlement Payment Time”) at which the repurchase proceeds for the USco shares will be paid. At the Redemption Time, the Trust units newly acquired by Buyco from the Plan will be redeemed by the Trust. As consideration for the units being redeemed, the Trust will assign an equivalent number of its USco shares to Buyco.

23. When the Three-Party Agreement comes into effect (at the time the Plan provides a Sale Notice), it will provide for (i) a beneficial conveyance of the Plan’s Trust units to Buyco; (ii) the Trust’s redemption of the units previously held by the Plan at the Redemption time; and simultaneously (iii) for a beneficial transfer of an equivalent number of USco shares from the Trust to Buyco.

24. At the Settlement Payment Time, occurring immediately after the Redemption Time, Buyco would be entitled to receive a cash payment from USco for the repurchase of its USCo shares. Rather than receiving such cash payment directly, Buyco will instead be required under the Three-Party Agreement to provide a direction (the “Buyco Direction”) to USco. The Buyco Direction will direct USco to pay the cash to the Plan. The cash payment by USco to the Plan will simultaneously satisfy (i) USco’s obligation to pay Buyco for its repurchased shares and (ii) Buyco’s obligation to pay for the Trust units assigned to it by the Plan.

25. Before the Redemption Time, USco will deposit to the Funding Account an amount at least equal to the repurchase proceeds for the USco shares. USco will be the beneficial owner of that deposit until the Settlement Payment Time. At the Settlement Payment Time, USco will provide a written direction (the “USco Direction”) to the Trust directing the Trust to hold the repurchase proceeds for the USco shares for the benefit of Buyco or as Buyco further directs. As described in paragraph 24 above, however, Buyco will have directed the Trust to hold such funds on behalf of the Plan as of the Settlement Payment Time. The Buyco Direction will provide that the transfer of beneficial interest in the funds in the Deposit Account to the Plan will satisfy USco’s obligation to pay Buyco for the repurchased USco shares and also effect Buyco’s payment to the Plan for the assigned Trust units.

26. The transactions described in paragraphs 21 to 25 to will all be stated to occur as of the Repurchase Date for purposes of the net asset value calculation described in paragraph 7 above. These transactions will not be legally effected until the following three separate instants in time have occurred: the instant before the Redemption Time at which the Plan’s Trust units are assigned to Buyco; the Redemption Time at which those units are redeemed by the Trust; and the Settlement Payment Time at which the USco shares are repurchased and the Repurchase Price is paid.

27. As soon as practicable after the Settlement Payment Time, the Trust in its capacity of bare trustee and agent will arrange for a wire transfer of the cash beneficially owned by the Plan from the Funding Account to a bank account held by the Plan.

ADDITIONAL INFORMATION

28. Buyco is not expected to earn any income in connection with the purchase of Trust units or otherwise by virtue of its participation in the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to enable the Trust to fund cash settled redemptions of Trust units held by Registered Plans without (i) causing those plans to directly hold shares of USco which are not Qualified Investments or (ii) triggering the application of US withholding tax on repurchases by USco of its shares.

RULING GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, Proposed Transactions and purposes of the Proposed Transactions, and provided further that the Proposed Transactions are carried out as described above, our ruling is as follows:

A. For purposes of subsections 198(1) and 207.04(1) and Part II of the Income Tax Regulations, a Registered Plan will not be considered to have acquired property that is a Non-qualified Investment for the Registered Plan solely because of its participation in the Proposed Transactions.

CAVEATS

Nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or made any determination in respect of any tax consequences relating to the facts and Proposed Transactions herein, other than those specifically described in the ruling given above. In particular, the CRA has not considered, confirmed or made any determination in respect of:

a. whether the Trust will be, at any particular time, a mutual fund trust within the meaning of subsection 132(6), or a unit trust within the meaning of subsection 108(2);

b. whether the Trust’s units are a “prohibited investment” (as defined in subsection 207.01(1)) for a Registered Plan;

c. the application of tax under Part XI.01 of the Act to any participant in the Proposed Transactions or any controlling individual of a participant, other than as described herein;

d. the fair market value of any property referred to herein; or

e. the tax consequences of the distribution of the Notes to a unitholder of the Trust, and in particular whether the Notes are a Qualified Investment for a Registered Plan.

The documentation submitted with your request that is not described above does not form part of the facts and transactions and any references to the documentation are provided solely for the convenience of the reader.

These rulings are subject to the limitations and qualifications set out in Information Circular IC 70-6R11, Advance Income Tax Rulings and Technical Interpretations, dated April 1, 2021 and are binding on the CRA, provided that the Proposed Transactions described in paragraphs 17 to 27 are completed by XXXXXXXXXX.

The above rulings are based on the law as it reads at the date of this letter and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

Yours truly,

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

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