securing & sustaining “mutual fund trust” status – tips ... · mutual fund trust may be...

Securing & Sustaining “Mutual Fund Trust” Status – Tips & Traps

Portfolio Management Association of Canada SeminarOffices of McMillan LLP

Toronto, OntarioSeptember 21, 2011

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Part ISecuring and Sustaining

“Mutual Fund Trust”Status – Tips & Traps

Presenters

Michael FriedmanPartner, Tax

McMillan LLP

Carl IrvineAssociate, TaxMcMillan LLP

Agenda – Mutual Fund Trusts

I. Mutual Fund Trust Status – An Overview

II. Basic Qualification Requirements

III. Retroactive MFT Status Election

IV. Loss of MFT Status – Mitigation Strategies

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“Mutual Fund Trust”

A conventional, inter vivos trust that satisfies certain qualifying conditions set out in the Income Tax Act and the regulations thereunder (the “Tax Act”).

•As of December 2010, interests in mutual funds and mutual fund wraps accounted for almost

27% of Canadians’ financial wealth•As of June 2010, almost 35% of Canadian

households invested in mutual funds

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Advantages of MFT Status

• Units may be “qualified investments” for RRSPs,RRIFs, RESPs, TFSAs and other registered plans

• Exemption from Part XII.2 tax• Capital gains refund mechanism• Exemption from alternative minimum tax• Exemption from 21 year deemed disposition rule

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Mutual Fund Trust Misconceptions

• “Mutual fund trust status can’t be lost.”• “There are no real limits on non-resident ownership

of a mutual fund trust.”• “All a trust needs are 150 unitholders to achieve

mutual fund trust status.”• “The activities of mutual fund trusts are unrestricted.”• “Redemption rights associated with the units of a

mutual fund trust may be significantly limited.”

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Basic Qualification Requirements

Five statutory tests must be satisfied for a trust to qualify as a “mutual fund trust” at any particular time:1.“Trust” test2.“Unit Trust” test3.“Resident in Canada” test4.“Sole Undertaking” test5.“Prescribed Conditions” test

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“Trust” Test

• A “mutual fund trust” must be a trust• Three “certainties” of a trust• Proper formation, documentation and administration• CRA audit initiatives – several focused on trusts

and trust-related issues

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“Unit Trust” Test

• “inter vivos trust the interest of each beneficiary under which was described by reference to units of the trust” and one of two conditions is satisfied

“Redeemable on demand” condition1. Issued units have conditions requiring the trust to

accept, at the demand of the holder and at prices determined and payable in accordance with the conditions, the surrender of the units.

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“Unit Trust” Test2. The fair market value of such units was not less

than 95% of the fair market value of all of the issued units of the trust.

Property Holdings conditionRestrictions on activities/types of property ownedIncome source requirementsRestrictions on concentration of property holdings

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“Resident in Canada” Test

• Evolving jurisprudence• Historical perspective – many focused on

residence of the trustee• Recent jurisprudence focusing more particularly

on the situs of the management and control of the trust (Garron)

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“Sole Undertaking” Test

• Permitted undertakingsInvesting of funds in property (other than rights/ interests in real property); andAcquiring, holding, maintaining, improving, leasing or managing rights/interests in real property that is capital property of the trust

• Trust cannot carry on business• Special statutory deeming rules

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“Prescribed Conditions” Test

• Prescribed conditions contained in Regulation 4801• Two basic prescribed tests:

1. A class of units is “qualified for distribution to the public”; or There has been a lawful distribution of units to the public and a prospectus, registration statement, or similar document was not required to be filed in respect of the distribution.

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2. In respect of any one class of units of the trust that satisfied the first test:

There are no fewer than 150 beneficiaries, each of whom holds:o Not less than one “block of units” of the class;

ando Units of the class having an aggregate fair

market value of not less than $500

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“Block of Units”a) 100 units, if the fair market value of one unit of the

class is less than $25,

b) 25 units, if the fair market value of one unit of the class is $25 or more but less than $100, and

c) 10 units, if the fair market value of one unit of the class is $100 or more.

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Group Holdings• Special deeming rules in the Income Tax Regulations

may apply to aggregate smaller group holdings to represent a “beneficiary” holding a “block of units”having a fair market value of not less than $500

• If a trust becomes a “mutual fund trust” at any particular time before the 91st day after the end of its first taxation year, and the trust properly elects in its first tax return, the trust is deemed to have been a “mutual fund trust” from the beginning of its first taxation year until the particular time.

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Retroactive Status Election

Jan. 1, 2011 March 30, 2012*

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Loss of Mutual Fund Trust Status

• Failure to Satisfy Qualification Requirements• Trust established or maintained primarily for the

benefit of non-residentsStatutory provision historically in fluxObjective, point-in-time testNot applicable if substantially all of the property of the trust is not “taxable Canadian property”Permanent loss of status

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Loss of Status Mitigation Strategies

• Initial Loss of Status Saving Provision“Redeemable on demand” condition / “Prescribed Conditions” Test

Applies in respect of calendar year in which status is lost

Trust required to have been a “mutual fund trust” at the beginning of the year

• “Registered Investment” ApproachMay permit preservation of “qualified investment” status

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Part IINavigating the

New RRSP/RRIF Anti-Avoidance Rules

Presenters


McMillan LLP


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Agenda – RRSP/RRIF Anti-Avoidance Rules

I. Historical Developments and OverviewII. Old RRSP Eligibility StandardsIII. New RRSP Anti-Avoidance Rules

“Prohibited Investments”“Advantages”Tax WaiversGrandfathering ReliefSpecial Considerations

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Historical Developments

• Proposed RRSP Anti-Avoidance Rules (the “Proposed Rules”) were first introduced in the March 22, 2011 federal Budget

• Proposed Rules re-introduced in June 6, 2011 federal Budget

• Draft legislation released on August 16, 2011• “Technical Notes” released on September 1, 2011

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Overview of Proposed Rules

• Based on rules governing tax-free savings accounts• Reflect desire of the Department of Finance to

address certain planning involving registered plans • Introduce concepts of “prohibited investments” and

“advantages”• Establish new penalty tax regime

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Old RRSP Eligibility Standards

• Section 146 of the Tax Act / Regulation 4900• “Qualified investment” status critical• Relatively broad array of property could be held by

an RRSP, including shares of certain private corporations

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“Prohibited Investments”

• Additional restriction on RRSP property holdings• Captures property that is:

a) a debt of the annuitant of the RRSP;

b) a share of the capital stock of, an interest in, or a debt ofi. a corporation, partnership or trust in which the RRSP annuitant

has a “significant interest”, orii. a person or partnership that does not deal at “arm’s length”

with (1) the RRSP annuitant, or (2) a person or partnership described in subparagraph i. above;

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“Prohibited Investments”c) an interest in, or a right to acquire, a share, interest or debt described

above; or

d) a “prescribed property”.

• Certain “excluded prescribed property” carved out of the definition of a “prohibited investment”

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“Significant Interest” [ss. 207.01(4)]

• Incorporates “specified shareholder” definition• Frequently captures 10% + holdings• Various look-through, deeming, and aggregation rules

“Arm’s Length” [s.251]

• Related party and factual tests

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“Prescribed Property” [Proposed Reg. 5001]

• Captures certain small business, venture capital, specified cooperative corporation shares

• Introduces potential traps

“Prescribed Excluded Property” [Proposed Reg. 5000]

• Certain insured mortgages [Reg. 4900(1)(j.1)]

• Certain shares/units of relatively new mutual fund corporations/trusts• Exclusion more complicated/restrictive than it first appears

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“Prohibited Investments” – Tax

• Tax payable by RRSP annuitant if property acquired is, or becomes, a “prohibited investment”or a “non-qualified investment” [ss. 207.04(1)]

• Tax = 50% of fair market value of property at time of acquisition/status change [ss. 207.04(2)]

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• Refund of tax potentially available in year RRSP disposes of “prohibited investment”.

• Refund equal to:1) the amount of tax paid, UNLESS2) it is reasonable to consider that the RRSP annuitant knew, or ought

to have known, at the time the property was “acquired” by the RRSP, that it was, or would become a “prohibited investment”, or

3) the property is not disposed of by the RRSP before the end of the calendar year following the calendar year in which the tax arose (or any later time the Minister considers reasonable in the circumstances).

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• If 2) or 3) above apply, no refund will generally be granted

• The new tax applies in respect of investments “acquired” after March 22, 2011

Several events could trigger the “acquisition” of an investment by an RRSP, including certain deemed dispositions/acquisitionsNote the Canada Revenue Agency’s published position regarding transfers of property between RRSPs

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“Advantages”

• Lengthy statutory definition captures many types of benefits and potentially advantageous transactions, including:

certain benefits associated with transactions that would not have occurred on the open market“swap transactions”a benefit that is income (including a capital gain) that is reasonably attributable, directly or indirectly, to a “prohibited investment”an “RRSP strip” [ss. 207.01(1)]

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“Advantages”

• Proposed amended definition of an “advantage”applies to transactions occurring, income earned, capital gains accruing and investments acquired after March 22, 2011, except for certain grandfathering in respect of “swap transactions”

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“Advantages” – Tax • A tax is generally payable by the annuitant of an RRSP in

the year an “advantage” in relation to the RRSP is extended to, or is received or receivable by, (1) the annuitant, (2) the RRSP, or (3) any other person that does not deal at “arm’s length” with the annuitant.

• However, an issuer of an RRSP can instead be liable for the tax alone if the advantage is extended by the issuer or a person with whom the issuer is not dealing at “arm’s length”. [s. 207.05]

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“Advantages” – Tax

• The amount of the tax equals:in the case of a benefit, the fair market value of the benefitin the case of a loan or an indebtedness, the amount of the loan or indebtednessin the case of an “RRSP strip”, the amount of the “RRSP strip

• Certain limited grandfathering relief may be claimed, subject to certain conditions

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Tax Waivers • The Minister may waive/cancel a tax liability

where the Minister considers it just and equitable to do so, having regard to all the circumstances, including whether the tax arose as a consequence of reasonable error. [ss. 207.06(2)]

• The Minister may not waive/cancel a tax in respect of an “advantage” unless payments are made, without delay, by the RRSP to the annuitant equal to the tax liability. [ss. 207.06(3)]

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Grandfathering Relief• Limited exclusion from “prohibited investment”

tax provisions• Until end of 2012, an annuitant may execute a

“swap transaction” to remove property from an RRSP without triggering an “advantage” in respect of the “swap transaction” if it is reasonable to conclude that the retention of the property in the RRSP would result in tax being payable under the Proposed Rules.

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Grandfathering Relief

• “Transitional prohibited investment benefit” reliefLimited ability to reduce “advantage” tax from 100% to 42.9%, provided certain conditions are satisfied. Among other things, access to such transitional relief requires:o subject property to have been a “prohibited investment” on

March 23, 2011o subject income to have been paid to the annuitant by the

RRSP within 90 days after the end of the taxation yearo an election to have been made before July, 2012

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Special Considerations

• Duty of care requirement for issuer of an RRSPIssuer must exercise the care, diligence and skill of a reasonably prudent person to minimize the possibility that an RRSP holds a “non-qualified investment”.Potential penalty for contravention [ss. 207.01(5)]

• Special return requirement [s. 207.07]

• Grandfathering relief traps• New “prohibited investment” compliance burdens• “Swap transactions”

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Questions

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Cautionary NoteThe foregoing commentary is summary in nature and does not address all of the issues and considerations that may be relevant under any particular set of circumstances.

The statements and material presented herein do not represent legal or tax advice.

No transactions should be executed on the basis of the foregoing statements, diagrams, and commentary. Formal legal, tax, and accounting advice should be obtained prior to making any investment or executing any transaction.

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McMillan LLPToronto, Ontario

[email protected]


Toronto, [email protected]

416.865.7266

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