Canada: Relieving Amendments To Trust Loss Restriction Rules For Investment Funds

Last Updated: October 23 2014
Article by Craig J. Webster

Most Read Contributor in Canada, September 2016

On October 20, 2014, the government tabled in the House of Commons a Notice of Ways and Means Motion containing proposed amendments to the Income Tax Act (Canada) ("Tax Act") providing relief from the loss restriction event rules for certain investment funds that are mutual fund trusts under the Tax Act, or that would be mutual fund trusts if they had 150 unitholders.

Generally, the loss restriction event rules result in a deemed taxation year-end and restrictions on the carry-forward of losses for a trust if a person becomes a majority-interest beneficiary, or a group of persons becomes a majority-interest group of beneficiaries. In the context of investment funds structured as trusts, the rules could have applied in several circumstances including: fund start-ups and wind-downs; fund-on-fund structures; fund mergers; day-to-day operations particularly where the units of a fund are not widely held.

The proposed amendments provide that a person will be deemed not to become a majority-interest beneficiary, and a group of persons will be deemed not to become a majority-interest group of beneficiaries, of a trust solely because of the acquisition of units of the trust if, (i) immediately before the acquisition the trust is an "investment fund" under the proposed amendments, and (ii) the acquisition is not part of a series of transactions or events that includes the particular trust becoming a portfolio investment fund, or ceasing to be an investment fund. An investment fund is defined as a trust that is a "portfolio investment fund" under the proposed rules, and is, at all times from the later of March 21, 2013 and the date the trust was created, a mutual fund trust under the Tax Act or, generally, a trust that would be a mutual fund trust under the Tax Act if it met the 150 unitholder requirement in the relevant regulations to the Tax Act.

A portfolio investment fund is defined by referring to the definition of "portfolio investment entity" in the SIFT rules in the Tax Act, with certain modifications. Generally, to qualify as a portfolio investment fund, a trust must not hold (i) securities of any entity (other than an entity that itself would be a portfolio investment entity) that have a value of more than 10% of the value of the entity's issued and outstanding equity; (ii) securities of any entity (other than an entity that itself would be a portfolio investment entity) if the securities of that entity or affiliated entities held by the trust have a total value of more than 50% of the total value of all the units of the trust; or (iii) certain real, resource or timber property situated inside or outside of Canada where the value of all such property held by the trust exceeds 50% of the total value of all the units of the fund. The real, resource or timber property in (iii) includes shares of corporations and interests in trusts and partnerships (other than taxable Canadian corporations and certain SIFT trusts and partnerships) if more than 50% of the value of the share or interest is derived directly or indirectly from one or any combination of real, resource or timber properties. For the purposes of the definition of portfolio investment fund, the definition of "securities" is the same as in the SIFT rules, which is more extensive than might otherwise be assumed.

Some issues that arise under the proposed amendments include:

1. In the start-up phase of a fund, the test in (ii) above will have to be carefully considered; such as where 100% of the fund's seed capital may be deposited in a bank account.

2. For investments in bonds, debentures and other debt instruments, the value of an issuer's debt in proportion to its issued and outstanding equity must be considered in the context of the test in (i) above.

3. The deeming rule only applies when a loss restriction event would otherwise occur as a result of an "acquisition" of units of a trust, and not as a result of a redemption; which can also result in a person becoming a majority interest beneficiary. We are hopeful this was an inadvertent omission which will be corrected.

4. For many real estate and resource focused funds, the test in (iii) above will likely be difficult to meet.

5. In the context of fund-on-fund structures, and on certain mergers, the tests in (i) and (ii) above will have to be carefully examined.

6. The intent and scope of application of the "series of transactions or events" exception to the relieving rule is not clear, particularly in the context of fund wind-downs.

The proposed legislation also contains a rule that provides that even where a trust is otherwise subject to the loss restriction event rules, the deemed year-end does not occur for certain purposes, including the time period in which the fund has to meet the 150 unitholder requirement in order to qualify as a mutual fund trust effective as of the day it was created. As well, trusts will be able to elect to have the relieving rules apply effective January 1, 2014 instead of March 21, 2013, which would be helpful for trusts that filed their 2013 tax returns on the basis of having a loss restriction event in that year.

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