Canada: Budget 2017: What It Means To The Investment Management Industry

On March 22, 2017 ("Budget Day"), the Liberal government released its second budget ("Budget 2017"). While Budget 2017 may be known more for the anticipated tax measures that it did not contain rather than the ones that it did, consistent with recent federal budgets, several tax measures were directed at the investment management industry and its investors. It is clear from the government's statements in the budget papers that many of these tax measures were introduced to promote greater consistency and tax neutrality across investment fund vehicles and registered plans. These measures and other tax proposals announced in Budget 2017 that may be of interest to the investment management industry are summarized below.

Switch Corporation Wind-Ups

The Liberal government's first budget in 2016 ("Budget 2016") addressed what it perceived to be unfair tax advantages in multi-class mutual fund corporations or "switch corporations". As a result, effective January 1, 2017, investors in switch corporations are no longer able to exchange or "switch" shares of one class (or mutual fund) for shares of another class (or mutual fund) on a tax-deferred basis. This amendment to the Income Tax Act (Canada) (the "Tax Act") eliminated one of the main advantages for taxable investors of investing in a class of a switch corporation versus a mutual fund trust; particularly where similar investment strategies are available to investors in corporate and trust form.

Department of Finance ("Finance") officials have not been amenable to requests from the investment fund industry to permit switch corporations to wind-up individual classes (or mutual funds) that may be less suited to a corporate structure on a tax-deferred basis, or expand the availability of tax-deferred class to class mergers within a switch corporation.1 However, in response to requests from the investment fund industry, Budget 2017 does extend the existing tax-deferred "qualifying exchange" rules that are applicable to mutual fund trust mergers to a complete wind-up of a switch corporation.

In order to meet the proposed new "qualifying exchange" definition, all or substantially all2 of a switch corporation's (the "transferor") property must be transferred to one or more mutual fund trusts (the "transferees"). This requirement may raise a technical concern for switch corporations that are structured in whole or in part as "fund-of-funds" since all or substantially all of the property held by the transferor corporation are units of the transferee trusts. In similar trust-on-trust mergers, the Canada Revenue Agency ("CRA") has taken the position that the definition of a "qualifying exchange" will not be met.3 Given the number of switch corporation "fund-on-fund" structures, it is expected that Finance and/or CRA will provide the investment fund industry with some clarity on this issue in the near future.

Another technical issue that may pose challenges is that all of the shareholders of the switch corporation must be redeemed within 60 days following the transfer of all or substantially all of the switch corporation's property to the mutual fund trusts. While this time frame works for mergers of mutual fund trusts, concerns have been expressed by members of the investment fund industry that it may be too short of a period for the wind-up of a large switch corporation given the systems and operational aspects of the mergers.

As is the case with the existing "qualifying exchange" rules, the use of losses of the merging funds will be restricted on the wind-up of the switch corporation. As a result, investment fund managers that are considering taking advantage of this new measure will need to undertake an analysis of the loss carryforward positions of the continuing mutual fund trusts before they proceed with the wind-up of their switch corporation. As a result of this analysis, some switch corporation wind-ups will likely be implemented in two stages with the first stage involving taxable mergers with mutual fund trusts that have significant tax loss carryforward positions.

This measure applies to qualifying exchanges that occur on or after Budget Day.

Segregated Fund Changes

Mutual funds and segregated funds are different legal forms of similar investment products. For many years, both the investment fund industry on behalf of mutual funds and the insurance industry on behalf of segregated funds have advocated for changes that will provide greater consistency in the tax treatment of mutual fund trusts and segregated funds. Budget 2017 includes measures that address some of the tax changes requested by the insurance industry.

A segregated fund is deemed to be a trust for purposes of the Tax Act (referred to as a "related segregated fund trust"). Under the current rules in the Tax Act, a related segregated fund trust is deemed to have made its "income" for the year payable to its beneficiaries so that it is not subject to tax. For taxation years that begin after 2017, it is proposed that the "taxable income" of the related segregated fund trust will instead become payable to beneficiaries. As a result of this measure, segregated funds will now be able to utilize their non-capital loss carryforwards in computing taxable income. Consequential to this amendment, a transitional rule is proposed for taxation years that begin after 2017 that will deem non-capital losses that arose in taxation years that begin before 2018 to be nil.

Budget 2017 also proposes to allow segregated funds to merge on a tax-deferred basis pursuant to new "qualifying transfer" rules that generally parallel the qualifying exchange rules applicable to mutual funds. Under this measure, a "qualifying transfer" will occur at a particular time if all of the property that, immediately before the transfer time, was property of a related segregated fund trust (the "transferor") has become, at the transfer time, the property of another related segregated fund trust (the "transferee"). As with the existing qualifying exchange rules, the use of losses of the merging funds will be restricted following a qualifying transfer.

In order to ensure that the insurance industry has an opportunity to provide comments on these proposed rules, these measures will apply to mergers of segregated funds carried out after 2017 and to non-capital losses arising in taxation years that being after 2017, as described above.

Anti-Avoidance Rules for Registered Plans

Anti-avoidance rules that exist for certain tax-assisted registered plans (i.e., Tax-Free Savings Accounts, Registered Retirement Savings Plans and Registered Retirement Income Funds) will be extended to Registered Education Savings Plans ("RESPs") and Registered Disability Savings Plans ("RDSPs"). These anti-avoidance rules generally include rules which (i) prevent the exploitation of the tax attributes of a registered plan (i.e., by shifting returns from a taxable investment to a registered plan), (ii) ensure that investments held by a registered plan are arm's length "portfolio" investments, and (iii) restrict the classes of investments that may be held by a registered plan. As noted in the budget papers, these tax measures are not expected to have an impact on the vast majority of RESP and RDSP holders, who typically invest in ordinary portfolio investments.

It is worth noting that the amendment of the "qualified investment" rules in respect of RESPs can be viewed as a relieving measure. Under the current rules in the Tax Act, an RESP is subject to revocation if it acquires property that is not a qualified investment, or if property held by it ceases to be a qualified investment and the property is not disposed of within 60 days after that time. These heads of revocation for an RESP will be repealed under this new measure and RESPs will now be subject to the same penalty taxes found in Part XI.01 of the Tax Act applicable to other registered plans that acquire or hold non-qualified investments.4

Subject to the exceptions described below, this measure will apply to transactions occurring, and investments acquired, after Budget Day. For this purpose, investment income generated after Budget Day on previously acquired investments will be considered to be a "transaction occurring" after Budget Day.

The exceptions to this effective date are as follows:

  • The advantage rules will not apply to swap transactions undertaken before July 2017. However, swap transactions undertaken to ensure that an RESP or RDSP complies with the new rules by removing an investment that would otherwise be considered a prohibited investment, or an investment which gives rise to an advantage under the new proposals, will be permitted until the end of 2021.
  • Subject to certain conditions, a plan holder may elect by April 1, 2018 to pay Part I tax (in lieu of the advantage tax) on distributions of investment income from an investment held on Budget Day that becomes a prohibited investment as a result of this measure.

Timing of Recognition of Gains and Losses on Derivatives

As noted in the budget papers, aside from the mark-to-market property regime applicable to financial institutions there are no specific rules in the Tax Act that govern the timing of the recognition of gains and losses on derivatives held on income account. The following two measures were introduced to provide some clarity to the scheme of the Tax Act in this regard.

Elective use of the mark-to-market method

A recent decision of the Federal Court of Appeal,5 held that a taxpayer that was not a financial institution was entitled to use the mark-to-market method of computing its income from its separate business of speculating on foreign exchange currency options on the basis that it provided an accurate picture of the taxpayer's income. This decision overturned the Tax Court's finding that the taxpayer was required to compute its income on a realization basis for tax purposes (i.e., through the sale or the close-out of the options).

In response to this decision, Budget 2017 introduces an elective mark-to-market regime for "eligible derivatives" held on income account. Once made, the election will remain effective for all subsequent years unless revoked with the consent of the Minister of National Revenue. An eligible derivative for purposes of this new elective regime is defined to mean a swap agreement, a forward purchase or sale agreement, a forward rate agreement, a futures agreement, an option agreement or similar agreement if (a) the agreement is not a capital property, a Canadian resource property, a foreign resource property or an obligation on account of capital of the taxpayer; (b) either (i) the taxpayer has produced audited financial statements prepared in accordance with generally accepted accounting principles in respect of the taxation year, or (ii) the agreement has a readily ascertainable fair market value.6 Once a taxpayer makes the mark-to-market election, the taxpayer will be required to annually include in computing the taxpayer's income the increase or decrease in value of the taxpayer's eligible derivatives. However, the recognition of any accrued gain or loss on an eligible derivative will be deferred until the derivative is disposed of.

This election will be available for taxation years that begin on or after Budget Day.

Straddle Transactions

The second measure aimed at addressing the timing of recognition of gains and losses on derivatives is a new anti-avoidance rule that targets straddle transactions. A straddle transaction is, in simple terms, a transaction whereby the taxpayer simultaneously holds an interest (or position) in two or more financial instruments with the result that equal and offsetting gains and losses are to be generated from the transaction. The measure will effectively defer the realization of any loss on the disposition of a position to the extent the taxpayer has an unrealized gain on an offsetting position. A gain in respect of an offsetting position would generally be unrealized where the offsetting position has not been disposed of and is not subject to mark-to-market taxation.

For the purposes of this measure, a position will generally be defined as including an interest in certain properties (e.g., a traded commodity, a share in a corporation, an interest in a partnership or trust), as well as derivatives and certain debt obligations. An offsetting position with respect to a particular position held by a taxpayer will generally be a position that has the effect of eliminating all or substantially all7 of the taxpayer's risk of loss and opportunity for gain or profit in respect of the particular position.

This new measure will not apply to a position held by a mutual fund trust or a mutual fund corporation for purposes of the Tax Act, providing investment funds another incentive to achieve and maintain such status. Other exceptions include a position held by financial institutions (as defined for the purposes of the mark-to-market property rules); a position that is part of certain types of hedging transactions entered into in the ordinary course of the taxpayer's business; or a position that is part of a transaction or a series of transactions none of the main purposes of which is to defer or avoid tax.

This measure will apply to any loss realized on a position entered into on or after Budget Day.

New Compliance Intitiatives

As part of Budget 2017, the Liberal government also stated its commitment to implementing stronger standards for corporate and beneficial ownership transparency that provide safeguards against money laundering, terrorist financing, tax evasion and tax avoidance. In particular, the budget papers indicated that the government was examining ways to enhance the tax reporting requirements for trusts in order to improve the collection of beneficial ownership information. As part of these initiatives, amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act are expected that, amongst other things, support more effective intelligence on beneficial owners of legal entities.

Footnotes

1 Under the current rules in the Tax Act, in order to effect a tax-deferred exchange on a merger of classes (or funds) the old share and the new share must derive their value in the same proportion from the same property or group of properties.

2 The phrase "all or substantially all" in the Tax Act is generally interpreted to mean 90% or more.

3 See CRA Views document no. 9608465, "Mutual fund reorganization", dated September 23, 1996, where the CRA states that in such circumstances "there would not be a disposition where units of the transferee held by the transferor are exchanged by the transferor for identical units of the transferee".

4 RDSPs were already subject to similar penalty taxes. Under this new measure, the non-qualified investment rules that currently apply to RDSPs will simply be moved to Part XI.01 of the Tax Act and existing Part XI of the Tax Act, which currently contains those rules applicable to RDSPs, will be repealed.

5Kruger Incorporated v. The Queen, 2016 FCA 186.

6 In the case of agreements held by financial institutions, there is a further requirement that the agreement is not a "tracking property" (as defined in subsection 142.1(1) of the Tax Act) other than an "excluded property" (as defined in subsection 142.1(1) of the Tax Act) of the financial institution.

7Supra footnote 2.

About BLG

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Blake, Cassels & Graydon LLP
Norton Rose Fulbright Canada LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Blake, Cassels & Graydon LLP
Norton Rose Fulbright Canada LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions