Securing & Sustaining Mutual Fund Trust Status Tips & Traps Portfolio Management Association of Canada Seminar Offices of McMillan LLP Toronto, Ontario September 21, 2011
Part I Securing and Sustaining Mutual Fund Trust Status Tips & Traps Presenters Michael Friedman Partner, Tax McMillan LLP Carl Irvine Associate, Tax McMillan LLP 2
Agenda Mutual Fund Trusts I. Mutual Fund Trust Status An Overview II. III. IV. Basic Qualification Requirements Retroactive MFT Status Election Loss of MFT Status Mitigation Strategies 3
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 4
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 5
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. 6
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 test 2. Unit Trust test 3. Resident in Canada test 4. Sole Undertaking test 5. Prescribed Conditions test 7
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 8
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 condition 1. 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. 9
Unit Trust Test 2. 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 condition Restrictions on activities/types of property owned Income source requirements Restrictions on concentration of property holdings 10
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) 11
Sole Undertaking Test Permitted undertakings Investing of funds in property (other than rights/ interests in real property); and Acquiring, 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 12
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. 13
Prescribed Conditions Test 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; and o Units of the class having an aggregate fair market value of not less than $500 14
Prescribed Conditions Test 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. 15
Prescribed Conditions Test 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 16
Retroactive Status Election If a trust becomes a mutual fund trust at any particular time before the 91 st 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. * Jan. 1, 2011 March 30, 2012 17
Loss of Mutual Fund Trust Status Failure to Satisfy Qualification Requirements Trust established or maintained primarily for the benefit of non-residents Statutory provision historically in flux Objective, point-in-time test Not applicable if substantially all of the property of the trust is not taxable Canadian property Permanent loss of status 18
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 Approach May permit preservation of qualified investment status 19
Part II Navigating the New RRSP/RRIF Anti-Avoidance Rules Presenters Michael Friedman Partner, Tax McMillan LLP Carl Irvine Associate, Tax McMillan LLP 20
Agenda RRSP/RRIF Anti-Avoidance Rules I. Historical Developments and Overview II. Old RRSP Eligibility Standards III. New RRSP Anti-Avoidance Rules Prohibited Investments Advantages Tax Waivers Grandfathering Relief Special Considerations 21
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 22
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 23
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 24
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 of i. a corporation, partnership or trust in which the RRSP annuitant has a significant interest, or ii. 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; 25
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 26
Prohibited Investments 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 27
Prohibited Investments 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 28
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)] 29
Prohibited Investments Tax Refund of tax potentially available in year RRSP disposes of prohibited investment. Refund equal to: 1) the amount of tax paid, UNLESS 2) 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). 30
Prohibited Investments Tax 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/acquisitions Note the Canada Revenue Agency s published position regarding transfers of property between RRSPs 31
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)] 32
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 33
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] 34
Advantages Tax The amount of the tax equals: in the case of a benefit, the fair market value of the benefit in the case of a loan or an indebtedness, the amount of the loan or indebtedness in the case of an RRSP strip, the amount of the RRSP strip Certain limited grandfathering relief may be claimed, subject to certain conditions 35
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)] 36
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. 37
Grandfathering Relief Transitional prohibited investment benefit relief Limited 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, 2011 o subject income to have been paid to the annuitant by the RRSP within 90 days after the end of the taxation year o an election to have been made before July, 2012 38
Special Considerations Duty of care requirement for issuer of an RRSP Issuer 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 39
Questions 40
Cautionary Note The 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. 41
Michael Friedman Partner, Tax McMillan LLP Toronto, Ontario michael.friedman@mcmillan.ca 416.865.7914 Carl Irvine Associate, Tax McMillan LLP Toronto, Ontario carl.irvine@mcmillan.ca 416.865.7266 42