Income Trust Reorganizations
As previously stated, the typical structure for so-called income trusts is to have the trust hold all the shares and notes of a corporation. Over the last year, some mutual fund groups have announced that their group was contemplating transferring the business from the wholly owned corporation to a limited partnership in which the mutual fund trust would be holding an interest as a limited partner.
Question 1
What are the CRA’s views on those reorganizations?
Response 1
The creation of various entities and the use of various rollover provisions are typically required to achieve the reorganization in question. One of the provisions used is section 132.2, which enables a mutual fund corporation to transfer its property to a mutual fund trust on a rollover basis. Hence, one of the proposed transactions will be the creation of a corporation that qualifies as a mutual fund corporation under subsection 131(8) and the role of that corporation is to hold the assets that are ultimately transferred to the mutual fund trust using section 132.2. The CRA accepted in ruling 2003-005398 that the use of section 132.2 to achieve the reorganization described in the ruling was acceptable and that section 245 would not apply to re-characterize the transactions.
Question 2
Would the changes to section 132.2 proposed by the Department of Finance on July 18, 2005 affect your response to question 1?
Response 2
No. The Department of Finance released some proposed changes to section 132.2 on July 18, 2005. As indicated in the technical notes, “new paragraphs 132.2(3)(f) and (g) are amended to ensure that the mutual fund merger rules do not apply inappropriately to create artificial or ‘phantom’ losses.” This clarifies that the provision is a rollover provision and that no gains or losses are intended to result from its application to transfers to a mutual fund trust, including transfers made in the course of the reorganization described in question 1.
Question 3
The board of directors of an existing corporation might contemplate converting the corporation into a mutual fund corporation meeting all the requirements of subsection 131(8) in order to benefit from the application of section 132.2. Would such conversion be challenged by the CRA?
Response 3
The CRA addressed this issue at the 2002 CTF Conference [Footnote 5] and that position has remained unchanged. The general anti-avoidance rule (“GAAR”) Committee has recommended that section 245 be applied where an existing corporation that carries on a business is converted into a mutual fund corporation in an attempt to benefit from the application of section 132.2 on the transfer of its assets to a mutual fund trust. Section 132.2 was designed to facilitate the transfer of assets from existing and active mutual fund corporations to mutual fund trusts or the consolidation of existing and active mutual fund trusts. Transfers of a business from a non mutual fund group to a mutual fund trust are expected to generate gains or losses. This is in contrast to question 1 above wherein the transfer of assets occurred in a reorganization of an existing income trust.