Income Trusts and Subparagraph 132(6)(b)(i) – “its only undertaking was the investing of funds.”
Subparagraph 132(6)(b)(i) requires that the trust’s only undertaking be the investing of its funds in property (other than real property). However, that phrase (“only undertaking was the investing of funds”) is not defined in the Act, and the tax community has expressed interest in any insight the CRA may be able to shed on the interpretation of this phrase.
Question 1
Is the CRA of the view that the holding of all the shares of a corporation or an interest in a limited partnership by the income trust satisfies the condition in subparagraph 132(6)(b)(i); i.e., that the trust’s only undertaking would be the investing of its funds in property (other than real property)?
Response 1
The CRA generally accepts that the holding of shares is the investment of funds in property. With respect to holding an interest in a limited partnership, the Tax Court of Canada indicated in the case of Robinson (Trustee of) v. The Queen[Footnote 2] that a limited partner is considered to be carrying on the business of the partnership. Section 253.1 provides that where the liability of the trust is limited by operation of any law governing the partnership arrangement, the trust is not considered to carry on the business of the partnership solely because of the acquisition and holding of that interest. Accordingly, by virtue of section 253.1, the Robinson case will not result in the trust failing to satisfy the requirements of subparagraph 132(6)(b)(i) solely by virtue of being a limited partner.
The relevant provincial legislation must be consulted to determine whether the trust is a limited partner. Provincial partnership legislation generally provides that the liability of a partner is limited to the extent that the partner is not involved in the business.
Question 2
Would your response change if the income trust also held 100% of the shares of the corporate general partner of the limited partnership?
Response 2
As previously stated, the holding of shares is accepted as being an undertaking that is the investment of funds in property. This is the case even if the corporation is wholly owned and that corporation carries on the business directly or it acts as the general partner of a partnership that carries on the business directly.
Question 3
Would the same conclusion be drawn where the trustees of the trust were also on the board of directors of a wholly owned corporation, including a corporate general partner?
Response 3
While each situation would have to be determined in terms of its particular facts, in all situations in which the CRA has been asked to rule, the trustees did not form the majority of the board of directors of a corporation and did not control the activities or decisions of the corporation. The CRA accepted that the trust had not engaged in a separate non-qualifying undertaking in those situations.
Question 4
Would an income trust still meet the conditions of subsection 132(6) and qualify as a mutual fund trust after having guaranteed a debt of a corporation held indirectly by a limited partnership or a debt of the limited partnership? For example, where a trust is a majority limited partner of a limited partnership (the “Partnership”) and has guaranteed the obligations of a corporation wholly owned by the Partnership or has guaranteed the debt of the Partnership itself? Assuming that the trust is not carrying on a business in respect of the operations of the Partnership, nor engaged in the business of lending money or guaranteeing loans, will the issuance of a guarantee in these circumstances be considered to be within the “only undertaking” requirement of subparagraph 132(6)(b)(i)?
Response 4
The agreement to provide a guarantee is an undertaking. If the guarantee stands on its own as a service [Footnote 3] to third parties, it would not qualify for purposes of that subparagraph. In determining whether the provision of the guarantee is part of the core undertaking [Footnote 4] of the trust, the CRA considers the degree of integration between the guarantee and the core investment undertaking. As subparagraph 132(6)(b)(i) provides that the “only” undertaking of the trust must be the investing of its funds in property as specified therein, the degree of integration between the guarantee and the investing of funds is subject to a high standard.
Question 5
Can you give us some examples of where this high degree of integration is achieved?
Response 5
Such degree of integration would be expected to exist where for no consideration a mutual fund trust guarantees a debt incurred by a wholly owned subsidiary to finance its commercial operation. In technical interpretation 2002-016767, a mutual fund trust guaranteed the borrowings of a wholly owned subsidiary which used the borrowings to finance acquisitions needed for use in its business and for working capital purposes. The CRA determined that that the requirements of paragraph 108(2)(b) and subsection 132(6) were not violated by the mere fact that the trust guarantees a loan that is contracted by the subsidiary. However, the payment of a fee by the subsidiary with respect to that guarantee might taint the trust.
In technical interpretation 2004-006822, the CRA was satisfied that the guarantee described therein would not disqualify the mutual fund trust under subparagraph 132(6)(b)(i), even though it was provided to a corporation which was not wholly owned by the trust because the particular facts indicated that the guarantee formed part of the core investment undertaking of the trust. Guarantees provided by a mutual fund trust in respect of the debt of an entity not wholly owned by the trust, or of the debt of an entity in which a wholly owned subsidiary has an interest, would have to be closely scrutinized in light of all the relevant circumstances.
Where the guarantee is structured in such a way that third parties benefit from such service, the mutual fund status might be lost where the resulting service or benefit conferred on third parties constitutes an undertaking which does not mesh completely with the investing of its funds.