Principal Issues: [TaxInterpretations translation]
Tax consequences resulting from the designation of a non-taxable capital gain on the adjusted cost base of a unit in a mutual fund trust if the amount designated has not been paid and was not payable to the holder of the unit.
Position: Does not reduce or increase the adjusted cost base of the unit
Reasons: Interpretation of the Act.
November 7, 2007
Mr. André Gauthier, CGA Industry Specialist, Financial Services Income Tax Rulings Directorate Quebec Tax Services Office 155 Pointe-aux-Lièvres St. Danielle Bouffard Quebec QC G1K 7L3 (613) 590-2155
2007-025386
Adjustment made to the adjusted cost base ("ACB") of units of a mutual fund trust
This is in response to your email of May 15, 2007 concerning the above subject. In particular, you wish our opinion on the situation described below.
Essentially, you have provided us with a calculation of the ACB of XXXXXXXXXX units held by a person in a mutual fund trust ("MFT") in 2005. That MFT was established under the laws of Alberta. The calculation provided takes into account, inter alia, an increase in the ACB of those units to reflect the non-taxable portion of the capital gains realized by the MFT in 2005 that, in your view, were not paid to the unitholder in 2005 and were not payable to the unitholder.
Although the result of the above calculation appears reasonable to you (since it avoids double taxation to the investor in case of resale of the said XXXXXXXXXX units), it does not, in your opinion, reflect the wording of the provisions of the Income Tax Act (the "Act").
Question
You asked us about the tax consequences resulting from the designation of a non-taxable capital gain to the ACB of a unit in an MFT if the amount designated was not paid and was not payable to the holder of the unit.
Our Comments
In the "Canadian Federal Income Tax Considerations" section of the MFT's prospectus, it is stated, inter alia, in the subsection "Taxation of Holders" (at pages 52 and 53) that [TaxInterpretations translation]
A holder will generally be required to include in computing income for a particular taxation year that portion of the net income of the Fund for that taxation year, including net realized taxable capital gains, paid or payable to the holder in the taxation year, whether such income was received in cash or reinvested in additional Trust Units. Provided that appropriate designations have been made by the Fund, that portion of (a) net realized taxable capital gains of the Fund (including taxable capital gains of issuers so designated by the Fund) and (b) taxable dividends received by the Fund on shares of taxable Canadian corporations (including taxable capital gains of issuers so designated by the Fund) that is paid or payable to a holder will retain its character and be treated as such in the hands of the holder. Any other income of the Fund will be treated as income from property, however arising. Losses of the Fund under the Income Tax Act cannot be allocated to the holders or treated as losses of the holders.
The non-taxable portion of net realized capital gains of the Fund that is paid or payable to a holder in a year will not be included in computing the holder's income for that year and will not reduce the adjusted cost base of the holder's Trust Units. Any excess over the net income of the Fund and the non-taxable portion of net realized capital gains designated in respect of a Holder for a particular taxation year that is paid or payable to the Holder in that year will not generally be included in computing the Holder's income for that year. However, such excess in respect of a Trust Unit paid by the Fund will generally reduce the adjusted cost base of the Trust Unit to the holder.
(emphasis added)
Furthermore, paragraphs XXXXXXXXXX of the MFT's trust deed provide as follows:
XXXXXXXXXX
(emphasis added)
As stated in Technical Interpretation 9423165, the ACB of a unit in an MFT is generally the price paid by the taxpayer for that unit less any amounts that have become payable to the taxpayer unless, inter alia, those amounts are included in the taxpayer's income or are derived from the non-taxable portion of a capital gain designated to the taxpayer by the MFT. The exception for the non-taxable portion of a capital gain is found in subclause 53(2)(h)(i.1)(B)(I). Subclause 53(2)(h)(i.1)(B)(I) provides that the ACB of a unit is not reduced by the amount of the taxable capital gain designated to the taxpayer by the MFT if the MFT was resident in Canada throughout its taxation year. This exception allows an MFT that was resident in Canada throughout its taxation year to designated the non-taxable portion of a capital gain payable to a beneficiary without reducing the ACB of the taxpayer's unit. In the absence of this exception, the ACB of the unit would be reduced by the non-taxable portion of the capital gain payable to the taxpayer and the taxpayer may be subject to tax on that portion upon the eventual disposition of the unit.
An increase in the ACB of a unit in an MFT is provided for in paragraph 53(1)(d.2). This paragraph requires a taxpayer to add to the cost of a unit in an MFT any amount required by subsection 132.1(2) to be added in computing the ACB of the unit. Subsection 132.1(2) does not increase the ACB of a unit by an amount equal to the taxable capital gain designated to the taxpayer by the MFT. In our view, subsection 132.1(2) allows the ACB of a unit to be increased by an amount by which the ACB has already been reduced by subparagraph 53(2)(h)(i.1). The ACB of a taxpayer's unit in an MFT is not reduced by the capital gain designated to it. The exceptions in clause 53(2)(h)(i.1)(A) and subclause 53(2)(h)(i.1)(B)(I) provide, respectively, that the ACB of a unit is not reduced by the taxable and non-taxable portions of a capital gain allocated to a taxpayer. Taking into account the foregoing comments, it is our view that the designation by an MFT to a taxpayer of a capital gain that has become payable does not increase or decrease the ACB of the taxpayer's unit in the MFT.
What is the explanation for the positive adjustment to the ACB of the unit by an amount equal to the non-taxable portion of the capital gain that is not paid to the investor in this situation? The explanation appears to be that, according to item XXXXXXXXXX of the trust deed, since the capital gain is payable, the reinvestment of any amount payable to an investor in the form of additional units would result in an increase in the ACB of their units. We have not verified the reinvestment of amounts payable, but it is clear from item XXXXXXXXXX of the Trust Deed that distributions payable may be reinvested. If the table you have provided is an accurate indication of what happened, the total distributions paid in cash exclude the amount in column E, which is the amount equal to 50% of the capital gain (i.e. the non-taxable portion of the gain) and it is this amount that increased the ACB of the units, presumably because of the reinvestment. It is therefore not the payment of the capital gain that affected the ACB, but the reinvestment of the non-taxable part of the capital gain in units, possibly followed by a consolidation.
We hope that these comments are of assistance. Should you require further information on the content of this letter, please do not hesitate to contact us.
Alain Godin,
Manager
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.