kpmg.ca/assetmanagement

September 2017

Asset Management Tax HandbookThe power of insights

http://www.kpmg.ca/assetmanagement

1 Introduction

2 Investment structures 3 Mutual fund trusts

3 Benefits of MFTs

4 Meaning of MFT

4 Unit trust

4 Prescribed conditions

5 Election to be an MFT

5 Compliance requirements

6 Mutual fund corporation

6 Meaning of MFC

7 Capital gains dividends refund mechanism (CGRM)

8 Fund switching and the 2016 federal budget

8 Merger rules for mutual fund corporations

8 Part IV tax

8 Other

9 Compliance requirements 9 Distributions to non-residents

10 Limited partnership 11 Adjusted cost base of a partnership

interest 11 At-risk amount 11 Qualified investment status 11 Compliance requirements 13 Investment corporations 13 Meaning of investment corporation 14 Benefit of an investment corporation 15 Registered investments 16 Registered investments 16 What are the requirements? 17 Penalty taxes 19 Compliance requirements

20 Canadian income tax characterization of income/gains and expenses/losses

21 Income type and tax treatment 21 Application to asset management

industry 24 Section 39(4) election and implications 24 Key considerations for investment

funds

Table of contents

25 Capital gains refund mechanism 25 What does the CGRM do? 26 Formula and definitions 26 Refundable capital gains tax on

hand (RCGTOH) 27 Recent developments 27 Application to asset management

industry 28 Derivative instruments 29 Linkage for tax purposes 29 Income recognition 30 Character conversion transactions

(CCT) 30 Compliance requirements 31 Synthetic disposition arrangement 32 Application to asset management

industry 32 Compliance requirements 33 Securities lending arrangements 34 Tax definition 34 Income tax consequences to the

lender 35 Income tax consequences to the

borrower 35 Other considerations

36 Stop loss rules 36 Technical application 36 Capital property 37 Non-capital property 38 Synthetic disposition arrangements 39 Suspended losses 39 Technical application 39 Calculation of suspended losses 40 Compliance requirements 41 Corporate actions 43 Other income and deduction 44 Application to asset management

industry 44 Compliance requirements 45 Allocation of expenses 48 Financial institutions 48 Meaning of financial institution 48 Tax implications 49 Change in financial institution status 50 Dividend tax credit 50 Taxation of dividend income 51 Eligible dividends vs. ineligible

dividends

52 Interest income 52 Income recognition 53 Deemed interest 53 Interest payments to non-residents 55 Trust loss restriction events 55 Subsequent amendments 56 Compliance requirements 57 Key considerations for investment

funds 58 Alternative minimum tax 58 Who is subject to AMT? 58 Calculation of AMT 59 Other relevant information 60 Investment fund mergers 60 Technical application 61 Tax-deferred merger of segregated

funds

62 Foreign tax matters 63 Foreign withholding taxes 64 Compliance requirements 65 Non-resident investment funds 65 Deemed resident 67 Compliance requirements

68 Other important topics 69 Flow-through shares 69 General rules 69 Investor 69 Corporation 69 Dispositions of flow-through shares 70 Mineral exploration tax credit 71 Accounting and tax differences 71 Common book to tax reconciliation

items 73 GST/HST and QST on investment funds 73 General tax framework 74 Special rules for investment plans 75 Cross-border issues and structuring 76 Tips and traps 76 The July 22, 2016 proposed

amendments and consultations 78 Common reporting standard

80 KPMG contacts

IntroductionThis is the second edition of KPMGs Asset Management Tax Handbook. This book is intended for business professionals and others with an interest in Canadas asset management industry. It outlines recent and significant provisions of Canadas federal income tax legislation applicable to domestic and foreign investment management activities.

As the competition for capital allocation intensifies, commercial relationships are becoming more important than ever in the asset management industry. Whether directly with clients, or through intermediaries, the trust-based relationship that exists between investor and fund manager is critical to commercial success. There was however general agreement that the industry is at a crossroads, and the winners will be those who focus on recruiting better people, designing and implementing better customer processes, and utilizing better technology to deliver the easiest, hassle-free experience at lowest cost. Tax risk governance and tax efficiency are an integral part of enhancing commercial relationships in the asset management industry. Increasingly, asset managers are highlighting the tax-efficient design of their products as a differentiator in order to enhance the client experience.

With tax reform happening in Canada and other parts of the world, tax risk and efficiency concerns amongst investors has never been greater, as in many cases existing structures or previously relied upon tax assessing practices have changed substantially and thus give rise to tax leakage. Asset managers and service providers have been proactive embracing technology in their investment strategy, regulatory and distribution models. Digital automation in tax compliance and reporting is no exception as the industry re-engineers itself to become the tax department of the future to streamline processes and automate tasks to increase productivity, heighten accuracy and lower costs.

We have prepared KPMGs Asset Management Tax Handbook with the most up-to-date tax developments to provide industry participants with a useful tax technical resource to help navigate through some of the tax fundamentals regularly faced by asset managers in order to help investment funds succeed in todays constantly changing environment. We hope that this book assists tax departments in their endeavour to understand the embedded risks in the ever-changing tax policy landscape in order to make more informed decisions on day-to-day operations, as well as channelling it proactively and positively to create real value for investors.

We trust that this book will be a helpful summary of the main features of our current asset management tax regime, both to readers who intend to undertake asset management activities in Canada and to readers who wish to establish asset management operations in Canada. We also hope that it will be a useful guide in everyday dealings with taxation matters affecting the industry.

Readers who require further information or assistance are invited to contact Joseph Micallef or any of KPMGs asset management professionals.

Statements of law in this book are current to July 31, 2017.

Joseph N Micallef, CPA, CA, Partner, National Financial Services Tax & National Asset Management Tax Leader

KPMG LLPBay Adelaide Centre333 Bay Street Suite 4600Toronto, Ontario M5H 2S5T: 416-777-8037M: 905-339-9139F: 416-777-8818 E: jmicallef@kpmg.ca

https://ca.linkedin.com/in/micallefjoseph

mailto:Jmicallef@kpmg.cahttp://www.https://ca.linkedin.com/in/micallefjosephhttp://www.https://ca.linkedin.com/in/micallefjoseph

Investment structures

3

Mutual fund trustsMutual funds are commonly structured as trusts. From a legal point of view, a trust is a relationship in which a trustee holds property for the benefit of beneficiaries. In the investment fund industry, a mutual fund trust (MFT) is formed by declaration of trust; the fund manager or professional trustee becomes the trustee and settles the trust with a nominal amount. Investors are invited to participate in the trust through a prospectus or offering memorandum.

The Income Tax Act, Canada (the Act) treats a trust as a separate taxpayer and as an individual. An MFT is subject to the highest personal tax rate on income retained in the trust. The Act permits a trust to flow the income out to its beneficiaries, and the income designated to the beneficiaries retains its characteristics for tax purposes. Certain tax advantages of the Act make the MFT a suitable vehicle for a variety of investors.

Benefits of MFTsThere are several benefits of attaining MFT status:

Non-application of alternative minimum tax (AMT). A trust that is an MFT throughout the year is exempt from the AMT. Without this exception, a trust could be subject to AMT even if it distributes all income and net realized capital gains to its beneficiaries.

Non-application of the Act, part XII.2 taxes. A trust that is an MFT throughout the year is exempt from the Part XII.2 taxes. Part XII.2 taxes apply to designated income of a trust if it has designated beneficiaries. Part XII.2 imposes a special tax on unitholders who are non-residents, or tax exempt.

Election for December 15 tax year-end. An MFT can elect a December 15 year-end to enable distributions to its unitholders by December 31. This election can be revoked at a later time.

Eligibility for capital gain refund mechanism (CGRM). An MFT can benefit from the capital gain refund mechanism and retain a certain amount of net realized capital gains in the fund without paying taxes, based on a formula. The details of this rule can be found in the section Capital gain refund mechanism.

INVESTMENT STRUCTURES

CANADIAN INCOME TAX MATTERS

FOREIGN INCOME TAX MATTERS

OTHERINVESTMENT STRUCTURES

CANADIAN INCOME TAX MATTERS

FOREIGN INCOME TAX MATTERS

OTHER

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