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Budget 2024: Legislative Changes of Note for Investment Funds

April 19, 2024 Tax Bulletin 4 minute read

The Income Tax Act (Canada) (the “Tax Act”) contains a host of provisions that influence how investment funds are structured and administered. The Tax Act also restricts the types of investments that may be held by registered plans and in other tax-advantaged accounts without adverse tax consequences.

In Budget 2024, the Government acknowledges that the restrictions placed on the property that may be held by registered plans have become unduly complex. Conversely, the Government has identified concerns with how certain tax-advantaged investment funds are administered and, in this regard, proposes to tighten the conditions that must be satisfied for a corporation to qualify as a “mutual fund corporation” for the purposes of the Tax Act.

“Qualified Investments” for Registered Plans

Registered retirement savings plans (“RRSPs”), registered retirement income funds (“RRIFs”), tax-free savings accounts (“TFSAs”), registered education savings plans (“RESPs”), registered disability savings plans, first home savings accounts (“FHSAs”), and deferred profit sharing plans (collectively, “Registered Plans”) are each afforded preferential treatment under the Tax Act. However, a Registered Plan is not permitted to hold property that is not a “qualified investment” for the Registered Plan.

The requirement that Registered Plans only be permitted to hold “qualified investments” was first introduced in 1966. The “qualified investment” limitation was enacted with a view to ensuring that Registered Plans limited their holdings to safe and stable investments. The somewhat paternalistic underpinnings of the “qualified investment” restrictions arose at a time when the range of investments available to the average taxpayer were limited and access to information about potential investments was constrained. With the continuing expansion of the global economy, the range of investments available to individual taxpayers has proliferated, and the number of categories of “qualified investments” has been incrementally expanded. Currently, there are more than forty different categories of “qualified investments”. Unlike 50 years ago, Registered Plans now include specialized savings vehicles that are focused not only on long-term retirement savings, but also on shorter term periodic savings (e.g., TFSAs) and savings for homes (e.g., FSHA). The scope of information available to taxpayers to make informed investment decisions has expanded and the conceptual basis for maintaining stringent “qualified investment” restrictions is now increasingly questionable.

In Budget 2024, the Government acknowledges that the current “qualified investment” rules “can be inconsistent or difficult to understand”. The Government has conceded that it is difficult to rationalize why:

  • Different types of Registered Plans are subject to slightly different “qualified investment” rules that restrict their ability to invest in small businesses;
  • Certain types of annuities are only “qualified investments” for RRSPs, RRIFs, and RESPs; and
  • Interests in certain pooled investment funds can only be “qualified investments” if the fund is registered with the Canada Revenue Agency (i.e., are “registered investments”).

Budget 2024 invites stakeholders to make submissions to the Government on how the “qualified investment” rules could be “modernized” to improve the clarity and coherence of the Registered Plans regime. The Government has specifically identified the following issues for consideration:

  • Whether and how the rules governing the investments that may be made in small businesses can be harmonized to apply consistently to all Registered Plans;
  • Whether annuities that are only “qualified investments” for certain Registered Plans should continue to be “qualified investments”;
  • Whether the conditions imposed for a pooled investment fund to be a “registered investment” are appropriate, including whether there is merit in maintaining a formal registration process for “registered investments”;
  • Whether and how the “qualified investment” rules could be adjusted to promote an increase in Canadian-based investments; and
  • Whether crypto-backed assets should be “qualified investments”.

Stakeholders are invited to make submissions to the Department of Finance by July 15, 2024 on changes to the “qualified investment” rules. Submissions may be made by e-mail sent to [email protected].

Mutual Fund Corporations

Historically, “mutual fund corporations” were a popular means of structuring pooled investment vehicles. However, in recent years, amendments to the Tax Act restricting the flexibility of mutual fund corporations, including rules that effectively eliminated so-called “switch funds”, have limited the utility of mutual fund corporations.

To be a “mutual fund corporation”, a corporation must satisfy a number of conditions, including qualifying as a “public corporation”. A “public corporation” includes a corporation that is resident in Canada at a particular time, if, at that time, a class of shares of the corporation is listed on a “designated stock exchange” in Canada.

The Government asserts that the policy rationale for granting mutual fund corporations preferential tax status is premised on such corporations serving as widely held pooled investment vehicles. The Government has become concerned that the equity of certain “mutual fund corporations” is not being widely held, despite shares of the corporation being listed on a designated stock exchange in Canada.

To counter attempts of closely held corporate groups to structure material holdings in “mutual fund corporations” in a manner that was not contemplated by the Government, Budget 2024 proposes to introduce a new anti-avoidance rule that will preclude a corporation from qualifying as a “mutual fund corporation” where it is controlled by or for the benefit of certain specified groups (which may be comprised of any combination of persons that do not deal with one another at “arm’s length”). The proposed technical amendments to the Tax Act will deem a corporation not to be a “mutual fund corporation” after a particular time if (i) a person or partnership, or any combination of persons or partnerships that do not deal with one another at arm’s length, (collectively, “Specified Persons”) own, in the aggregate, shares of the capital stock of the corporation having a fair market value of more than 10% of the fair market value of all of the issued and outstanding shares of the corporation, and (ii) the corporation is controlled by or for the benefit of one or more Specified Persons. The proposed anti-avoidance rule will not apply to a corporation if (i) the corporation was incorporated not more than two years before the particular time, and (ii) the aggregate fair market value of the shares of the capital stock of the corporation owned by Specified Persons does not exceed $5,000,000.

It is instructive to note that if the anti-avoidance rule applies at a particular time, the status of the corporation will be permanently tainted and the corporation will not be able to qualify as a “mutual fund corporation” at any time in the future. In addition, the phrase “for the benefit of” is used sparingly in the Tax Act and certain jurisprudence suggests that whether a corporation is controlled “for the benefit of” a Specified Person may be interpreted in an expansive manner.

The new “mutual fund corporation” anti-avoidance rules are proposed to apply to taxation years beginning after 2024.

by Michael Friedman

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2024

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