The transitional relief measures are intended to provide affected taxpayers with additional time to unwind their derivative forward agreement structures.
The 2013 Federal Budget announced proposals regarding character conversion transactions. A character conversion transaction seeks to reduce tax by converting, through derivative contracts, the returns on an investment that would normally be considered to be ordinary income to capital gains which are only 50% taxable.
The budget had announced that the character conversion measures would apply to derivative forward agreements entered into on or after March 21, 2013 that had a term in excess of 180 days or were part of a series of agreements with a term in excess of 180 days. The budget had also stated that this measure would also apply to derivative forward agreements entered into before March 21, 2013 if the term of the agreement would be extended on or after March 21, 2013.
For more details on the 2013 federal budget proposals regarding character conversion transactions, see TaxNewsFlash-Canada 2013-10 "2013 Federal Budget Highlights".
For details on how the character conversion rules may inadvertently affect normal commercial transactions, see TaxNewsFlash-Canada 2013-20 "New Financial Products Anti-Avoidance Rules Cast a Broad Net".
According to Finance's press release, derivative forward agreements that were entered into before March 21, 2013 and had a term ending before 2015 may be excluded from the application of the character conversion rules until the end of 2014. However, new growth limits specified by Finance must be respected for such a derivative forward agreement to qualify for transitional relief.
The proposed changes address situations where certain investment funds use a series of short-term derivative forward agreements (e.g., so-called "rolling" 30-day agreements) and longer-term derivative forward agreements that end before 2015. In particular, transitional relief will also be extended to situations where either the term of a derivative forward agreement is extended to no later than the end of 2014 or a derivative forward agreement is part of a series of agreements that concludes before 2015.
Under the 2013 federal budget proposals a series of 30-day rolling forward derivative forward agreements would have had 180 days of grandfathering after its first post-March 20, 2013 renewal date. Finance's announcement states that derivative forward agreements entered into after March 20, 2013 and before July 11, 2013 will have at least 180 days of grandfathering.
Finance states to ensure investment funds are not given an inappropriate long period of grandfathering, it proposes that transitional relief will not be provided to purchases and sales that occur after March 21, 2018 under a derivative forward agreement. This change is consistent with the intent of the character conversion measure to limit such relief to a reasonable period. Transitional relief may also be unavailable for such derivative forward agreements if their size is increased beyond certain limits after March 20, 2013.
Under the proposed technical changes, forward agreements will no longer qualify for grandfathering if there has been growth in excess of notional amount of the derivative forward contact at March 20, 2013 has grown by more than the sum of:
- The net change in the market value of the underlying investments (reference assets) that is not due to any new investments
- The amount of any cash on hand before March 21, 2013 that can reasonable be considered to have been committed to the forward agreement before March 21, 2013
- Proceeds from the exercise of an over-allotment option after March 20, 2013 provided that the option was granted and the forward was entered into before March 21, 2013
- Increases occurring after March 20, 2013 and before July 11, 2013 up to a maximum of 5% of the notional amount of the derivative forward agreement before March 21, 2013.
When calculating the growth limit described above, rebalancing of the derivative forward agreement is taken into account.
The rules also allow for grandfathering for the merger of investment funds provided that the combined notional amount of the merged forward agreements do not exceed the predecessor derivative forward agreements and previous terms.
For more information, contact your KPMG adviser.
Information is current to July 16, 2013. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500