Disclosing Tax Consequences of Fundamental Changes
This article was originally published in the Investment Funds Practitioner in September 2016.
Certain proposed fundamental changes to an investment fund, such as a proposed merger of funds or a proposed change in the investment objectives of a fund, may have tax consequences for the funds involved and their investors. In recent reviews, staff have raised questions about the adequacy of the disclosure of these potential tax consequences in the related information circular.
In staff's view, managers are in the best position to analyze and provide information as to the overall tax impact of a proposed change on the fund and investors in the fund. We appreciate that the manager's analysis is based on prevailing conditions and may change as conditions change. However, in staff's view, the potential for changing conditions may be addressed in the disclosure and does not preclude providing meaningful disclosure about the various potential tax consequences of the proposed change for the various types of investors in the fund.
To inform the investor's decision on the proposed change and avoid misleading investors, staff's view is that the disclosure in the information circular should provide a balanced discussion of the potential tax consequences of the change. For example, some fund mergers are effected on a "tax-deferred" rollover basis, but only after a portion of the terminating fund's portfolio has been liquidated before the merger. In circumstances where this pre-merger liquidation is expected to result in distributions for taxable investors, staff's view is that the information circular could mislead investors if it describes the merger as tax-deferred without also disclosing the expected tax consequences of the pre-merger liquidation, i.e. distributions for taxable investors.
Staff note that section 5.6 of NI 81-102 requires that the materials sent to investors in connection with a proposed merger include a circular that describes, amongst other things, the income tax considerations for the funds participating in the transaction and their investors. However, other types of fundamental changes may result in tax consequences for investors as well. For example, a proposed change in investment objectives could involve liquidations of portfolio securities expected to result in distributions for taxable investors. Staff view tax consequences arising from a fundamental change to be relevant information for investors. As such, our view is that the circular provided to investors in connection with a fundamental change should describe the income tax considerations for the funds participating in the transaction and provide sufficient detail to enable reasonable investors to make an informed decision.
Staff also expect that, when referring a proposed fundamental change to the IRC for its approval or recommendation, the investment fund manager would provide the IRC with the manager's analysis of the expected overall tax impact of the change on the fund and investors in the fund, so that the IRC may consider whether the proposed fundamental change, in its entirety, meets the standard for IRC approval or recommendation as set out in subsection 5.2(2) or subparagraph 5.3(1)(a) of National Instrument 81-107 Independent Review Committee for Investment Funds, as appropriate.