Labour Sponsored Investment Funds

Information Bulletin 2-06, March 2006

About this Bulletin

This bulletin is provided as a guide to proposed transition rules for the Labour Sponsored Investment Funds (LSIF) program. Legislative amendments would be required to the Community Small Business Investment Funds Act. The proposed amendments are not yet law. Any amendments introduced are subject to the approval of the Legislature. Unless otherwise specified, the amendments would be effective for 2005 onward.

On September 30, 2005, the Minister of Finance announced that the LSIF tax credit would be eliminated at the end of the 2010 tax year. The minister also announced consultations with the industry to develop rules to assist the transition of the program to a federal-only credit. The phase-out of the tax credit was introduced in Bill 18, Budget Measures Act, 2005 (No. 2), which received Royal Assent on December 15, 2005.

Phase-Out Schedule

The phase-out of the tax credit is legislated under paragraphs 7 to 8.2 of subsection 25(4) of the Community Small Business Investment Funds Act (the Act), and is summarized in the following table:

Taxation Year	Retirement Savings Plan Sales Season	Labour Sponsored Investment Fund Tax Credit	Research Oriented Investment Fund Tax Credit
2006	2007	15%	5%
2007	2008	15%	5%
2008	2009	15%	5%
2009	2010	10%	5%
2010	2011	5%	5%
2011	2012	0	0

Shareholders who redeem shares prior to the eighth anniversary of their acquisition will continue to be subject to an early redemption penalty.

Sections of the Act that would be amended are included in parentheses following each heading.

Qualifying Debt Obligation (Subsection 12(1))

The definition of qualifying debt obligation would be amended as follows:

The prohibition against LSIFs preventing an eligible business from incurring any other debts would be removed.
The term floating charge would be replaced with language that would allow LSIFs to take a security interest in one or more of the assets of an investee business, provided that the security agreement does not prevent the borrower from dealing with the collateral in the ordinary course of business prior to default.
LSIFs would be permitted to take a guarantee from any person, not just from another LSIF.
The requirement that a debt obligation be subordinate to all other debt would be replaced with a requirement that LSIF debt not rank ahead of any other creditor secured against the same asset.

Amendments to clause 18(1)(b) of the Act would also clarify that if an LSIF guarantees a qualifying debt obligation issued by an eligible business, the guarantee would be treated as an eligible investment with a cost of 25 per cent of the amount of debt guaranteed.

Amendments to the definition of qualifying debt obligation and related amendments to clause 18(1)(b) of the Act would be effective upon receiving Royal Assent.

LSIF Investment Level Requirements (Pacing) (Subsection 17(1))

LSIFs are currently required to invest 70 per cent of the capital that they raise with the tax credit in small and medium enterprises, subject to some adjustments.

For 2005 through 2011, the pacing formula would be based on 60 per cent of the aggregate amount of equity capital received on the issue of Class A shares outstanding at the end of the calendar year that were issued before the sixty-first day of the calendar year;

excluding Class A shares that have been outstanding for at least eight years
excluding Class A shares eligible for redemption within the first 60 days of the following calendar year, and
reduced by 20 per cent of the aggregate amount of equity capital received on the issue of Class A shares issued during the period beginning on the 61st day of the previous year and ending on the 60th day of calendar year.

For 2012 and subsequent years, the pacing formula would be based on 60 per cent of the aggregate amount of equity capital received on the issue of Class A shares outstanding at the end of the calendar year that were issued before the sixty-first day of 2011:

excluding Class A shares that have been outstanding for at least eight years, and
excluding Class A shares eligible for redemption within the first 60 days of the following calendar year.

For 2005 and subsequent years, the percentage of gains realized on eligible investments added to the pacing formula under letter "D" would also be lowered from 70 to 60 per cent.

Dispositions (Subsection 17(3))

Under subsection 17(3), currently an LSIF can count an investment that it has disposed of against pacing requirements for 9 months following the disposition. This deemed eligibility period would be extended from nine months to 24 months for dispositions occurring on or after January 1, 2005.

Listed Company Limit (Subsection 18.1(5))

The limit on investments in publicly listed companies would be eliminated for the 2005 and subsequent calendar years.

Small Business Requirements (Subsection 18.1(8))

The small business investment requirement would be eliminated for the 2005 and subsequent calendar years.

Follow-on Investments (Section 18)

A follow-on investment in an investee that no longer meets the definition of eligible business only because it is either larger than 500 employees or has more than $50 million in assets would be counted as an eligible investment, provided that:

when the LSIF made its initial investment the investee met the definition of eligible business, and
the LSIF continues to hold the initial investment.

Reserves (Subsection 19(2))

The definition of "reserves" would be expanded to allow LSIFs to hold shares of public securities listed on a Canadian or foreign stock exchange prescribed under the federal Income Tax Act.

Aggregate Investments (Subsection 20(2))

The $15 million limit on aggregate investments in an eligible business and any related business would be increased to $20 million.

Material Change (Subsection 21(2))

The deemed eligibility period following a material change would be extended to 24 months for material changes occurring on or after January 1, 2005.

Wind-Up Provisions (Section 27.2)

Proposed wind-up rules would allow an LSIF whose fund mangers had determined that continuing in the program was not in the best interest of shareholders to exit the program without penalty to the fund or to shareholders. If approved, the wind up rules would be effective August 29, 2005.

An LSIF choosing to exit would be required to notify the minister of its intention to wind up. The notice to the minister would be required to include a reasonable date for the end of the wind-up period (the wind-up date), when the LSIF would surrender its registration. Any public statement of an LSIFs intention to wind up (e.g., in a prospectus, through press release, on a website) will be considered to be notification to the minister.

An LSIF that notifies the minister of its intention to wind up would be subject to the following rules:

Following notification, the LSIF would no longer be eligible to issue tax credits.
Class A shares redeemed as part of the wind up, and occurring within a reasonable number of days before the wind up date, would not be subject to a clawback of the tax credit under section 14.1 of the Act.
While winding up, LSIFs would not be subject to pacing requirements under section 17 of the Act. If notification was received:
- by January 31, 2006, the LSIF would not be subject to pacing requirements for 2004, and subsequent years.
- after January 31, 2006, the LSIF would not be subject to pacing requirements beginning in the year in which notice was received, or the prior year if notice were received in the first 31 days of the year.
While winding up, the LSIF would not be required to inform the minister of material changes to its investments under section 21 of the Act.
While winding up, subsection 27(4.1) of the Act would not apply, and the LSIF would be permitted to return stated capital to shareholders.
On the wind up date, the LSIF would surrender its registration without penalty under subsection 27(2.1) of the Act, assuming all Class A shares had been redeemed by that time.

An LSIF that notifies the minister after January 31, 2007 of its intention to wind up would be permitted to use the wind-up rules only if it had raised less than 20 per cent of its Class A equity, excluding Class A shares that have been outstanding for at least eight years, in the 24 months prior to notification. Class A shares issued pursuant to an asset purchase arrangement under section 27.1 of the Act in the 24 months prior to notification would not be included in this calculation.

In addition, while winding-up, LSIFs will be permitted to sell investments to continuing LSIFs. Investments purchased by continuing LSIFs would be deemed to be eligible investments for the purchaser under section 18 of the Act. The fair market value at the time of purchase would be considered the cost of the investment for the purchaser for the purpose of pacing requirements.

Enquiries

For further information concerning this information bulletin, or to obtain copies of other Ministry of Revenue publications, please visit the ministry website at: ontario.ca/revenue.

To contact the Ministry of Revenue by telephone, please call your local Ministry of Revenue tax office, listed under 'Taxes' in the blue pages of the telephone directory, or call:

Toll-free: 1 866 ONT-TAXS (1 866 668-8297)
Teletypewriter (TTY): 1 800 263-7776

03/06

ISBN 1-4249-0668-7