Nick Wright, BA JD MBA LLM (Tax)

Wright Business Law

A mutual fund trust ("MFT") is a trust-based structure commonly used for pooled investment funds in Canada that may facilitate the flow-through of income and gains to investors under the Income Tax Act (Canada). In Ontario, its formation and operation engage securities law requirements, including prospectus exemptions under NI 45-106 and registration analysis under NI 31-103. Sponsors must structure the declaration of trust, management arrangements, and offering documents to align with both tax qualification requirements and investment fund regulation. This article outlines the principal legal and regulatory considerations involved in forming and operating a private pooled MFT in Ontario.

Regulatory Framework and Sources of Law

A MFT sits at the intersection of trust law, securities law and tax law. It is created through a declaration of trust, typically governed by the common law of trusts in Ontario and supplemented by statutory provisions such as the Trustee Act (Ontario). Subject to the terms of the declaration of trust and applicable law, the trustee generally holds legal title to fund property and owes fiduciary obligations to the unitholders.

From a securities law perspective, units of an MFT are “securities” under s. 1(1) of the Securities Act (Ontario). Private pooled MFT units are typically distributed in reliance on prospectus exemptions under NI 45-106, most commonly the Accredited Investor and Offering Memorandum (OM) exemptions. 

NI 31-103 registration analysis requires determining whether the trust is an “investment fund” under the Securities Act (Ontario). If its primary purpose is investing money provided by its security holders and it does not actively manage the businesses in which it invests, it will generally meet the definition. In that case, additional NI 31-103 obligations are engaged and, where the fund is a reporting issuer, or a mutual fund to which the Instrument applies, NI 81-106 disclosure requirements may also apply.

If the trust is an investment fund, the entity directing or managing it will typically require registration as an investment fund manager (IFM). Internal discretionary management may trigger portfolio manager (PM) registration. Distribution activities require careful dealer registration analysis. In many private offerings, subscriptions are processed through a registered exempt market dealer (EMD) or another appropriately registered dealer.

Notably, tax classification as a “mutual fund trust” under the Income Tax Act (Canada) is a separate analysis from securities law classification as a “mutual fund” or “investment fund.” A trust may meet one definition and not the other. Each regime must be assessed independently at formation and on an ongoing basis.

The Income Tax Act (Canada) and its regulations play a central role. A trust that qualifies as an MFT may access a number of favourable tax attributes under the Income Tax Act (Canada), and investment fund trusts commonly distribute income and gains in a manner that minimizes entity-level taxation.

Qualification requires compliance with detailed statutory and regulatory conditions, including requirements relating to the trust’s structure, unitholder base, and permitted activities.

Definitions and Thresholds

A "mutual fund trust" is defined in Income Tax Act (Canada), s. 132(6) as a trust that is a unit trust resident in Canada and that satisfies the additional conditions in that subsection, including compliance with prescribed conditions set out in the Income Tax Regulations.

More precisely:

The trust must be a unit trust within the meaning of s. 108(2). This requires that the beneficiaries’ interests be described by reference to units representing defined beneficial interests in the trust property. Unit trust status may be satisfied where units are redeemable at the demand of the holder, or where prescribed public trading or ownership dispersal conditions are met. Redemption rights are common, but they are not the sole route to qualification.

The trust must comply with the prescribed conditions under paragraph 132(6)(c), which are set out in section 4801 of the Income Tax Regulations. These conditions provide alternative pathways to qualification. One pathway is public distribution, including exchange listing. In practice, however, most private pooled MFTs qualify under the ownership dispersal test in Regulation 4801(a). That provision generally requires that not fewer than 150 beneficiaries each hold units of a class having an aggregate fair market value of not less than the prescribed minimum per holder. As a result, exchange listing or broad public trading is not required for MFT qualification where the dispersal threshold is satisfied.

The trust’s undertaking must be limited to the investing of its funds in property, subject to the specific activities permitted in paragraph 132(6)(b). The provision permits investing in property and, in certain circumstances, acquiring, holding, maintaining, improving, leasing or managing real property that is capital property of the trust. The trust must not carry on a business beyond those permitted activities.

To establish a unit trust as a matter of private law, the declaration of trust must create units representing undivided beneficial interests in the trust property and define the rights attached to those units with sufficient certainty. The instrument typically provides mechanisms for issuance, transfer and, where applicable, redemption of units, and sets out how income and capital are allocated among unitholders. While allocation mechanics are driven largely by tax and commercial considerations, clarity of unitholder rights is essential to support unit trust status and investor certainty.

Under NI 45-106, investors subscribing to an MFT typically qualify under the Accredited Investor thresholds in s. 1.1, which include income of at least $200,000 ($300,000 with a spouse) or net financial assets exceeding $1 million. Where the OM exemption is used to also allow for investors below the Accredited Investor income and wealth thresholds, Form 45-106F2 must be delivered, together with the prescribed risk acknowledgement form.

Application in Practice

Forming an MFT begins with drafting a comprehensive declaration of trust. This document sets out the governance framework, including the appointment, powers and duties of the trustee, the rights of unitholders, the investment objectives and strategies of the trust, valuation procedures and redemption mechanics. Unlike a corporate statute, trust law offers significant flexibility, so the declaration of trust must be drafted carefully to reflect the economic and legal intentions of the sponsor.

Sponsors then consider the manager. Most MFTs appoint a management entity under a management agreement. The manager provides investment management, administrative services, record keeping and investor communications. This agreement must address conflicts of interest, valuation oversight and the allocation of responsibility between the trustee and the manager.

Units of the MFT are offered to investors through subscription documents that incorporate representations, warranties, eligibility certifications and AML/KYC procedures. The offering materials may be a Private Placement Memorandum (PPM) or an Offering Memorandum (OM), depending on the exemption strategy. After each closing, the manager must file Form 45-106F1 within ten days on SEDAR+.

NI 81-106 ‘Investment Fund Continuous Disclosure’ applies primarily to investment funds that are reporting issuers and imposes requirements relating to financial statements, management reports of fund performance (MRFPs), valuation policies, and NAV calculation. Certain provisions of NI 81-106 may also apply to mutual funds that are not reporting issuers, subject to the scope of the Instrument and available exemptions. The applicability of NI 81-106 should therefore be assessed on a fund-by-fund basis. Where a registered investment fund manager (IFM) is involved, NI 31-103 applies independently and imposes its own obligations, including compliance systems, conflicts management, and valuation-related controls.

Redemption features are central to the trust structure. Units of an MFT are generally redeemable at the option of the unitholder, although private MFTs sometimes limit redemption frequency to manage liquidity.

Grey Areas and Regulator Focus

A significant grey area involves determining whether the MFT’s activities qualify it as an investment fund or an operating entity. Most MFTs will be investment funds because they hold passive investment portfolios. However, some strategies involve significant operational activity, such as real estate development or private lending with active loan origination. These activities may avoid classification as an investment fund, but also risk causing the MFT to carry on a business, which can jeopardize tax status and shift regulatory expectations.

Another area of regulatory focus is conflicts of interest. The Ontario Securities Commission (OSC) expects investment fund managers to implement conflict management procedures under NI 31-103, particularly where the sponsor or manager earns performance fees, participates in transactions with related parties, or controls the trustee. Related-party transactions require rigorous oversight and disclosure.

Valuation presents another grey area. MFTs with private assets, such as real estate or private credit instruments, face scrutiny regarding appraisal methodology, frequency of valuation and independence of valuators. NI 81-106, when applicable, requires consistent, transparent policies, and OSC compliance reviews often examine whether valuation practices align with industry standards.

Finally, investor disclosure and marketing practices are subject to close oversight. NI 31-103 and OSC Staff Notices emphasise the need for balanced, fair and accurate marketing materials, particularly where performance claims or forward-looking statements are made.

Illustrative Scenarios

Imagine a sponsor forming a fixed-income MFT to invest in publicly traded bonds. The trust provides weekly redemptions and calculates NAV weekly. Because the MFT holds passive portfolio securities and investors do not participate in day-to-day management, it would likely meet the Securities Act (Ontario) definition of an investment fund. If the MFT is a reporting issuer, NI 81-106 would apply and require annual audited financial statements and management reports of fund performance. If it is a mutual fund that is not a reporting issuer, certain provisions of NI 81-106 may still apply, subject to the scope of the Instrument and available exemptions. If the trust is not a mutual fund, NI 81-106 would generally not apply, although audited financial statements may still be required under NI 31-103 where a registered investment fund manager is involved and are commonly expected by institutional investors. The manager would generally be required to register as an investment fund manager (IFM) and portfolio manager (PM) under NI 31-103, and distribution under NI 45-106 would, for a private offering, typically be conducted through a registered exempt market dealer (EMD).

In a different scenario, a manager forms a private MFT to invest in residential properties through special-purpose subsidiaries. Although the trust undertakes some operational activity through its subsidiaries, the trust itself remains a passive investor. The manager must monitor the activities of the trust and its subsidiaries to ensure continued compliance with the requirements for MFT qualification and to avoid activities that could compromise the trust’s tax status.

A third scenario involves a cross-border MFT offered to both Canadian and US investors. Canadian investors subscribe under NI 45-106, while US investors subscribe under Rule 506(b) of Regulation D. The manager harmonises disclosure to meet both regimes and ensures that withholding tax and passive foreign investment company (PFIC) considerations are properly disclosed.

Compliance Checklist

Structure

• Structure the trust to satisfy section 132(6) and section 108(2) of the Income Tax Act (Canada) and the prescribed conditions in Regulation 4801 and analyze investment fund classification under Ontario securities law.
• Settle a declaration of trust addressing governance, unit rights, investment restrictions, valuation, distributions, conflicts, and redemption mechanics.
• Establish any subsidiaries in a manner that does not jeopardize MFT qualification.

Management

• Organize the manager and enter into a management agreement defining authority, compensation, standard of care, conflicts oversight, and termination.
• Complete NI 31-103 registration analysis for IFM, PM, and dealer categories, and allocate responsibilities between trustee and manager.

Offering

• Confirm availability of NI 45-106 prospectus exemptions.
• Prepare offering and subscription documents with disclosure of strategy, risks, fees, liquidity, conflicts, and tax considerations.
• Implement investor qualification, AML/KYC procedures, and file Form 45-106F1 as required.

Operations and Ongoing Compliance

• Implement NAV and valuation policies and financial reporting systems, including audited statements where required.
• Maintain NI 31-103 compliance systems, including conflicts and fair valuation policies.
• Monitor ongoing MFT qualification, subsidiary activities, redemption practices, and required securities filings and marketing compliance.

Conclusion and Next Steps

An MFT offers a flexible and tax-efficient structure for pooled investment strategies in Ontario. Its trust-based governance, redemption features and flow-through tax attributes make it suitable for a wide range of fund strategies, from traditional securities portfolios to alternative real-asset strategies. But these advantages require careful planning and ongoing compliance. Sponsors must navigate trust formation, NI 45-106 exemption strategies, NI 31-103 registration considerations and MFT qualification under the Income Tax Act (Canada). A well-structured MFT with disciplined governance and compliance can form the basis of a scalable investment platform capable of serving investors for many years.

Book a Consultation

If you are forming, restructuring, or operating a mutual fund trust (MFT) in Canada, contact us to schedule an initial consultation with Nick Wright.