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Citation: 2004TCC792
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Date: 20041217
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Docket: 2003-3554(GST)G
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BETWEEN:
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CANADA TRUSTCO MORTGAGE COMPANY,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Bowman, A.C.J.
[1] This appeal is from an assessment
of the Goods and Services Tax ("GST") made under the Excise
Tax Act ("E.T.A.") by the Minister of National Revenue
for the period from January 1, 1997 to
December 31, 1998.
[2] The issue is whether GST is
exigible in respect of a portion of the payments made to Canada
Trustco Mortgage Company ("CTM" or the "appellant") by three
trusts to which the appellant sold groups of residential
mortgages. The Minister of National Revenue assessed GST,
calculated in the manner set out below, on the basis that the
amounts subjected to tax were fees for servicing the mortgages
and were excluded from "financial service" as defined, because
they are management or administrative services provided to the
trusts whose principal activity was the investing of funds. The
appellant contends that no portion of the amounts are taxable and
a number of reasons are advanced.
[3] CTM carries on the business of
lending money on mortgages. It has to borrow money for that
purpose. The interest rate that it pays on the money that it
borrows depends, at least in part, on the type of assets that are
used to secure its borrowing. Therefore CTM enters into
transactions which are described as "asset-backed
securitization transactions". These transactions involve
transferring the more secure assets (such as residential
mortgages) into a separate entity (in this case a trust) and
having that entity raise money on the commercial paper market.
The relatively lower risk attached to such assets permits the
money to be borrowed at a lower interest rate than would have
been required had the commercial paper been issued directly by
CTM.
[4] The sale of the mortgages to the
trusts involved a transfer of the beneficial ownership which was
inextricably bound up with an agreement whereby CTM agreed to
service the mortgages. This included collecting and accounting
for payments made by the mortgages and dealing with defaults,
foreclosures and renewal of mortgages. It continued to bear an
economic risk of loss on the mortgages. CTM's servicing of the
mortgages was done on behalf of the trusts. To the mortgagor
nothing changed after the sale. The transfer was not registered
in the registry office and the mortgagor would, in the normal
course, have no reason to know of the existence of the
trusts.
[5] It is clear that CTM made a supply
of services to the trusts in conjunction with the sale of the
mortgages. That however is not the issue. The issues are:
1) Whether the principal activity of the trusts is the
investing of funds.
2) Whether the sale and servicing of the mortgages were two
elements of a single supply, or two distinct
supplies.
3) If the latter, whether the servicing of the mortgages was
incidental to
their sale and whether both supplies were sold to the trusts for
a single consideration as contemplated by section 138 of the
E.T.A.
4) Whether section 139 of the E.T.A. applies to
deem the supply of services to be exempt.
[6] I start the analysis with a brief
description of the statutory regime under which the case arises.
Subsection 165(1) of the E.T.A. imposes on the recipient
of a taxable supply a tax of 7 percent on the value of the
consideration for the supply. Supply is defined in
section 123 as the supply of a property or service. Taxable
supply is a supply made in the course of a commercial activity.
The definition of commercial activity excludes the making of
exempt supplies which are defined as supplies included in
Schedule V. Part VII of Schedule V, to the extent
relevant here, refers to a supply of a financial service.
Financial service is defined at length in subsection 123(1).
It is agreed by counsel for both parties that the sale of the
mortgages by CTM to the trusts as well as the servicing of the
mortgages would be the supply of financial services, subject only
to the respondent's position that under the definition in
subsection 123(1) financial service does not include
(q) the provision, to a corporation, partnership or
trust the principal activity of which is the investing of funds,
of
(i) a
management or administrative service, or
(ii) any
other service (other than a prescribed service),
where the supplier is a person who provides management or
administrative services to the corporation, partnership or
trust.[1]
[7] The appellant's position is that
the servicing of the mortgage does not fall within the exception
in paragraph (q). The appellant contends further that
even if it does the payment forms part of a single composite
consideration for an exempt supply. The appellant relies in
addition on section 138 of the E.T.A. which reads
Incidental supplies - For the purposes of this Part,
where
(a) a
particular property or service is supplied together with
any other
property or service for a single consideration, and
(b) it
may reasonably be regarded that the provision of the
other property or service is incidental to the provision of the
particular
property or service,
the other property or service shall be deemed to form part of
the particular property or service so supplied.
[8] In the further alternative the
appellant relies upon section 139
Financial services in mixed supply - For the purposes
of this Part, where
(a) one or
more financial services are supplied together with one or more
other services that are not financial services, or with
properties that are not capital properties of the supplier, for a
single consideration,
(b) the
financial services are related to the other services or the
properties, as the case may be,
(c) it is the
usual practice of the supplier to supply those or similar
services, or those or similar properties and services, together
in the ordinary course of the business of the supplier, and
(d) the total
of all amounts, each of which would be the consideration for a
financial service so supplied if that financial service had been
supplied separately, is greater than 50% of the total of all
amounts, each of which would be the consideration for a service
of property so supplied if that service or property had been
supplied separately,
the supply of each of the services and properties shall be
deemed to be a supply of a financial service.
[9] I have set out above a somewhat
abbreviated version of the facts for the purpose of stating the
issues. A more detailed exposition of the facts is contained in a
partial Agreed Statement of Facts ("ASF") which is attached as
Schedule A to these reasons. A large number of documents
were also put in evidence. They are essentially the documents
relating to the creation of SMART TRUST, PURE TRUST and MASTER
TRUST and the sale to them of the residential mortgages by CTM.
It is agreed that SMART TRUST is representative of the others. I
shall therefore refer only to the documents relating to that
trust.
[10] Two further preliminary points should
be mentioned:
(a) Paragraph 18 of the ASF refers to
pools of the National Housing Act insured
Mortgage-backed Securities. There is an issue in
paragraph 24 to 27 of the notice of appeal of the
pleadings on fees paid on the sale of pools of these mortgages to
the public. The respondent has agreed that the GST assessed in
respect of these fees should be deleted.
(b) In paragraph 23 of the ASF it is stated that
the appellant recorded as a "normal servicing fee" in its
financial statements for 1997, 125 basis points, as opposed
to 25 basis points. The Minister assessed GST on the basis of the
amount represented by the 125 basis points. It is accepted that
this was an error and that even if the respondent's position is
otherwise upheld an amount equal to the portion of the payment
represented by the additional 100 basis points will have to be
deleted from the amount upon which the GST was levied.
[11] I come then to the first question
that must be answered: Is paragraph (q) of the definition
of financial service in subsection 123(1) applicable? CTM
provides management or administrative services to a trust. Is
SMART TRUST a trust whose principal activity is the investing of
funds. ("... une fiducie dont l'activité principale
consiste à investir des fonds.") Counsel for the appellant
argues that SMART TRUST does not carry on its activities to earn
a profit and that it is implicit in the word "invest" that there
be a profit motive. Therefore its principal activity is not
investing funds but merely acting as a conduit for the purpose of
raising money for CTM or the other institutions that sell assets
to it in the course of similar forms of asset-backed
securitization transactions. It is merely a financing
vehicle.
[12] With respect, I am unable to
accept this proposition. Article Two of the Declaration of Trust
reads:
ARTICLE TWO
ACTIVITIES OF THE TRUST
Section 2.01 Activities of the Trust. The Trust will carry
on activities in order to produce income for the benefit of the
Beneficiary. The activities of the Trust will be the purchase,
acquisition, creation and administration of Asset Interests which
the Trust purchases or otherwise acquires or creates from time to
time for the purpose of producing income therefrom, which
purchase, acquisition or creation is to be funded through the
issuance of Notes from time to time pursuant to the terms of the
Trust Indenture, all in accordance with and subject to the terms
and conditions of the Programme Agreements, together with all
-such activities as may be reasonably incidental to the foregoing
or necessary in connection with the performance by the Trust of
its obligations under the Programme Agreements. The activities of
the Trust will be deemed to have been established on the date of
purchase, acquisition or creation of the first of the Asset
Interests by the Trust and not before that date. The Trust shall
not engage directly or indirectly in any activity other than the
activities described in this Section 2.01.
[13] The beneficiary referred to in
the article is United Way, a charitable organization. The purpose
as stated in the Declaration of Trust is to earn a profit, albeit
a small one, ($10,000) which is distributed to the beneficiary.
Everything else goes to CTM in accordance with the Master
Mortgage Sale Agreement.
[14] Quite apart from the statement in
Article Two of the trust purpose, I do not think that a profit
motive is necessarily an essential ingredient of investing.
Counsel referred to a number of dictionary definitions that
suggest that to invest implies the placement of money for profit
but not all standard dictionaries, either in English or in
French, support this view. In most cases investing is done for
the purpose of earning a profit, but where the word stands by
itself I do not think it is appropriate to add "with a view to
profit". Parliament is quite capable of spelling out the
requirement of a profit motive when it chooses to do so (for
example "with a reasonable expectation of profit", "for the
purpose of gaining or producing income"). I do not think it is
reasonable to suggest that an institution that borrows two and
one half billion dollars from the public and buys that amount in
mortgages or other securities yielding a greater return than the
interest it pays does not have as its principal activity the
"investing of funds".
[15] I turn then to the next issue.
Are the sale and servicing of the mortgages two elements of the
same supply or are these two distinct supplies? This question is
not the same as whether we are dealing with two separate supplies
where one is incidental to the other. The second question does
not arise in the context of this first issue although it is
relevant if we are required to consider the possible application
of section 138.
[16] There is a great deal of
jurisprudence on the question of single supply. I can do no
better than refer to the leading case decided by
Justice Rip, O.A. Brown Ltd. v. Canada,
[1995] G.S.T.C. 40. In that case the appellant bought livestock
for its customers, not as agent but on its own account. It
charged the customers disbursements and a clearing commission in
addition to the cost of livestock. The Minister assessed GST on
the commission and other disbursements.
[17] Justice Rip said at pages
40-5 to 40-7:
The GST
legislation is of recent vintage in Canada and Canadian courts
have not judicially considered what may constitute a single or
multiple supply for purpose of GST. The Value Added Tax
statute in the United Kingdom contains many provisions
similar to our GST. In the English cases the issue has been
defined as whether the supply in question comprises a compound
supply or a multiple supply. A compound supply is a supply where
there are a number of constituent elements which, if supplied
separately, some would have been taxed and some not. With respect
to these types of supplies, it is necessary to determine the
quality of the final compound supply for tax purposes regardless
of its constituent elements. A multiple supply has been defined
as a transaction involving the supply of a number of separable
goods or services. Each supply must be considered as an
independent supply for tax purposes, the single consideration
being apportioned among the separate supplies as appropriate.
In deciding
this issue, it is first necessary to decide what has been
supplied as consideration for the payment made. It is then
necessary to consider whether the overall supply comprises one or
more than one supply. The test to be distilled from the English
authorities is whether, in substance and reality, the alleged
separate supply is an integral part, integrant or component of
the overall supply. One must examine the true nature of the
transaction to determine the tax consequences. The test was set
out by the Value Added Tax Tribunal in the following fashion:
In our opinion, where the parties enter into a transaction
involving a supply by one to another, the tax (if any) chargeable
thereon falls to be determined by reference to the substance of
the transaction, but the substance of the transaction is to be
determined by reference to the real character of the arrangements
into which the parties have entered.
One factor to
be considered is whether or not the alleged separate supply can
be realistically omitted from the overall supply. This is not
conclusive but is a factor that assists in determining the
substance of the transaction. The position has been framed in the
following terms:
What should constitute a single supply of services as opposed to
two separate supplies, is not laid down in express terms by the
value added tax enactments. It would therefore be wrong to
attempt to propound a rigid and precise definition lacking
statutory authority. One must, it seems to us, merely apply the
statutory language, interpreting its terminology, so far as the
ordinary meaning of the words allows, with the aim of making the
statutory system of value added tax a practical workable system.
For this purpose one should look at the degree to which the
services alleged to constitute a single supply are
interconnected, the extent of their interdependence and
intertwining, whether each is an integral part or component of a
composite whole. Whether the services are rendered under a single
contract, or for a single undivided consideration, are matters to
be considered, but for the reasons given above are not
conclusive. Taking the nature, content and method of execution of
the services, and all the circumstances, into consideration
against the background of the value added tax system,
particularly its methods of accounting for and payment of tax, if
the services are found to be so interdependent and intertwined,
so much integral parts or mere components or items of a composite
whole, that they cannot sensibly be separated for value added tax
purposes into separate supplies of services, then Parliament, in
enacting the value added tax system, must be taken to have
intended that they should be treated as a single system,
otherwise, they should be regarded for value added tax purposes
as separate supplies.
The fact that a separate charge
is made for one constituent part of a compound supply does not
alter the tax consequences of that element. Whether the tax is
charged or not charged is governed by the nature of the supply.
In each case it is useful to consider whether it would be
possible to purchase each of the various elements separately and
still end up with a useful article or service. For if it is not
possible then it is a necessary conclusion that the supply is a
compound supply which cannot be split up for tax purposes.
This passage was approved by the Federal Court of Appeal in
HiddenValley Golf Resort Assn. v. The Queen, [2000]
G.S.T.C. 42.
[18] The approach taken by Rip J. in
O.A. Brown did not depend upon the application of the
specific provisions of sections 138 or 139. The premise upon
which the resolution in O.A. Brown is based is that a
distinction must be drawn between multiple supplies and a single
supply.
[19] The administrative position of the
Canada Revenue Agency is set out in a release dated
April 26, 2004, P-077R2 - Single and Multiple
Supplies. A portion of the release is reproduced below:
Issue
At issue is whether a transaction consisting of several
elements is a single supply or two or more supplies. This
distinction is important in cases where a combination of elements
is supplied, some of which would be taxable at 7% or 15%, and
some of which would be zero-rated or exempt from the GST/HST, if
supplied separately.
Decision
It is the Canada Revenue Agency's (CRA's) position that, for
GST/HST purposes, the determination of whether a transaction
consisting of several elements is to be regarded as a single
supply or multiple supplies is based on a determination of
fact.
The CRA will use the following principles to determine whether
a transaction consisting of several elements is to be regarded as
a single supply or multiple supplies.
1. Every supply should be regarded as distinct
and independent.
2. A supply that is a single supply from an
economic point of view should not be artificially split.
3. There is a single supply where one or more
elements constitute the supply and any remaining elements serve
only to enhance the supply.
Discussion
General Comments
The following text discusses how to apply the principles set
out above in order to determine whether a particular transaction
consists of a single supply or multiple supplies. However,
because of the variety of situations in both traditional and
electronic commerce in which such a determination must be made,
it is difficult to provide guidance covering every
eventuality.
Multiple supplies occur when one or more of the elements can
sensibly or realistically be broken out.
[20] For the principle in O.A. Brown
to apply there must be an inextricable interdependency between
the two elements so that they are integral parts of a composite
whole that cannot, as a matter of commercial reality, be sensibly
separated into separate supplies. Whether these criteria are met
depends upon a number of factual considerations and these will
vary from case to case. Here we have a sale of mortgages of which
the servicing is not only an integral part but is requisite as a
matter of commercial exigency. There is an intimate commercial
relationship between CTM and the trusts in which CTM not only
holds the registered title to the mortgages in trust for the
trusts, but also performs the very services which are essential
to the commercial viability of the trusts' investment. For
someone other than CTM to service the mortgages would, as a
practical matter, be commercially infeasible and would be
inimical to the raison d'être of the
transaction.
[21] In my opinion on the basis of the
foregoing we are dealing here with a single supply of the type
contemplated by O.A. Brown.
[22] This conclusion is sufficient to
dispose of the case. Nonetheless, out of respect for the
arguments of counsel, I shall deal with the alternative positions
advanced. It is apparent that at least for the purposes of this
case three categories of supply (or supplies) are contemplated by
the statute and the case law:
(a) Single supplies comprising two or more elements that are
"inextricably bound up with each other" and are "intertwined and
interdependent..." (the O.A. Brown principle).
(b) Incidental supplies of the type described in
section 138. The application of this section is premised on
there being two services or properties supplied for a single
consideration, one of which is incidental to the provision of the
other supply or service. I shall describe these supplies as the
dominant and the subservient supply.
(c) The category described in section 139 in which financial
services are mixed with non-financial services for a single
consideration. A number of conditions must be met for
section 139 to apply - the financial services must be
related to the other services, the supplier must supply those
services in the ordinary course of its business and the portion
of the consideration for the financial services must be over
50 percent of the total consideration.
[23] What will be apparent, I believe, is
that the line between these categories is not always easy to
draw. The three categories - single supplies with several
elements, multiple supplies where one is dominant and others are
subservient or incidental and mixed financial and
non-financial supplies - can merge rather easily into each
other with subtle shifts of emphasis.
[24] I shall therefore consider the possible
application of sections 138 and 139. One of the conditions
of section 138 is that there be a single consideration.
Another is that one supply be incidental to the other. The
consideration for the servicing in this case is not stated to be
a separate identifiable fee: it is stated to be part of, or an
adjustment to, the purchase price. Article Two of the Master
Mortgage Sale Agreement between SMART TRUST and CTM provides for
CTM to provide the trust with a purchase notice setting out
details of the mortgages that it proposes to sell to the trust.
Section 2.02 reads:
Acceptance of Mortgages. If the Trust agrees to the
terms and conditions set out in the Purchase Notice, it shall
signify its acceptance thereof by having the Administrative Agent
execute and return to the Seller such Purchase Notice at least
two Business Days before the proposed Closing Date referred to in
the Purchase Notice (or such lesser period as is agreed to by the
Trust and the Seller). If the Trust fails to accept such Purchase
Notice within such period it shall be deemed to have declined
such Purchase. Upon its acceptance of a Purchase Notice, but
subject to compliance by the Seller with the conditions precedent
set out in Sections 3.01(2) and (3), there shall exist a
binding agreement between the Trust and the Seller for the
purchase of the Mortgages set out therein for a purchase price
equal to the Closing Payment less the amount to be deposited by
the Seller pursuant to Section 3.01(3) plus the amounts payable
hereunder to the Seller on account of the Deferred Amount, in
each case in respect of such Purchase.
Section 5.01 of Article Five reads:
Purchases on a Serviced Basis. All sales of Purchased
Mortgages pursuant to the provisions of this Agreement shall be
on a serviced basis, meaning that the Trust shall have no
obligation to service the Purchased Mortgages or collect the
payments thereunder or to pay further compensation to the Seller
for its services in connection therewith as provided for
hereunder. The Seller acknowledges that the responsibility for
servicing the Purchased Mortgages is that of the Seller until the
Trust designates a Servicer pursuant to Section 8.03 and until
such time the Seller will carry out and fulfil such
responsibility by performing its obligations hereunder or by
appointing an agent acceptable to the Trust to perform such
obligations on its behalf. If the Seller should appoint an agent
to perform its obligations hereunder, the Seller shall remain
responsible for the performance by such agent of its obligations
hereunder and be liable to the Trust for any failure on the part
of such agent to perform such obligations.
Article Six reads in part:
Application of Mortgage Proceeds. (1) On each
Settlement Date, the Trust will apply out of all moneys deposited
into the Collections Account (i) on account of principal pursuant
to Sections 2.04, 4.02, 5.02(1)(a), 5.03(3), 7.03, 7.04,
7.06, 8.05 and 8.07; and (ii) pursuant to any draw made by the
Trust from the proceeds of issuance of Subordinated Notes, in
repayment of its current principal obligations under the Senior
Notes or the Liquidity Agreement, as the case may be, at such
time, an amount that would reduce the Program Amount to an amount
equal to the aggregate Net Book Value of all Purchased Mortgages
that are not Defaulted Mortgages on such Settlement Date.
(2) On each Settlement Date, the Trust will
apply the balance of the moneys so deposited into the Collections
Account,
(a) first, at the option of the
Trust, in payment to any holder of an Adverse Claim referred to
in Section 5.03(2) to the extent that the Seller has been
deemed to have received a Collection pursuant thereto but has not
made the payment required pursuant to Section 5.03(3);
(b) second, in reimbursement of any
amount paid by the Seller pursuant to Section 5.04;
(c) third, in payment of the
funding obligations of the Trust incurred by it during the period
commencing, in respect of the first Settlement Date, on the
related Closing Date and, in respect of each succeeding
Settlement Date, on the day following the immediately preceding
Settlement Date and ending in each case on such Settlement Date
under the Senior Notes and the Liquidity Agreement, as the case
may be, in respect of the Program Amount on the immediately
preceding Settlement Date and any hedging transaction (other than
the Swap Transaction) entered into by the Trust in connection
therewith, and under the Subordinated Notes;
(d) fourth, in payment of any
Settlement Amount (as defined in any agreement evidencing a Swap
Transaction) payable to the Trust in respect of the immediately
preceding Settlement Period;
(e) fifth, in payment of any
Servicer Fees in respect of the immediately preceding Settlement
Period;
(f) sixth, in satisfaction of
the aggregate Program Fee payable to the Trust in respect of the
period commencing, in respect of the first Settlement Date, on
the related Closing date and, in respect of each succeeding
Settlement Date, on the day following the immediately preceding
Settlement Date and ending in each case on such Settlement Date;
and
(g) seventh, in repayment of any
amounts drawn by the Trust from the proceeds of issuance of the
Subordinated Notes which remain unpaid at such time.
(3) The balance of the amounts held in
the Collections Account after the applications of
Section 6.01(2) shall be paid to the Seller by deposit into
the Deferred Purchase Account as an adjustment to the purchase
price of the Purchased Mortgages. The Trust will, on behalf of
the Seller, apply such amounts on each Settlement Date,
(a) first, by retention in the
Deferred Purchase Account (and investment thereof in investments
permitted by the Issuer Trustee with the return thereon to be
maintained therein) of an amount equal to the aggregate Required
DPA Amount at such time;
(b) second, in payment of any
amount due from the Seller hereunder, as an adjustment to the
purchase price of the Purchased Mortgages; and
(c) last, subject to
Section 6.01(4), by payment of the balance thereof to the
Seller on account of the Deferred Amounts by wire transfer or as
otherwise agreed by the parties.
[25] The passages quoted above represent the
agreement between the parties and, in the absence of evidence
that the agreement is different, establish conclusively that the
consideration for the sale of the mortgages and the servicing of
the mortgages was a single consideration.
[26] The respondent however argues that an
entry in the financial statements of CTM establishes that there
was a separate consideration equal to 25 basis points on the face
amount of the mortgages. The following note appears in the
financial statements of CTM for 1997 and 1998:
(f) Securitizations
Where groups of loans are sold to special purpose entities
under terms which transfer the significant risks and rewards of
ownership to third parties, the transaction is recognized as a
sale and the related loan assets are removed from the balance
sheet. Gains on these sales are recorded as other income in the
statement of earnings only when funds have been received and
there is no recourse to the funds. Fees earned for servicing the
portfolio of loans are recorded as fees in the statement of
earnings as they are earned.
[27] The Minister's reliance upon the
financial statements of CTM is evident from two letters sent to
the appellant by officials of the CRA.
Mr. E.H. Gauthier, Deputy Assistant Commissioner wrote
on July 2, 2002:
The CCRA
agrees that an indicator of a single consideration is whether
there is a separately identifiable charge for the
non-exempt supply. However, the CCRA does not agree that
only the agreement between the parties determines whether there
is a separate charge made. The CCRA examines all of the relevant
information including the books and records of a registrant to
determine the tax status of a transaction. Your own financial
statements, "The Summary of Significant Accounting Policies
(Note 1. to the Financial Statements)" states:
"Fees earned for servicing the portfolio of loans are recorded
in the statement of earnings as they are earned." This
indicates that an actual, separate fee, and not just a notional
one, is being charged for the mortgage servicing aspect
notwithstanding that the agreement may not be clear on this
issue. For this reason section 139 is not available to
exempt the supply of mortgage servicing.
Similarly, Mr. Drew Burrell wrote on February 29,
2000:
The fact that the Master Mortgage Sale Agreement does not
specify the consideration for the supply of servicing the
mortgages is not an indication that the supply of servicing was
in fact for nil consideration or for a single consideration that
is part of the consideration for the sale of the mortgages. CTM's
financial statements recognize the servicing fees as material
based on standards set by OSFI and section 3860 of the CICA
handbook. The notes attached to the financial statements indicate
"normal servicing fees are recognized as other income in the
statement of earnings when collected". Amounts recognized as
mortgage-backed security administration fees recorded in
general ledger account 3150 are based on the cash flow from the
interest spread as determined under the provisions of the
agreement.
[28] There is in my view no basis for the
respondent to assume that a note in the financial statements of a
party to a transaction who is not even the person primarily
liable for the GST can override the intentions of both parties as
evidenced in the agreement between them. The 25 basis points were
based, according to the evidence, on guidelines issued by the
Office of the Superintendent of Financial Institutions ("OSFI")
with respect to NHA-insured mortgage-backed securities. It
is clearly not based on any agreement between CTM and the trust.
There is no evidence that the trust or its administrator (CIBC
World Markets) even knew of the 25 basis points being recorded in
CTM's accounts.
[29] It has often been observed that
accounting entries do not create reality, but they should reflect
it. The notes to the financial statements and the recording of an
amount in account 3150 of the books of CTM neither create nor
reflect reality. The substance of the transaction is contained in
the agreement between the parties.
[30] It should be observed that the 25 basis
points on which the Minister is levying GST is itself only a very
small portion of the difference between the net book value of the
mortgages sold to the trust and the amount ultimately received by
CTM, which is normally called the "excess spread". This is
defined in the report of the expert accounting witness, Loraine
D. McIntosh:
What is Securitization?
In its simplest form, securitization is a method of funding
"receivables" (including but not limited to mortgage and other
loans, leases, credit card balances, and trade receivables)
through the issuance of tradeable securities backed by those
receivables. In a typical transaction, an enterprise such as
Canada Trust Mortgage Corporation (i.e. - the "Seller") would
pool and sell a group of mortgage loans or other assets to a
single seller or multi-seller securitization conduit
(typically a Trust or other form of special purpose vehicle)
which in turn issues securities to investors to finance the
purchase. Sellers enter into these types of transactions for many
reasons, including increased liquidity, regulatory capital
relief, lower cost of funding, funding diversification, and
improved balance sheet metrics.
Securitization transactions take on many different forms -
from an outright sale of the receivables with no continuing
involvement by the Seller to transactions where the Seller
retains the right and / or obligation to reacquire the
receivables at some future date (i.e. - securities repurchase
agreements or "repos"). Most transactions, however, fall
somewhere in between these two extremes. In most cases the Seller
has some continuing involvement with the transferred pool of
receivables, both through the provision of credit enhancement,
liquidity support or limited recourse protection to the
securitization conduit and through the retention of ongoing
servicing responsibilities with respect to the transferred pool.
Credit enhancement or recourse is provided through a variety of
means, including cash reserves, deferred purchase price amounts,
holdbacks, or overcollateralization. The credit enhancement
provided by the Seller typically enables the conduit to issue
securities with a higher credit rating, thereby lowering the
overall cost of funds for the Seller. Transactions in Canada are
also almost exclusively structured such that the assets are sold
on a fully serviced basis, without any specific servicing
compensation to the Seller.
The Seller is generally entitled to receive any "excess
spread" generated by the transferred pool. For purposes of these
transactions, "excess spread" is defined as the difference
between the yield on the transferred assets and the
securitization conduit's cost of funds, including hedging costs
less (i) any losses due to obligor default, (ii) program fees,
and (iii) other conduit expenses / distribution requirements
(including liquidity fees, third party credit enhancement fees,
trustee fees, rating agency fees, etc). Although not specified in
the legal agreements, this entitlement to "excess spread" is in
substance viewed as compensation to the Seller in exchange for
providing credit enhancement and / or liquidity support and for
servicing the portfolio.
[31] The Minister appears to accept that the
excess spread is exempt from GST except for the small portion
that is represented by the 25 basis points.
[32] In my view there is a single
consideration and even if it could be said that there are two
supplies the supply of the servicing is clearly incidental to the
sale. Therefore, section 138 would be applicable.
[33] If section 138 were not
applicable, section 139 would apply. Even if the
O.A. Brown principle did not apply, it would need as
a minimum to be accepted that financial services are supplied
with one or more non-financial services for a single
consideration and the services are related. The consideration for
the financial services, (the sale of the mortgages) if they were
supplied separately, is obviously greater than 50 percent of
the total. Certainly it is in the ordinary course of CTM's
business to supply such services.
[34] A question of interpretation arises in
section 139. It is whether the words in paragraph (c) "...
those or similar services" refer to the financial services or the
non-financial services, or both, as mentioned in paragraph (a).
The French version incorporates the English paragraph (a) into
the preamble and (b) uses the expression "ces services ou des
services semblables". Clearly the condition is met if both types
of services are supplied in the ordinary course of the supplier's
business. The scale upon which CTM engages in these
asset-backed securitization transactions and their
frequency brings this activity within its ordinary course of
business. Whether the condition in section 139 is met if
only financial services or only related non-financial services
are performed by the supplier in the course of its business is a
question best left to another day.
[35] Any one of the following three
hypotheses would justify the exemption of the amount on which GST
was levied.
(a) The sale of the mortgages to
the trust and the servicing of those mortgages are two integral
components of a single supply. The O.A. Brown
principle is in my view applicable and determinative.
(b) Even if the servicing of the
mortgages is a separate supply it is incidental to the sale and
both were provided for a single consideration. Therefore the
servicing is deemed to form part of the supply of the mortgages
under section 138.
(c) Even if the servicing of the
mortgages is not a financial service it is provided with the
supply of the mortgages and they are supplied for a single
consideration. The supply of the mortgages and the supply of the
services are related. The supply of those services is made in the
ordinary course of CTM's business. If it were possible to supply
the financial services separately (the sale of the mortgages) the
consideration for them is much greater than 50 percent.
Indeed, even if we were to separate the sale of the mortgages at
their net book value from the excess spread and treat the excess
spread as consideration for a separate supply, it is obvious that
the 25 basis points forms a very small portion of the excess
spread which the Minister has treated as exempt.
[36] If I had to choose between the three
hypotheses I think that the closest fit is the O.A. Brown
principle, although any of the three hypotheses that I have set
out above could apply to render exempt the amounts on which GST
was levied.
[37] The appeal from the assessment made
under the E.T.A. is allowed with costs and the assessment
is referred back to the Minister of National Revenue for
reconsideration and reassessment on the basis that the portion of
the amounts paid by the trusts referred to in the Agreed
Statement of Facts on which the Minister has assessed goods and
services tax forms part of the consideration paid for exempt
financial services, and also on the basis of the concession made
by the respondent at trial with respect to the NHA insured
Mortgage-backed Securities.
Signed at Ottawa, Canada, this 17th day of December
2004.
Bowman, A.C.J.
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