1 July 1996 GST/HST Interpretation 11595-2[2] - Tax Status of Supplies of Distribution and Administrative Services to Certain Mutual Funds

This is in reply to your request for our views with respect to the tax status of supplies of distribution and administrative services made by the above-noted registrant to certain mutual funds.

Statement of Facts

1. XXXXX (the "Trust") was established by its trustee, XXXXX as the "issuer trustee", for (among other things) the purpose of arranging for the distribution of mutual fund units through registered dealers and brokers and performing certain administrative duties in connection with the mutual funds (the "Funds").

2. The Funds are managed by XXXXX[.]

3. Under a Distribution and Administration Agreement dated February 23, 1994, between the Trust, the Funds, XXXXX and XXXXX the Trust agrees to perform the following:

•   arrange for the distribution of redemption fee securities (the "securities") solely through registered dealers and brokers approved by the Funds; redemption fee securities are securities of a fund which may be acquired without payment of a sales charge at the time of purchase but in respect of which a deferred redemption fee may be payable if they are redeemed before a specified time period;

•   pay the selling commission in respect of redemption fee securities which are issued and for which full payment is received; XXXXX of the fee is to be paid to the registered dealers and brokers and XXXXX of the fee is to be paid to XXXXX for payment of its sales and promotional expenses;

•   provide or cause to be provided the following administrative services:

•   establish and maintain a register to record the names and addresses of the holders of the securities;

•   establish practice and procedures for and approval of the transfers of the securities and register such transfers;

•   approve the form of certificates representing the securities from time to time;

•   establish practices and procedures relating to the issuance of certificates representing the securities, arrange for the issuance of certificates and issue replacement certificates when necessary;

•   prescribe the form, manner and minimum amount for the subscription of the securities;

•   accept or reject subscriptions for the securities in whole or in part in its discretion and, upon acceptance of a subscription, issue to the subscriber the securities and, upon rejection of a subscription, make a prompt refund to the subscriber;

•   prescribe the form and manner of redemption requests requiring a Fund to redeem all or any part of the securities held by a security holder;

•   accept and process redemption requests from security holders;

•   accept notices in writing from holder of the securities who assert their right to receive distributions of income and capital gains in cash;

•   credit, pay and otherwise process the distribution of income and capital gains to holders of the securities on the record date for such distributions;

•   annually distribute to security holders such information which may be required by securities regulation and policy and such information regarding the Funds which the Trust and XXXXX consider desirable.

4. Administrative services not specifically included in the agreement are not the responsibility of the Trust but are done by XXXXX[.]

5. The Trust is compensated as follows:

•   in the case of each trustee fund XXXXX, an annual rate of XXXXX % of the net asset value of the securities;

•   in the case of XXXXX and the XXXXX XXXXX an annual rate of XXXXX % XXXXX respectively of the net asset value of the securities;

•   in the case of all funds, all the deferred redemption fees payable on redemption of the securities of such fund.

6. For the purposes of calculating the GST payable for the services provided, the parties have agreed that a reasonable allocation of the above fees is XXXXX % for the administrative services provided and XXXXX % for the distribution services provided. The parties have agreed to renegotiate the allocation each year.

7. Each Fund XXXXX ) is responsible for and pays out of the assets of each Fund, in addition to the above fees, all expenses incurred by or on behalf of the Fund relating to the operation of the Fund and the carrying on of its business, e.g. administrative costs, registry and transfer agency services, legal fees, dividend and distribution crediting services.

8. Under a Trust Administration Agreement and Interim Sub-Administration Agreement, both dated January 21, 1994, the Trust has appointed XXXXX as its agent with respect to the performance of all of its administrative duties as set out above.

9. XXXXX as administrative agent, is entitled to reimbursement for all expenses incurred on behalf of the Trust and is paid such fees in connection with its activities and services as may be agreed to by the Trust and itself from time to time.

Audit's Position

GST should be charged on the administrative and distribution services since the Trust provides the same service as the fund manager. The fees paid to the Trust are in lieu of what would be paid to the fund manager had the fund manager provided those services.

Registrant's Position

The distribution fees are exempt since the services provided should be considered independently. The agreements and invoices provide for separate identification of administrative and distribution services, therefore section 139 may apply.

Questions

1. What is the tax status of distribution and redemption revenue?

2. Does the proposed amendment of December 7, 1994 to paragraph (q) of the definition of "financial service" in subsection 123(1) have any impact?

Our Position

Generally, a mutual fund manager provides one single combined supply of management, administration and distribution services to a mutual fund for a single fee, i.e., the services are not provided separately.

In this particular case, the Trust has a XXXXX offering of asset-backed notes which appear to provide the pool of funds that allows the Trust to pay sales commissions to its offering agents on sales of Redemption Fee Securities. In addition, the Trust's appointment as distributor is restricted only to Redemption Fee Securities and is not a general distribution mandate. Section 2.2 of the Distribution and Administration Agreement provides that the appointment as distributor is only for the period from February 1994 to September 30, 1994.

The combination of the above facts appears to lead to the conclusion that there has been a specific issue of Redemption Fee XXXXX Securities, with respect to which the Trust has undertaken specific distribution functions for a specified period. Under these circumstances, it appears that the distribution function constitutes a supply of services that is separate from the provision of management and administration services on an ongoing basis.

Assuming that the foregoing is correct, (it is suggested that this be confirmed by obtaining additional information about the Trust's offering of asset backed notes and whether in fact there was a specific offering of Redemption Fee Securities of the various funds), it is our view that, prior to December 8, 1994, the distribution service supplied by the Trust to the Funds is exempt under paragraph (l) of the definition of "financial service" under subsection 123(1), i.e., "... the arranging for, a service referred to in any of paragraphs (a) to (i),".

Paragraph (q) of the same definition, as it read prior to the proposed amendment, excludes from the definition of "financial service" only management or administrative services supplied by the person to the mutual fund trust. As a result, the administrative services supplied by the Trust are taxable. The distribution services remain exempt to the extent that they are not management or administrative services and have been separated from the administrative services that do not form part of the distribution services. It is a question of fact whether the allocation between the distribution services and the administration services is reasonable, i.e., whether XXXXX for distribution services and XXXXX for administrative services reflects the fair market value of the respective services.

The proposed amendment to paragraph (q) excludes from the definition of "financial service" all services supplied by the person to the mutual fund where the person also supplies management or administrative services to the fund. On April 23, 1996, the Minister of Finance tabled a Notice of Ways and Means Motion proposing changes to the Excise Tax Act. The Ways and Means Motion reintroduces this previously announced amendment and provides that revised paragraph (q) comes into force on December 17, 1990 except where the supplier did not, on or before December 7, 1994 charge or collect tax. In this particular case, tax was not charged so existing paragraph (q) applies on or before December 7, 1994. However, under the proposed paragraph (q), after December 7, 1994, the distribution services supplied by the Trust to the Funds are taxable, notwithstanding that they are supplied separately and for a separate consideration, since the Trust also supplies administrative services to the Funds.

The Trust should be encouraged to voluntarily comply with the proposed legislative amendment as of its effective date, i.e., December 8, 1994. It should be made aware that if it does not voluntarily comply then there may be retroactive consequences when the legislation is passed, i.e., once Parliament enacts a retroactive amendment, the Excise Tax Act requires the Department to calculate interest retroactively on any resulting amount that is payable or remittable by a person. However, penalty will apply only from the date Parliament enacts the amendment.

With respect to the services supplied by XXXXX to the Trust under the Trust Administration Agreement and the Interim Sub-Administration Agreement, the relationship between the Trust and XXXXX should be reviewed to see if they are dealing at arm's length and whether tax is being collected by XXXXX on fees charged by it that may be taxable.

The agreements do not specify the consideration for the services supplied. The Trust Administration Agreement states that XXXXX "... shall be entitled to reimbursement for all expenses incurred on behalf of the Trust in accordance with the Distribution and Administration Agreements and shall be paid such fees in connection with its activities and services as may be agreed to by the Trust and the Administrative Agent from time to time". XXXXX agrees under the Interim Sub-Administration Agreement to supply its services to the Trust, "... in consideration of the sum of XXXXX now paid by the Trust to XXXXX and for other valuable consideration, the receipt and sufficiency of which XXXXX hereby acknowledges ...".

With respect to the issue of section 139, since the consideration for the financial service is less than 50%, this section does not apply.

If you have any questions, please contact P. Roach at (613) 952-9214 or R. Osudar at (613) 952-9220.

Yours truly,

J. Sitka
A/Director
Financial Institutions/
Corporate Reorganizations
GST Rulings and Interpretations