5 April 2001 Internal T.I. 2000-0058107 - Performance Fee

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1. whether subsection 75(2) is applicable.

2. whether performance fees are deductible.

Position:

1. 75(2) would apply to any property transferred to the trust by the trustees as the conditions of the trust would dictate it's application.

2. Performace fees are charged by the manager of the mutual fund to the unitholder provided that certain conditions are met. This fee is not deductible by the unitholder under 20(1)(bb).

Reasons:

1.must ascertain how the units got into the trust...75(2) may apply to any income & gains earned on these units depending on how the trust acquired the units.

2.As the trust holds the units, the performance fee is not deductible at the trust level. It is neither advice on buying or selling a specific share or security by the taxpayer nor is it for the administration or the management of the shares or securities of the taxpayer, as the taxpayer here is the unitholder; in order to be deductible it would have to be paid by the fund and meet the parameters of 20(1)(bb).

			April 5, 2001

		Arun Khanna	Trusts Section
		Manager V & E	L. Holloway
		(Southern Ontario Region)	957-2104
		c/o Toronto West TSO

		Attention:  Navita Uppal
				2000-005810

Performance fee of XXXXXXXXXX

This is in reply to your e-mail of November 23, 2000, concerning the tax treatment a of "performance fee" charged by the manager of a mutual fund the units of which are held as an investment by an inter vivos trust. In particular, you described the scenario as follows:

"The trust is held in the name of the taxpayers' children (who are all under the age of 18). The trustees are the taxpayers i.e. the children's parents. The trust's property consists of shares held within an investment group. The trust is required to pay a performance fee on these shares only if the value of the shares increase. In XXXXXXXXXX the performance fee was approximately $XXXXXXXXXX. This performance fee was deducted as a carrying charge by the taxpayers on their T1 returns, not by the trust."

You asked if we concur with your opinion that these performance fees are deductible under paragraph 20(1)(bb) and whether this fee would be an expense of the trust.

Your second issue involves the application of the attribution rules to the trust and whether the income of the trust should be attributed back to the persons who contributed property to the trust. As the minor beneficiaries' parents are also the trustees, you were of the opinion that paragraph 3 of IT-369 may be applicable in that the trust property may be distributed to beneficiaries determined by the persons who initially contributed the property and also that the property may only be disposed of with the consent of the contributors during the contributors' lifetimes.

Our Comments

The trust was settled by XXXXXXXXXX. The trustees of the trust are XXXXXXXXXX (the "parents") and the trust was set up for the benefit of their children. XXXXXXXXXX the trust terms allow for full trustee discretion with respect to how much income or capital of the trust is paid out and to whom. We have noted that the pages of "XXXXXXXXXX" that were faxed to us are stamped "Draft", therefore you should ensure that the final version of the trust terms are identical to the one marked "Draft".

Subsection 75(2) will apply to attribute income to the transferor of a property if under the trust terms the property is held on any of the following conditions:

(a) that it may revert to the transferor;

(b) that it may pass to persons to be determined by the transferor at a time subsequent to the creation of the trust; or

(c) that it will not be disposed of during the lifetime of the transferor without his consent or direction.

XXXXXXXXXX the trust terms would clearly cause paragraph 75(2)(b) to apply with respect to any property transferred to the trust. Subsection 75(2) applies only to attribute income, losses, capital gains, or capital losses from a property (or substituted property) directly or indirectly received by the trust and held by it. Therefore if the property (or substituted property) does not produce any income, loss, capital gain, or capital loss, there would be no income to attribute under this provision. This is the rationale for setting up the trust with a non-income producing asset such as XXXXXXXXXX. Your e-mail did not outline how exactly the units of XXXXXXXXXX were acquired by the trust. If the XXXXXXXXXX were used as collateral to secure a loan from an independent third party (i.e. a financial institution), subsection 75(2) would not be applicable. If the units were acquired by the parents and then transferred to the trust, subsection 75(2) would apply. Alternatively, if the units were acquired with funds loaned to the trust by the parents (or by any other non-arm's length person) then section 74.3 could apply to attribute any income earned on the units and distributed to the minor beneficiaries.

If, on the other hand, the parents provided a guarantee on a loan provided by a financial institution to the trust, subsection 74.5(7) would apply. Subsection 74.5(7) provides that if an individual is obligated, either absolutely or contingently, to effect any undertaking including any guarantee, covenant or agreement given to ensure the repayment in whole or in part of a loan made by any person directly or indirectly to or for the benefit of a specified person (in this case the minor beneficiaries), the individual who provided the guarantee is deemed to have made the loan to the specified person and the attribution rules in sections 74.1, 74.2 and 74.4 would apply as if the loan were made by the guarantor. Therefore the circumstances under which the funds were obtained to enable the trust to acquire units of XXXXXXXXXX will determine which, if any, attribution rules apply.

The performance fee charged by the manager attaches to the units. That is, as a feature of unit ownership, the holder of the units is required to pay an annual performance fee equal to XXXXXXXXXX% of the amount by which the percentage increase in net asset value per unit exceeds a threshold annualized increase of XXXXXXXXXX%. In a year where a performance fee is payable, the manager would be entitled to receive from the unitholder XXXXXXXXXX% of the gains in net asset value of his or her units in excess of XXXXXXXXXX%. The payment of the performance fee to the manager is usually satisfied by the redemption of units (by the manager) on behalf of the investor/unitholder. Unlike the management fee, it is not a payment from the fund, XXXXXXXXXX, to the manager for services.

XXXXXXXXXX document we received from you shows the "XXXXXXXXXX" for the XXXXXXXXXX Children's Trust. The performance fee of $XXXXXXXXXX was indeed paid by the unitholder (the XXXXXXXXXX Children's Trust) via a redemption of units, therefore a disposition should be reported by the trust. Any gain resulting from the deduction of the trust's adjusted cost base from the proceeds of disposition (equal to the amount of the performance fee charged) must be reported. As the performance fee was not an expense of disposing of the units redeemed it cannot be deducted as an expense of this disposition.

IT-238R2, Fees paid to investment counsel, explains when a paragraph 20(1)(bb) deduction is allowed to a taxpayer for fees paid, other than commissions, for advice on buying or selling a specific share or security by the taxpayer or for the administration or the management of the shares or securities of the taxpayer. The fees must be paid to a person whose principal business is advising others whether to buy or sell specific shares or whose principal business includes the administration or management of shares or securities. Paragraph 4 goes on to state that fees that are not commissions but that otherwise meet the requirements of paragraph 20(1)(bb) are not disallowed solely by reason of the fact that they are determined or computed with reference to the fair market value of the portfolio at a particular time. In this case, while the fund manager's principal business is the administration of securities, the securities managed are those of the fund, not those of the unitholder (the XXXXXXXXXX Children's Trust) and as such the unitholder could not claim a 20(1)(bb) deduction since it is the fund's shares and securities that are being managed or administered.

When the units of the fund are held as capital property, the performance fee would not appear to be deductible under the general rules for computation of income under section 9 as such fees would be on capital account and thus restricted by paragraph 18(1)(b). However, if the units were held as trading property such fees would appear to be deductible.

The performance fee is not deductible by the parents. It was not paid by them and does not pertain to their property.

Should you have any questions concerning the above please contact Lena Holloway at 613-957-2104.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer.

Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at 819-994-2898. A copy will be sent to you for delivery to the client.

T. Murphy
Manager
Trusts Section
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch