Please note that the following document, although correct at the time of issue, may not represent the current position of the Canada Revenue Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence du revenu du Canada.
Excise and GST/HST Rulings Directorate
Place de Ville, Tower A, 11th floor
320 Queen Street
Ottawa ON K1A 0L5
[Addressee]
Case Number: 217144
Dear [Client]:
Subject: GST/HST INTERPRETATION
Trailing Commissions in the Mutual Fund Industry
Thank you for your letter of [mm/dd/yyyy], concerning the application of the goods and services tax/harmonized sales tax (GST/HST) to fees charged by a mutual fund manager (the manager) to a mutual fund (the fund) as well as amounts paid as trailing commissions by a manager to a mutual fund dealer (the dealer).
The HST applies in the participating provinces at the following rates: 13% in Ontario; and 15% in New Brunswick, Newfoundland and Labrador, Nova Scotia and Prince Edward Island. The GST applies in the rest of Canada at the rate of 5%.
All legislative references are to the Excise Tax Act (ETA) unless otherwise specified.
[…] .
In support of your request, you have provided the following documents:
1. A partial copy of an RSP statement […] for the [monthly] period [mm/dd/yyyy] to [mm/dd/yyyy], [yyyy] from […] (the Dealer) and a copy of a […][yearly fee statement] for the period [mm/dd/yyyy] to [mm/dd/yyyy]. The RSP statement shows that the account holds a no-load […] mutual fund that is an I-Series fund which, you say, is also known as A-Series. The […][yearly fee statement] shows that the Dealer received trailing commissions from other parties of $[…]. It states that trailing commissions are paid by […] ([…] a mutual fund company) to the Dealer for the delivery of services you receive. It states that trailing commissions may vary based on the specific investment that the investor has purchased and is not charged directly to the investor, however the commissions reduce the amount of the investment’s return.
2. A partial copy of an RSP statement […] for the [same monthly period of the subsequent year][…] from the Dealer for the same self-directed account referenced in #1 and a copy of the […][yearly fee statement for the subsequent year] for the period [mm/dd/yyyy] to [mm/dd/yyyy]. The RSP statement shows that the no-load […] fund has been converted to a D-Series fund. The […][yearly fee statement] shows the following fees:
a. Operating charges of $[…] plus taxes of $[..]; and
b. Trailing commissions of $[…].
3. A partial copy of an RSP statement […] for […][a monthly period approximately two years after the date mentioned in fact #1] from the Dealer for the same account as in #1 and #2 that shows the account still holds the no-load […] D-Series fund.
4. […][Additional documents from the Dealer including]:
a. a welcome letter from […] Funds addressed to […];
b. the Dealer questionnaire;
c. a Mutual Funds distribution Acknowledgement;
d. a F-Series Distribution Agreement; and
e. a summary of various other agreements.
5. […].
In your request, you have provided the following information:
- […]
- The funds are trusts and have declarations of trust (the DOTs) with their trustees. Managers are usually trustees as well and are subject to the DOT. Under securities law, managers are required to act in the best interests of the trust and not in their own best interests.
- Managers remove amounts from the trusts, on a periodic basis, sufficient to pay dealers trailing commissions. They also remit GST/HST derived from the assets of the trusts to pay the Canada Revenue Agency (the CRA) calculated on the amount of the trailing commissions paid to dealers and the GST/HST remitted is an expense of the trust, not of the manager or trustees.
- […]. GST/HST Technical Information B-105 Changes to the Definition of Financial Service (TIB-105), which incorporates Notice 250 states, in Example 4, that:
- It would be a question of fact as to whether the services provided in any particular case are considered to be a single supply that is made only in consideration of the commission on the purchase of the units or a combination of the commission on the purchase and the trailing commission. The facts and circumstances of each transaction would have to be considered on their own merits.
[…]
- You have referenced the various […] simplified prospectuses that deal with trailing commissions, […]
- The copies of RSP statements that you have provided show that a higher trailing commission is paid by the mutual fund for the I-Series fund ($[…]) and is lower for the same mutual fund but held as a D-Series fund ($[…]).
We further note additional information from the following publicly available documents:
- […] (Management Agreement) between […] (a mutual fund corporation) and the Manager, dated [mm/dd], 2021; and
- Simplified Prospectus for the funds, dated [mm/dd], 2020.
The Management Agreement states that the mutual fund corporation wishes to appoint the Manager as the manager of the funds and the Manager is willing to promote each fund. […] of the Management Agreement sets out that the Manager agrees to act as manager and administrator of each fund and has been delegated all of the business and affairs of each fund. The Manager is appointed to distribute the shares of the fund under […] of the Management Agreement and may make all necessary arrangements for the sale and redemption of the shares of the funds. The Manager may make arrangement for the distribution of the shares by appointing distributors. In consideration for the management services provided under the Management Agreement, the Manager receives a management fee from each fund in accordance with […] of the Management Agreement as set out in the relevant prospectus.
The simplified prospectus describes the management fees paid to the Manager in consideration of providing, or arranging for the provision of, management, distribution, and portfolio management services and oversight of any portfolio sub-advisory services provided to the funds One of the services listed is the payment of annual trailing commissions to the dealer, including where the dealer is a discount broker, in connection with the distribution of the shares of the funds. The prospectus further states that the Manager may pay an annual […] commission to dealers, including discount brokers. Dealers generally pay a portion of this commission to financial advisors “for the services they provide to their clients” and […]commissions are paid out of the management fee.
RULING REQUESTED
You have requested a ruling as to whether GST/HST is payable on trailing commissions that are paid by a fund with respect to amounts collected by a manager. You also wish to know if […], as an investor, is entitled to a refund of the GST/HST equal to the amount paid by the funds held […].
INTERPRETATION GIVEN
As set out in GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service (Memo 1.4), a GST/HST ruling sets out the Canada Revenue Agency’s (CRA’s) position on how the relevant provisions of the ETA apply to a clearly defined fact situation of the taxpayer and a ruling applies only to the taxpayer or on whose behalf it is requested. […][As an investor] is neither a supplier nor a recipient with respect to the supplies that give rise to trailing commissions. Accordingly, […] is not considered the taxpayer with respect to the supplies for which you seek a ruling. We are unable to provide you with a ruling under the circumstances. However, we are pleased to provide an interpretation that we hope will address your concerns.
A supply is taxable at the full rate of GST/HST unless it is otherwise zero-rated or exempt under the provisions of the ETA. Supplies of financial services are exempt in accordance with section 1 of Part VII of Schedule V to the ETA unless otherwise zero-rated. There is a definition of a financial service in subsection 123(1) of the ETA. If a service falls within the financial service definition, GST/HST will not apply. If a service does not fall within the financial services definition, it will be taxed at the full rate of GST/HST unless otherwise exempt or zero-rated under another provision of the ETA.
The construct of the financial service definition in subsection 123(1) addresses a supply where the essential character of that supply falls within any of paragraphs (a) to (m) of the definition but does not fall within any of paragraphs (n) to (t) of the definition.
As you have written, a mutual fund will normally have an agreement (“management agreement”) with a manager for the provision of management and administrative services which will include management of the fund’s assets and the distribution of the fund’s units. The agreement will set out the basis for the manager earning its fees from the fund.
In fulfilling these duties, the manager, in its capacity as manager of the fund, would then enter into an agreement with a mutual fund dealer (the dealer) for the distribution of the fund’s units. Under the agreement, a trailing commission (or otherwise referred to as a trail(er) fee or a trailer commission) is, typically, an amount that is required to be paid by the manager to the dealer on a periodic basis. The trailing commission would be in addition to any upfront sales commission that is payable by the manager to the dealer. A manager may also have an agreement with a dealer where the dealer is responsible for the distribution of units of the fund using a network of agents that enter into agreements for their services directly with the dealer (rather than the manager).
The consideration charged by the manager to the fund is reflected in the Management Expense Ratio (MER) which takes into account the management fee and other cost recoveries including any applicable trailing commissions. In the circumstances outlined above, for GST/HST purposes, the manager makes a supply to the fund and the consideration for the supply is reflected in the calculation of the MER.
In considering the GST/HST treatment, it is necessary to address each of the following supplies:
- Supplies of services made by the manager to the fund; and
- Supplies of services made by the dealer to the manager.
Supplies of services made by the manager to the fund
Paragraph (q) of the financial services definition specifically excludes the following from the financial service definition:
The provision, to an investment plan (as defined in subsection 149(5)) or any corporation, partnership or trust whose principal activity is the investing of funds, of
(i) a management or administrative service, or
(ii) any other service (other than a prescribed service).
The prescribed services for purposes of subsection (q) are set out in the Financial Services and Financial Institutions (GST/HST) Regulations as follows:
- the issuance of a financial instrument by, or the transfer of ownership of a financial instrument from, the supplier to the person;
- the operation or maintenance of a savings, chequing, deposit, loan, charge or other account that the person has with the supplier; and
- if the person is a trust governed by a self-directed registered disability savings plan, a self-directed registered education savings plan, a self-directed registered retirement income fund, a self-directed registered retirement savings plan or a self-directed TFSA, the arranging for the issuance, renewal, variation or transfer of ownership of a financial instrument for the person.
None of these prescribed services would typically be applicable with regards to supplies of the services from the manager to the fund under the management agreement.
A mutual fund trust or corporation would ordinarily meet the definition of an investment plan as defined in subsection 149(5). Paragraph (q) also applies to a corporation, partnership or trust whose principal activity is the investing of funds. As a result of exclusionary paragraph (q) of the definition of financial service, all of the services supplied by a manager to a fund under a management agreement are considered to be taxable services and not exempt financial services. This is the case even where certain services supplied by the manager to the fund may be exempt financial services. In these circumstances, the manager is still required to collect GST/HST from the fund even where a part of the manager’s duties is to pay exempt commissions to dealers.
Supplies of services made by the dealer to the manager
The provision of services by a dealer to the manager will be exempt for GST/HST purposes to the extent that they meet the financial service definition in the ETA. Arranging for the sale of shares or units in a mutual fund is an exempt supply of a financial service in accordance with paragraphs (l) and (d) of that definition.
A dealer may receive an upfront payment in accordance with an agreement for the dealer to distribute shares or units in a mutual fund. This commission is consideration for the supply of arranging for the sale of mutual fund units or shares and is a financial service. GST/HST would not apply to the upfront sales commission paid by the manager to the dealer. Generally, where, under the distribution agreement between the dealer and manager, the dealer is also entitled to receive a trailing commission, this amount will usually be additional consideration for the supply of the financial service of arranging for the sale of shares or units. This is on the basis that the trailing commission is not consideration for a separate supply from the dealer to the manager. In these circumstances, GST/HST would not apply to the payment of the trailing commission by the manager to the dealer.
However, there may be some exceptional circumstances where payments received by the dealer from the manager are not consideration for the supply of arranging for the sale of shares or units in the fund. One example is where the dealer is not the same person that arranged for the initial sale of the mutual fund unit. Another case could be where the trailing commission is specifically linked in the agreement between the dealer and the manager to the provision of specific services and it could be determined that these services constitute a separate supply from the supply of arranging for the sale of shares or units. In these exceptional cases, the payments may be consideration for a separate supply and may therefore have a different GST/HST treatment.
This treatment was addressed in Notice 250 and TIB-105 as referenced in your request. However, these publications address the treatment applied to the supplies made by the dealer to the manager and do not address the treatment applied to the supplies made by the manager to the fund.
Summary
Where the manager has the responsibility for the distribution of the shares or units, this would be considered part of the manager’s duties and responsibilities under the management agreement between the manager and the fund. The provision of the distribution service by the manager to the fund is subject to GST/HST in accordance with paragraph (q) of the financial service definition. This is the case even if the supply of the services from the dealer to the manager that give rise to trailing commissions are GST/HST exempt financial services.
Entitlement to a Refund/Rebate
There is no provision within the ETA whereby an investor, like […], would be entitled to claim a refund/rebate of GST/HST in such circumstances because the investor has not paid an amount as or on account of tax. In these circumstances, it is the fund rather than the investor that has paid an amount as or on account of tax. Furthermore, based on the above, even where there is an exempt supply of a service from a dealer to a manager, the tax was correctly applicable on the supply from the manager to the fund and would not give rise to a refund/rebate for the fund.
[…]
In accordance with the qualifications and guidelines set out in Memo 1.4, the interpretation(s) given in this letter, including any additional information, is not a ruling and does not bind the CRA with respect to a particular situation. Future changes to the ETA, regulations, or the CRA’s interpretative policy could affect the interpretation(s) or the additional information provided herein.
If you require clarification with respect to any of the issues discussed in this letter, please call me directly at 613-292-0934 or call my manager, Lloyd McMaster, at (905) 213-3840. Should you have additional questions on the interpretation and application of GST/HST, please contact a GST/HST Rulings officer at 1-800-959-8287.
Yours truly,
Kirk Moore
Financial Services Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate
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