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: 187184
Business Number: […]
Dear [Client]:
Subject: GST/HST INTERPRETATION
Application of GST/HST to mutual fund trailing commissions in the mutual fund industry
Thank you for your letters of [mm/dd/yyyy] and [mm/dd/yyyy], concerning the application of the goods and services tax/harmonized sales tax (GST/HST) to the trailing commissions paid to […](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.
You have provided us with the following documents:
- Two letters, dated [mm/dd/yyyy] and [mm/dd/yyyy], detailing your ruling request.
- A blank new account application package for the Dealer’s clients, including the […] Disclosure Agreement.
- Two samples of Agency Agreements between the Dealer and individual agents outlining the terms and conditions for an agent to be appointed as a representative of the Dealer; signed and dated [mm/dd/yyyy] and [mm/dd/yyyy](“Agency Agreement 1” and “Agency Agreement 2” respectively). The terms agents, advisors and representatives are used interchangeably throughout the incoming letters and are referred hereafter in this letter as the “agent”.
- Two samples of Dealer Agreements for […] securities between the Dealer and […](“Manager1”) and […](“Manager2”), respectively dated [mm/dd/yyyy] and [mm/dd/yyyy].
- Two Fund Fact Sheets providing information about two mutual funds, one from each asset manager.
- […] Simplified Prospectus (the “Prospectus”) dated [mm/dd/yyyy].
STATEMENT OF FACTS
From the above documents and your ruling request, we understand the following:
1. You represent the Dealer, who is a corporation that is a licensed mutual fund dealer, registered for GST/HST purposes. You have described the Dealer as a small sized mutual fund dealership in […][a province] that has agreements with various mutual fund companies for the distribution and sale of mutual fund units to individual investors. In order to distribute mutual fund units, the Dealer contracts with agents to distribute mutual fund units to clients who are individual investors.
2. The terms and conditions of Agency Agreement 1 and Agency Agreement 2 indicate the following:
i. The Dealer appoints the agent as a representative of the Dealer to solicit, as a self-employed proprietorship, subscriptions and applications with respect to the purchase of financial products for which the Dealer is from time to time a distributor.
ii. With respect to the relationship between the Dealer and the agent, the agent is independent of the Dealer and the agent shall be responsible for their own expenses […].
iii. All sales of financial and investment products offered by the Dealer must be placed through the Dealer. Any deviation from this without the written approval of an officer of the Dealer may result in immediate termination of sponsorship of the agent license(s) by the Dealer and termination of the agreement.
3. You have stated that the agent has the only direct contact with the investor and provides the following services:
a) Initial meeting to determine investor requirements;
b) Completion of questionnaire re. risk tolerance, time horizon, income, net worth knowledge, etc.;
c) Financial planning;
d) Tax and estate planning;
e) Portfolio selection (this involves the design and architecture of the portfolio);
f) Continuous monitoring and reporting; and
g) Document preparation.
You have indicated that items a, b, and g are a low percentage of the services provided by the agent while c, d, e, and f are a high percentage of the service provided.
4. You have stated that there are different types or series of funds that the Dealer distributes through its sales representatives. These include Series A and Series F securities.
5. Series A securities are common mutual fund securities. They are normally purchased by individual (also referred to as retail) investors. There are few requirements for the purchase of these securities and they are typically available under different sales charge options, which will be discussed later. Upfront commissions and ongoing amounts, referred to as trailing commissions, are typically paid to the Dealer and the agent in respect of these securities by the fund.
6. Series F securities are available to investors who have fee-based arrangements with their advisor. An ongoing fee is charged directly to the investor. Generally, no trailing commission is paid to the Dealer by the fund manager in respect of these securities. The management fee charged by the mutual fund manager to the Fund is usually lower, as it reflects the fact that there is no trailing commission that is payable to dealers.
7. You have described four options with respect to the purchase of Series A securities:
a. Deferred Service Charge (the “DSC”) – also referred to as Back-End-Load. The Dealer receives an upfront amount (sales charge or commission) of usually 5 per cent which is paid by the fund manager. The investor does not pay an amount up front but may be required to pay an amount to the fund if they sell within a certain period (typically seven years).
b. Low Service Charge – similar to the DSC but the time period within which the client may be required to pay a fee is reduced.
c. No Load – no up front or deferred charges are paid by the investor.
d. Front End or Front Load – This is the initial sales charge option and is similar to No Load. Here, the Dealer has the right to charge a fee (sales charge or commission) on the initial purchase to the investor. The sales charge is deducted from the amount invested. The amount is given to the Dealer and a portion goes to the agent.
8. The Prospectus indicates that the investor may have to pay the Dealer a sales charge upon the purchase of Series A securities under the initial sales charge option. The sales charge is collected by the mutual fund from the amount invested and paid to the Dealer as a commission. No sales charge is paid to the Dealer by the investor for Series A securities under “the standard DSC or intermediate DSC option.”
9. The Prospectus also states that the fund manager pays a trailing commission for various funds (Series A but not Series F). The Prospectus provides the following information regarding “trailing commissions”:
i. Manager 2 pays the Dealer a trailing commission on certain classes of securities for ongoing services they provide to investors, including investment advice, account statements and newsletters.
ii. The trailing commissions are calculated monthly and payable monthly or quarterly based on the total client assets invested in certain classes of securities of funds managed by Manager 2 held by all of an agent’s clients throughout the month.
iii. Manager 2 can change or cancel trailing commissions at any time at its discretion and without prior notice.
10. Trailing commissions are usually paid to the Dealer as long as the investor owns the securities. The […]Disclosure Agreement indicates that trailing commissions are generally paid by the fund to encourage dealers to provide on-going services to their investors after the date of purchase, for which no sales commission would otherwise be received. Trailing commissions are deducted from the investor’s assets. These fees are paid to the Dealer, under a contract between the Dealer and various mutual fund companies. The financial advisors are then paid a percentage of this fee on a monthly basis. No GST/HST is paid to the Dealer. Also, no GST/HST is paid to the advisors.
11. The Dealer Agreement between the Dealer and Manager1 is for Series F securities. This series is for dealers whose investors participate in dealer sponsored investment programs where Manager 1 is not required to pay commissions or trailing commissions to dealers. The Dealer must undertake to ensure that all investors owning Series F participate in the Series F program.
12. Similarly, the Dealer Agreement between the Dealer and Manager2 is also for Series F securities and is designed for dealers whose investors participate in programs that do not require them to pay sales or redemption charges, and that do not require Manager2 to pay trailing commissions to dealers. Potential Series F investors include those of dealer-sponsored “wrap account” programs. These investors are charged an asset-based fee by their dealer “for ongoing financial planning advice incorporated in a wrap program instead of transaction sales charges.”
13. The description of Series F securities in the Prospectus dated [mm/dd/yyyy] states that they are available to investors who participate in fee-based programs and that investors pay their representative’s firm directly so a lower management fee is charged to the fund since no commissions or trailing commissions are paid to the dealers. Class A securities pay a higher management fee since commissions and trailing commissions are paid to the dealers.
14. The fund manager may collect the investment advisory fee that is negotiated between the investor and the agent, on behalf of the Dealer. This fee is generally in the % range and is deducted directly from the investor’s investment. This investment advisory fee is charged on a monthly or quarterly basis and is paid to the Dealer directly. GST/HST is added to the amount paid to the dealership.
15. In your letter of [mm/dd], you write that mutual fund fees can vary drastically and that, in most cases, there are embedded trailing commissions that range from […]% up to […]%. You confirmed that the Dealer receives trailing commissions in situations where it is the original Dealer that facilitates the initial sale of shares or units in a mutual fund corporation or trust. You have also confirmed that the Dealer receives trailing commissions when it is not the person who facilitates the initial purchase or sale of shares or units in a mutual fund corporation or trust.
RULING REQUESTED
1. Is GST/HST applicable to the amounts paid to the Dealer as a sales commission by Manager1 and Manager2 to the Dealer? Also, is GST/HST applicable to the amounts paid to an agent by the Dealer, which is a portion of the sales commission received by the Dealer from Manager1 and Manager2?
2. Is GST/HST applicable to the trailing commissions paid, on an ongoing basis, by Manager1 and Manager2 to the Dealer? You would also like to know if GST/HST is applicable to the amounts paid by the Dealer to an agent which is a portion of the trailing commissions received by the Dealer?
3. Is GST/HST applicable to the fees charged, on an ongoing basis, to investors by the Dealer in respect of F Series funds?
INTERPRETATION GIVEN
As indicated in GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service, requests for rulings should include copies of any relevant supporting agreements or documents, together with references to, and summaries of the specific provisions of these agreements or documents which pertain to the request. As we do not have documents or agreements concerning the services supplied by the Dealer to the mutual fund manager for which an up front commission or a trailing commission is paid by the mutual fund companies, or agreements between the Dealer and the investor, we are unable to issue a ruling. However, we are pleased to provide you with an interpretation with respect to these supplies.
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. The definition of financial service is found 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 service 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.
In considering the GST/HST treatment of the services described above, it is necessary to address each of the following supplies:
- Supplies of services made by a mutual fund manager (“manager”) to a mutual fund (“fund”);
- Supplies of services made by a mutual fund dealer (“dealer”) to a manager; and
- Supplies of services made by an agent to a dealer.
Supplies of services made by a manager to a fund
A 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 or shares. The management agreement will usually set out the basis for the manager earning its fees from the fund. The consideration charged by the manager to the fund is reflected in the Management Expense Ratio (“MER”) which ordinarily takes into account the management fee and other cost recoveries including any applicable commissions and trailing commissions paid by the manager. For GST/HST purposes, the manager is considered to make a supply of its services 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 a manager to a fund under a 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 though certain services supplied by a manager to a fund may be exempt financial services such as buying and selling equity and debt securities on behalf of the fund or distributing shares or units of the fund. 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 a dealer to a manager where the dealer has a network of agents that the dealer contracts with directly
It is first necessary to examine supplies made by a dealer to a manager in general before discussing the application to specific fund options.
In fulfilling the duties described above, a manager, in its capacity as manager of the fund, enters into agreements (dealer agreements) with dealers for the distribution of the fund’s units or shares. Under the agreement, an upfront commission and a trailing commission may be paid by the manager to the dealer. Trailing commissions are paid by a manager to a dealer on a periodic basis for certain funds including Series A funds. The trailing commission may be in addition to any upfront sales commission that is payable by the manager to the dealer. In these circumstances, a 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). A portion of the upfront commission and trailing commission received by the dealer would then be paid to the agents.
The provision of services by a dealer to a mutual fund 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 the definition.
Where an agreement provides for a number of services or property and services, it must first be determined whether a single supply or multiple supplies have been made under the agreement. This distinction is important in cases where a combination of services and or property are supplied by a person under an agreement, some of which would be taxable and some of which would be exempt if supplied separately. In this type of situation it is a question of fact whether the person is making a single supply or multiple supplies. GST/HST Policy Statement P-077R2, Single and Multiple Supplies, provides additional information on determining whether a single supply or multiple supplies are being provided.
If it is determined that multiple supplies are being provided by a person, the possible application of sections 138 and 139 must also be considered. However, if it is determined that a single supply is being provided, then the essential character of that supply must be established to determine the nature of the supply. If the essential character of the single supply is determined to be a financial service, then the supply as a whole will be considered a financial service.
As indicated above, a dealer would normally be responsible for the distribution of shares or units of a fund under a dealer agreement with a manager who relies on these agreements for the distribution of units or shares of the funds that it manages. The essential character of the supply made to the manager under the dealer agreement would be the distribution of the fund’s shares or units. This would be the service that the manager is essentially paying for. Any other services provided would be ancillary to this purpose. Thus, the supply by the dealer to the manager would be arranging for a financial service i.e., the sale of shares or units of mutual funds. An upfront commission under this agreement is consideration for a financial service and GST/HST would not apply. Further, where under the distribution agreement between the dealer and manager, the dealer is also entitled to receive ongoing amounts as a trailing commission, this amount would ordinarily be viewed as 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 are not consideration for the supply of arranging for the sale of shares or units in the fund. In these exceptional cases, the payments may be consideration for a separate supply and may therefore have a different GST/HST treatment.
Where a dealer is not the same person that facilitated the initial sale of shares or units in the fund but receives a trailing commission in respect of those shares or units, the supply is a separate supply from the supply of arranging for the initial sale of shares or units. Unless the service provided by the dealer in these circumstances falls within the financial services definition, the trailing commissions would attract GST/HST. For example, where the dealer receives the trailing commission for the servicing of an investor's account, this is not a supply of a financial service as defined in the ETA.
Where a dealer is the same person that facilitated the initial sale of shares or units in the fund and receives a trailing commission in respect of those shares or units but the entitlement to the trailing commission was not created at the same time and under the same agreement(s) with respect to the facilitation of the initial sale of shares or units in the fund, the supply is a separate supply from the supply of arranging for the initial sale of the shares or units. Unless the service provided by the dealer in these circumstances falls within the financial services definition, the trailing commissions would attract GST/HST. For example, where the dealer receives the trailing commission for the servicing of an investor's account under a separate, unrelated agreement, this is not a supply of a financial service as defined in the ETA.
Where a dealer is the same person that facilitated the initial sale of shares or units in the fund and receives a trailing commission in respect of those shares or units and the entitlement to the trailing commission was created at the same time and under the same agreement(s) with respect to the facilitation of the initial sale of shares or units in the fund, the payments would ordinarily be consideration for a single supply. The exception would be if there is clear indication in the agreement(s) for the dealer’s services that the payment of the trailing commission is directly linked to a supply of specific services and those services are not so intertwined with the service of arranging for the sale of units or shares in the fund that the supply of each of those services could be effectively supplied separately. In these cases, if the trailing commissions are determined to be consideration for a separate supply, the commissions would attract GST/HST unless the supply falls within the financial services definition. Factors to consider in making that determination include:
- Is there a direct link between trailing commissions earned and specific services supplied?
- Is there an impact to the trailing commission entitlement (such as a refund/credit or an indemnification/guarantee), should the dealer not perform certain activities?
These factors are not necessarily determinative and may not change the characterization of the supply. Each supply must be examined on a case by case basis and these factors can assist in that determination. Typically, a manager is entering into the agreement with a dealer for the purpose of distributing shares or units of the funds that the manager manages. Where other elements of the supply to be provided by the dealer would, if supplied separately, not meet the financial service definition, unless it can be clearly ascertained that the supply of these elements is a separate supply, these additional elements are considered to be part of the single supply of arranging for the distribution of the shares or units in fund.
DSC or Low Service Charge funds
For a DSC or low service charge fund, where both an upfront commission is payable by a manager to a dealer and an ongoing trailing commission is payable by a manager to the dealer while the investor holds the shares or units, those payments are ordinarily consideration for a single supply unless any of the above exclusions apply. As discussed above, the essential character of the supply is arranging for the sale of shares or units in the fund. Accordingly, the supply is an exempt supply of a financial service in accordance with paragraphs (l) and (d) of the financial service definition in the ETA and GST/HST would not apply to either the upfront commission or the trailing commission.
No load funds
In the case of no load funds, usually there are neither front end nor back end sales commissions applicable and only trailing commissions apply. In these circumstances, the trailing commissions are the only consideration for the supply provided by the dealer.
Where trailing commissions are payable with respect to an agreement between the dealer and the manager for the distribution of shares or units in a mutual fund and the dealer is the person who facilitated the initial sale of shares or units in the fund and receives a trailing commission in respect of those shares or units, the payments of the trailing commissions would ordinarily be consideration for the supply of arranging for the sale of shares or units in the fund unless any of the above exceptions apply. Accordingly, the supply is an exempt supply of a financial service in accordance with paragraphs (l) and (d) of the financial service definition in the ETA and GST/HST would not apply to the trailing commissions.
Front end load funds
With front end load funds, the investor is ordinarily charged an upfront fee or commission directly by the dealer upon the initial purchase of shares or units by the investor. The dealer may also receive an ongoing trailing commission from the manager. This trailing commission is usually payable under the agreement between the dealer and the manager. It is necessary to examine the agreement to determine the essential character of the supply. Where the agreement is for the distribution of units or shares of the fund, the supply made under the agreement by the dealer to the manager would be one of arranging for a financial service unless any of the above exceptions apply. Even though there is no upfront commission payable by the manager, the consideration for this supply is the ongoing trailing commissions and the essential character of the supply is arranging for the sale of shares or units in the fund. Accordingly, the supply is an exempt supply of a financial service in accordance with paragraphs (l) and (d) of the financial service definition in the ETA and GST/HST would not apply to the trailing commissions.
Please refer to the below discussion concerning F Series concerning whether the upfront commission charged to the investor is a financial service.
Supplies of services made by an agent to a dealer
Agency agreements are, typically, for the purpose of distributing shares or units of mutual funds. The duties of the agent may require the agent to provide a degree of ongoing investment support to the investor.
The determination of whether the supply made by an agent to a dealer under an agency agreement is a financial service will be based on the duties and actions of the agent. Where under an agreement with the dealer, the agent solicits potential investors, introduces them to the dealer and assists in the purchase, redemption and exchange of mutual fund units or shares, the essential character of the supply received by the dealer would be for the acquisition of mutual fund shares or units by investors. This would be considered a financial service of arranging for the purchase of financial instruments. This is still the case even where the service includes certain ancillary services like meeting with the client, discussing the client’s needs, answering questions and providing other assistance.
Where both an upfront commission is payable to the agent and an ongoing trailing commission is payable to the agent while the investor holds the shares or units, those payments would normally be consideration for a single supply. Where there is a single supply, the essential character of the supply is still arranging for the acquisition of shares or units in the fund. Please refer to the discussion above concerning trailing commissions paid to dealers for further clarification concerning the circumstances where the trailing commissions together with an upfront commission constitute consideration for a single supply or where the trailing commission constitutes consideration for a separate taxable supply and how this would apply to the various fund options.
F Series
With F Series funds, we understand that usually both an upfront commission and ongoing investment advisory fees are charged directly by a dealer to an investor under an agreement between the two parties. These funds typically have lower management fees since the manager does not pay either an upfront commission or trailing commissions under the agreement with the dealer. Although the investor is liable to pay the ongoing investment advisory fee to the dealer, the manager may deduct this fee directly from the investor’s units or shares and transfer the amount to the dealer. A portion of this fee may then be paid to the agent that initially dealt with the investor and continues to provide services to the investor.
The determination of whether the supply made by the dealer to the investor under an agreement is a financial service will be based on the essential character of the supply. Where under the agreement the dealer, or agent, solicits the investors for the purpose of investing in the mutual fund units or shares and assists in the purchase, redemption and exchange of mutual fund units or shares, this is considered to be a financial service of arranging for the sale of financial instruments. This is still the case even where the supply includes certain ancillary services such as meeting with the client, discussing the client’s needs, answering questions and providing other assistance.
Where the dealer receives an ongoing investment advisory fee from the investor in respect of the investor’s shares or units and the entitlement to the fee was created at the same time and under the same agreement with respect to the initial investment by the investor, the payments would ordinarily be consideration for a single supply. That supply would be an exempt supply of arranging for a financial service unless there is clear indication in the agreement for the dealer’s services that the payment of the ongoing fee is directly linked to a supply of specific services and those services are not so intertwined with the service of arranging for the sale of units or shares in the fund that the supply of each of those services could be effectively supplied separately. This is consistent with the exceptions described above dealing with supplies of services made by a dealer to a manager. In these cases, if the ongoing advisory fee is determined to be consideration for a separate supply, it would attract GST/HST unless the supply falls within the financial services definition. Factors to consider in making that determination include:
- Is there a direct link between investment advisory fee and specific services supplied?
- Is there an impact to the investment advisory fee entitlement (such as a refund/credit or an indemnification/guarantee), should the dealer not perform certain activities?
This would also apply to the portion of the ongoing fee that is paid to any agent that was involved in the transactions in these circumstances.
For transactions where the dealer is the original dealer facilitating the sale of the financial instruments, the advice and administration activities provided by the dealer, or the original agent under an agreement between the dealer and an agent, may be considered part of the financial service of “arranging for” the transfer of ownership of a financial instrument. In that case, the commission and the ongoing fee together form the consideration payable for a single supply of a service that is included in paragraph (l) of the definition of financial service. Accordingly, this supply would be an exempt financial service under section 1 of Part VII of Schedule V.
In the case where the ongoing fee is consideration for a separate supply of services provided to the investor, the fee is for a single supply of an advisory service and that service would be taxable, as there are no applicable exempting provisions. As such, the ongoing fee received for the supply of such services would be consideration for a taxable supply.
In accordance with the qualifications and guidelines set out in GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service, the interpretations given in this letter, including any additional information, is not a ruling and does not bind the Canada Revenue Agency (CRA) with respect to a particular situation. Future changes to the ETA, regulations, or the CRA’s interpretative policy could affect the interpretations 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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