File: 11595-2; 11585-26
This is in reply to the memorandum of October 27, 1995 from XXXXX wherein he requested our opinion with respect to distribution fees charged by the fund manager of the above-noted mutual fund.
Statement of Facts
1. XXXXX (the "Fund") has entered into a Management and Distribution Agreement (the "Agreement") with a mutual fund manager (the "Manager") whereby the Manager agrees to act in three capacities:
• manager of the Fund;
• registrar and transfer agent of the Fund; and
• exclusive distributor of the units of the Fund.
3. Under the Agreement, the Manager agrees that it shall, in its capacity as exclusive distributor of the units, provide the following services:
• as agent for the Fund, appoint one or more persons to arrange for the distribution of units for such period as the Manager determines, including the right to appoint itself, and to determine the contractual arrangements with such persons;
• distribute and sell or cause to be distributed and sold only through registered dealers who are approved by the Manager, in all jurisdictions where the same may lawfully be distributed or sold, units which are qualified for distribution and sale;
• compensate any person referred to in (1) above for its assistance in the distribution of units in accordance with the terms of the prevailing distribution agreement, if any, provided however that in consideration for accepting such responsibility the Fund agrees with the Manager that its will pay to any such distributor in accordance with the terms of the distribution agreement then in effect such part of the redemption charge received by the Fund on the redemption of units as is provided in such distribution agreement;
• cause all units to be distributed and sold at an issue price equal to the Net Asset Value per unit on the following bases so that a purchaser may elect:
• to pay at the time of purchase the Net Asset Value per unit for each unit purchased plus a sales charge; or
• to pay at the time of purchase only the Net Asset Value of each unit purchased (the "Deferred Charge Option") and to have a selling commission paid in respect of each unit purchased under this option by the Manager or such other person as may be appointed by the Manager to arrange for the distribution of units pursuant to the Deferred Charge Option;
• purchasers electing the Deferred Charge Option are subject in respect of each unit held upon which a selling commission is paid, on each unit issued on the immediate investment of proceeds realized on the redemption of units of another mutual fund managed by the Manager acquired under a similar deferred charge option by such other fund and on each unit issued on the automatic reinvestment of distributions, to a distribution fee as described below and to a redemption charge in respect of each unit redeemed within a specified number of years of its date of issue;
• provide, or cause to be provided, marketing and advice and assistance to registered dealers in connection with the distribution and sale of units;
• establish from time to time the minimum initial and subsequent investment in units and the floor amount;
• accept or reject, as agent for the Trustee, in its discretion, subscriptions for the purchase of units;
• receive and transmit, or cause to be received and transmitted, to the custodian of the Fund, cheques and other moneys received from unitholders, persons selling units or others in connection with the issuance of units, calculate the number of units to be issued and issue appropriate confirmations and other required documents to purchasers of units;
• redeem units and issue appropriate instructions to the custodian to permit the redemption of units and deliver appropriate confirmations and other required documents to redeeming unitholders together with any cheque or other property issued or delivered to such redeeming unitholder.
4. In consideration for the management and administrative services performed and for certain expenses paid by the manager, the Manager receives a monthly management fee of XXXXX of the average Net Asset Value of the Fund during each month.
5. In consideration for the services performed by the Manager in distributing and selling and arranging for the distribution and sale of units pursuant to the sales charge option, the Manager is entitled to retain all sales charges paid by purchasers of units who use this purchase option and may, at its discretion, pay the whole or part of such sales charge to any registered dealer who distributes units on this basis.
6. The Manager shall determine, in its sole discretion, whether to charge a redemption charge on the redemption of units purchased under the sales charge option. Any such redemption charge is retained by the Fund and not by the Manager.
7. In consideration for the services performed by the Manager in distributing and selling and arranging for the distribution and sale of units pursuant to the Deferred Charge Option and the waiver of sales charges that might otherwise be payable but for the offering of the Deferred Charge Offering, the Managers receives from each unitholder who acquires units under the Deferred Charge Option an annual fee equal XXXXX of the Net Asset Value per unit of each unit which is a Deferred Charge Unit for so long as it remains outstanding.
8. To the extent possible, the fee is paid out of any income or capital gains distribution to which the unitholder is entitled. In the event that the Fund does not distribute sufficient income or capital gains to a unitholder to pay the amount of the fee accrued, a sufficient number of Deferred Charge Units held by the unitholder are redeemed and the proceeds applied against the outstanding fee.
9. A redemption charge applies to all Deferred Charge Units. This redemption charge is XXXXX if the unit is redeemed during the first year after issue and declines XXXXX each year until there is no redemption charge after the XXXXX year following the year in which the unit was issued.
10. The Manager is entitled to the redemption charges received by the Fund as a result of the redemption of any Deferred Charge Units which are issued while the Manager is the manager of the Fund, other than redemption charges which are payable to a contractual distributor or pursuant to any distribution agreement to which the Fund is a party.
11. Beginning in 1994, the fees were combined into one management fee. It is our understanding that this was due to unitholder dissatisfaction with the previous arrangement.
Registrant's Position
The distribution fee of XXXXX, described in item 7 above is exempt since it is payable by the unitholder and not the Fund.
Since the distribution fee is payable by the unitholder, the unitholder is the recipient of the supply, i.e., "... the person who is liable under the agreement to pay that consideration.". As a result, the supply is not excluded from the definition of "financial service" under paragraph 123(1)(q) of that definition since the service is not provided to the Fund, i.e., it is not provided to "... a corporation, partnership or trust the principle activity of which is the investment of funds on behalf of shareholders, members or other persons,".
Our Position
It is our view that the fee charged by the Manager for distribution services does not fall outside paragraph 123(1)(q). Although the unitholders appear to be the source of the compensation, the Fund and not the unitholders is the person to whom the service is being provided, i.e., it is the Funds' units that are being distributed. The Agreement is between the Fund and the Manager, the unitholders are not party to the Agreement.
There may be an argument that the "recipient" of the supply is the unitholders and not the Fund, i.e., the unitholders are, "... the person who is liable under the agreement to pay that consideration,". However, this position would depend on the terms of the subscription agreements that the unitholders completed and the Fund's offering literature. Specifically, (i) whether the unitholders and the Fund contractually agree that the Manager would have direct recourse to the unitholders' units for an annual fee, rather than the Fund deducting this amount and remitting it to the Manager and (ii) whether the unitholders understand that they are purchasing "distribution and sales services" from the Manager. These documents should be examined to determined if in fact the Manager has a legal right to obtain payment directly from the unitholders.
Even if it can be shown that the unitholders come within the technical language of the definition of "recipient", it would still have to be shown that the unitholders and not the Fund are the person to whom the services are provided, i.e., the unitholders are the beneficiaries of the services. It is our view that it is unlikely that the commercial reality is that the unitholders are being provided distribution services by the fund manager.
Unless the subscription agreement or the Fund's offering literature indicate otherwise, notwithstanding that the unitholders may be liable to pay the consideration for the supply, the services is still being provided to the Fund and therefore it is a service that falls under paragraph (q) of the definition of "financial service" in subsection 123(1) and is therefore taxable.
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
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