19 November 2003 GST/HST Interpretation 45736 - GST Voluntary Disclosures - "No Name Disclosure"

Please note that the following documents, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ces documents, bien qu'exacts au moment émis, peuvent ne pas représenter la position actuelle de l'Agence.

This is in reply to your memorandum XXXXX to XXXXX GST/HST Rulings which was forwarded to us.

Our understanding of the facts as set out in XXXXX letter XXXXX and summarized below is as follows:

Statement of Facts

ABC is incorporated and continued under the Canada Business Corporations Act. GHI Corporation and XYZ are wholly-owned subsidiaries of ABC. The principal business of ABC, GHI and XYZ is the management of investments in general, and of commodity and futures trading in particular.

DEF Partnership (the Partnership) was formed XXXXX under the XXXXX for the purpose of engaging in global derivatives trading. The units of the Partnership were sold through a private placement with additional units issued at a later date. GHI is the general partner of the Partnership.

The Partnership has appointed XYZ as its trading manager for carrying out the global derivatives trading. The Partnership has appointed, through XYZ, commodity trading advisors (CTAs) registered with the XXXXX. The CTAs are located outside of Canada. The CTAs manage and carry out trading in commodity and futures contracts on behalf of the Partnership. They have limited power of attorney and discretionary authority to trade in commodities and futures contracts on behalf of the Partnership. Contracts traded consist solely of (a) commodity and financial futures contracts, (b) inter-bank foreign exchange contracts, and (c) options on such contracts. While trading activities are undertaken by CTAs, brokers/Futures Commission Merchants (FCMs) outside Canada perform activities relating to maintaining margin accounts and recording trade positions. Transactions are traded through recognized commodity and futures exchanges located outside Canada.

XYZ is in the business of investment management and has been appointed trading manager by the Partnership. As trading manager, XYZ is actively involved in selecting, retaining, removing, replacing and adding CTAs to manage investment accounts and allocating and reallocating assets among CTAs. XYZ also provides other management services to the Partnership.

The Partnership earns income from its trading activities. Its expenses consist of fees paid to FCMs, CTAs and XYZ.

XYZ earns all or substantially all of its revenues from the contract with the Partnership as its trading manager. Its expenses consist of operating costs to run its business as well as an inter-company management fee paid to ABC (however there is no written agreement between XYZ and ABC that describes these services or the fee paid).

ABC's principal source of income is the inter-company management fee received from XYZ and its expenses consist of legal and professional fees, marketing, employee compensation and other general and administration expenses.

You have requested that we provide our opinion on the following:

1. Are the supplies made by ABC to XYZ taxable?

2. Are the supplies made by XYZ to the Partnership taxable?

3. Are the supplies of contracts for commodity and financial futures and made by the Partnership zero-rated?

4. Would the Partnership be required to allocate ITCs in respect of exempt and zero-rated supplies as outlined in the incoming letter?

5. Would the Partnership be required to self-assess GST on services provided by the CTAs?

Our Comments

1. Are the supplies made by ABC to XYZ taxable?

Although there is no written agreement between ABC and XYZ, if ABC is in fact providing management services to XYZ, these services are taxable supplies.

2. Are the supplies made by XYZ to the Partnership taxable?

Supplies made by XYZ to the Partnership are those of investment management services. The Partnership pays three types of fees to XYZ as follows:

a. Flat Fee - a residual flat fee, also referred to as the transaction fee. The agreement authorizes XYZ to charge a Flat Fee of XXXXX% of Net Asset Value (NAV) per annum, net of the fee payable to brokers. This fee has averaged XXXXX% of NAV per annum.

b. Management Fee - XYZ is entitled to a net residual annual Management Fee in addition to the Flat Fee equal to XXXXX% of NAV less the Fixed Fee payable to CTAs.

c. Incentive Fee - XYZ is also entitled to an incentive fee equal to XXXXX% of net new trading profits of the Partnership earned on the assets less the Incentive Fee payable to CTAs.

Although the services provided by XYZ to the Partnership consist of some elements which may be defined to be financial services, the overall supply is that of an investment management service which is a taxable supply.

3. Are the supplies of contracts for commodity and financial futures and made by the Partnership zero-rated?

Contracts for commodity futures traded on a recognized commodity exchange and financial futures are financial instruments as defined in paragraphs 123(1)(f) and (i) of the Excise Tax Act (ETA) respectively of the definition of "financial instrument". Trading of commodity and financial futures on a recognized commodity exchange is a financial service pursuant to paragraph 123(1)(d) of the definition of "financial service". A financial service is exempt unless it is zero-rated pursuant to Part IX of Schedule VI to the ETA. Since the Partnership is engaged in trading of futures on non-resident exchanges the zero-rating provisions may be applicable.

Section 1 of Part IX of Schedule VI to the ETA states:

"A supply of a financial service (other than a supply that is included in section 2) made by a financial institution to a non-resident person, except where the service relates to ...

(e) a financial instrument (other than an insurance policy or a precious metal) acquired, otherwise than directly from a non-resident issuer, by the financial institution acting as a principal."

The Partnership is a listed financial institution under paragraph 149(1)(iii) of the ETA as "a person whose principal business is as a trader or dealer in, or as a broker or salesperson of, financial instruments or money."

Since the Partnership is a financial institution making supplies of financial services acting as a principal, i.e., for its own account, to non-resident persons, the zero-rating provision may be applicable. Therefore the main issue to be determined is whether the supplies of contracts for commodity and financial futures made by the Partnership are purchased directly from a non-resident issuer. If they are, then the supplies of the financial services made by the Partnership will be zero-rated since the financial service relates to a financial instrument acquired directly from a non-resident issuer, otherwise, the financial service remains an exempt supply.

Based on our understanding of the futures markets, the counterparties to the exchange-traded transactions entered into by the Partnership (i.e., commodity and financial futures) are the clearinghouses of the futures exchanges not the exchange itself. The clearinghouse may be a department within the exchange or may be separately incorporated and independent from the exchange. The role of the clearinghouse in futures markets is different from that of clearing associations in banking and securities markets. Although both kinds of institutions perform a banking function by facilitating the transfer of funds between contracting parties and their agents, clearing associations in banking and securities markets do not become legal parties to transactions, do not act as guarantors, and do not operate as a pervasive self-regulatory institution. Nor are they involved in facilitating settlement by delivery. In futures markets clearing associations are not a mere processing convenience; they are an integral component of these markets. In essence, they convert a forward contractual obligation into a futures obligation. 1 (Futures & Options, Franklin R. Edwards and Cindy W. Ma (1992), p. 53.)

Based on the above, the clearinghouse is considered to be the non-resident issuer of the financial instrument therefore the Partnership is acquiring the financial instrument directly from the non-resident issuer and is consequently not excluded from zero-rating by paragraph (e) of section 1 of Part IX of Schedule VI to the ETA.

4. Would the Partnership be required to allocate ITCs in respect of exempt and zero-rated supplies as outlined in the incoming letter?

Yes. Since the Partnership is engaged in both taxable, i.e., zero-rated, and exempt activities it would be required to allocate ITCs.

5. Would the Partnership be required to self-assess GST on services provided by the CTAs?

Section 217 imposes tax in respect of certain supplies made outside Canada and in respect of other supplies on which the recipient, as opposed to the supplier, is required to account for tax. Paragraph 217(1)(a) defines "imported taxable supply" as "a taxable supply (other than a prescribed supply) of a service made outside Canada to a person who is resident in Canada, other than a supply of a service that is (i) acquired for consumption, use or supply exclusively in the course of commercial activities of the person ...".

Since the service provided by the CTAs to the Partnership is a supply of a service acquired for use exclusively in the course of the Partnership's commercial activities, it is not required to self-assess GST on these services.

Should you have any further questions, do not hesitate to contact me at (613) 952-9577 or Duncan Jones at (613) 952-9210.

Marilena Guerra
Senior Rulings Officer
Financial Institutions Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings