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.
Principal Issues: 1. Will 12(2.1) or 104(7.1) apply to specific hypothetical scenarios
Position: 1. may
Lena Holloway, CA
October 12, 2012
Re: Interpretation Request – Trailer fees and subsections 12(2.1) and 104(7.1) of the Income Tax Act (the “Act”)
This is in reply to your letter of May 16, 2012 in which you requested a technical interpretation of subsections 12(2.1) and 104(7.1) of the Act in a particular scenario. The scenario presented in that letter and your related interpretation follow:
1. Units (“Units”) of a mutual fund trust (as defined in the Act) (the “Mutual Fund”) will be offered for sale through the manager of the Mutual Fund (the “Manager”) and by other distribution agents, including “registered securities dealers” (as defined in the Act) and portfolio managers (individually a “Dealer”).
2. The Mutual Fund has only one class of units, however, there are multiple fee plans.
3. Under one fee plan, if an investor in the Mutual Fund (the “Investors”) acquires Units through a Dealer or portfolio manager, the Dealer or portfolio manager will be paid a commission by the Mutual Fund at the time of purchase of the Units (the “DCS Commission”) and the Dealer or portfolio manager will also be paid an annual trailer fee by the Mutual Fund (the “Trailer Fee”).
A typical transaction is as follows:
i. An Investor requests that a Dealer purchase a specified dollar value of Units.
ii. The Dealer executes the purchase by transferring the Investor’s money to the Mutual Fund and transferring the Units received from the Mutual Fund to the Investor’s account with the Dealer.
iii. The Mutual Fund pays the applicable DSC Commission and Trailer Fees to the Dealer as a result of the Investor’s purchase of Units through the Dealer.
4. A particular dealer proposes to implement procedures that will provide an Investor with a rebate of a portion of the DSC Commission and Trailer Fees paid to the Dealer by the Mutual Fund (the “Rebate”) as a result of the Investor’s purchase of Units through the Dealer.
5. The Rebate will be paid in cash by the Mutual Fund directly to the Investor. Alternatively, the Rebate will be paid in cash by the Mutual Fund to the Dealer who will in turn provide it to the Investor.
6. The purpose of the Rebate is to ensure that an Investor that purchases Units through a dealer recovers any fees that the Investor would not have incurred (ie. The DSC Commission and the Trailer Fees) if the Investor had purchased Units directly from the Mutual Fund.
In respect of the scenarios outlined above you had asked if subsection 12(2.1) would apply to deem the Rebate received by an Investor to be received by the Mutual Fund and also if the Rebate would cause subsection 104(7.1) to apply to deny a paragraph 104(6)(b) deduction to the Mutual Fund. It is your opinion that neither 12(2.1) nor 104(7.1) would apply as the Rebate is not being paid as an inducement or as a reimbursement or as a form of assistance in respect of the cost of property or an expense of the Mutual Fund nor is one of the main purposes of these scenarios to give an Investor a greater percentage in the property of the Mutual Fund than the income.
Whether or not subsections 12(2.1) and 104(7.1) are applicable in a particular situation is a question of fact. In order to make such a determination the CRA (Canada Revenue Agency) would need to have a complete understanding of all the relevant facts and circumstances which would normally require a review of any relevant contracts, agreements or other documentation or information pertaining to the particular situation.
Generally, where a decision has been made by the Dealer to pay the Investor a portion of the DSC Commission and Trailer Fees without any involvement by the Mutual Fund and the amount is paid directly from the Dealer to his client (Investor), subsection 12(2.1) would not apply. Where the Rebate is paid to the Investor through the Mutual Fund, subsection 12(2.1) may be applicable, particularly where the agreements entered into by all three parties so dictate. Where however transactions are structured and legally effective so as to make the amount paid to the Investor a distribution from trust income, subsection 12(2.1) would not be applicable. In such a case, subsection 104(6) would generally be applicable to allow the Mutual Fund a deduction for the payment to the Investor while 104(13) would bring the amount into the Investors’ income. The DCS Commissions and Trailer Fees paid (net of the rebate) by the Mutual Fund to the Dealer would be business income to the Dealer.
As for the applicability of subsection 104(7.1), in many of the cases we have seen subsection 104(7.1) was not applicable because it was not “reasonable to consider that one of the main purposes for the existence of any term, condition, right or other attribute of an interest in a trust (other than a personal trust)” was “to give a beneficiary a percentage interest in the property of the trust that is greater than the beneficiary's percentage interest in the income of the trust”. That is, where a Dealer wishes to pass on to his clients a portion of the DSC Commission or Trailer Fee that he has earned, as a marketing tool in order to remain competitive, the main purpose test required in subsection 104(7.1) would not be met. Again we must emphasize that the conclusion reached will depend on the facts of each case including all agreements related thereto.
We trust the above comments will be of some assistance.
Trusts Section I
Trusts and Financial Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs
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