20 October 1998 External T.I. 9813415 - TRAILER FEE REBATE TO INVESTOR

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether compensation (similar to commission) called a trailer fee to an investment manager for acquiring third party investment passed on to his investor clients whose investments are held in trust would be included in income pursuant to paragraph 12(1)(x) & subsection 12(2.1)?

Position:

Generally yes if received directly by investor.

Reasons:

Trust acquires investments and trust investors receive from the investment manager a portion of trailer fee received by the investment manager for selling these investments to them via the trust.

981341
XXXXXXXXXX L. Holloway
(613) 957-2104
October 20, 1998

Dear Sir:

Re: Application of Paragraph 12(1)(x) to a Shared Trailer Fee Arrangement

This is in reply to your letters dated May 25, July 17, August 11, and August 19, 1998 and further to our telephone conversations (Holloway/XXXXXXXXXX) in which you requested an advance income tax ruling with respect to the application of paragraph 12(1)(x) of the Income Tax Act (the “Act”) in a particular situation. The scenario presented involved amounts received by an investment manager (the “Manager”) from third party mutual fund managers as compensation (the “trailer fee”) for investing in units of third party mutual funds on behalf of the clients of the Manager (the “Investors”). The trailer fees were described as regular payments from the third party fund managers for the ongoing service to be provided to Investor accounts. We were asked to confirm the tax implications in a number of scenarios whereby the Manager would effectively share the trailer fee earned with the Investors; the purpose being to create pricing flexibility with the third party mutual fund investments where it does not exist via the prospectus directly. The third party mutual fund units acquired by the Manager would be held in trust by a trustee (the “Trust”) for the benefit of the Investors.

As discussed, we were unable to provide an advance income tax ruling as the original request did not identify specific proposed transactions, but rather requested confirmation on general activities that were being contemplated by the taxpayer. Nevertheless, as agreed, we can provide you with a technical interpretation regarding the application of paragraph 12(1)(x) of the Act.

Your Comments

Further to our discussions on the same, your letter outlined these four hypothetical scenarios and your related interpretations thereto:

i) Where an Investor receives a portion of the trailer fee directly from the Manager in the form of cash and the Investor has sole discretion with respect to how the cash is used, whether it is retained by the Investor or reinvested for additional units of the third party mutual fund, subsection 12(2.1) should not apply to deem the trailer fee income to have been received by the Trust for purposes of paragraph 12(1)(x). Section 9 will include in the Investor’s income, their portion of the trailer fee received.

ii) Where an Investor receives a portion of a trailer fee in the form of additional units of a third party mutual fund held by the Trust, subsection 12(2.1) would apply for purposes of paragraph 12(1)(x) to deem the income received by the Investor to be income of the Trust and section 9 would apply to include the amount-in-kind received by the Investor also in the Investor’s income.

iii) Where an Investor receives a portion of the trailer fee in cash directly from the Manager and if the Investor is required to purchase additional units, the tax consequences discussed in ii) above will apply.

iv) Where the Manager pays to the Trust the portion of the trailer fee allocable to the Investor and the Investor receives a share of this fee through the Trust and is free to use this amount at the Investor’s discretion, subsection 12(2.1) would not be applicable. The Investor would be taxed on the amount allocated to it by the Trust under subsection 104(13) and the Trust would deduct this amount from income under subsection 104(6).

Our Comments

We assume that the reference to an Investor investing in or being in receipt of additional units of the third party mutual fund should be a reference to an Investor investing in or in receipt of additional units of the Trust.

Generally, we agree with your comments provided above with the exception of scenario i). The application of subsection 12(2.1) does not depend on the Investor’s discretion regarding the use of the amount received. Thus, we do not agree with your comments on subsection 12(2.1) in scenario i). In our opinion, the better view is that the Investor has received an amount from the Manager as an inducement in respect of the activities of the Trust, being the Trust’s investment in the units of the third party mutual funds.

These comments are provided in accordance with the guidelines set out in paragraph 22 of IC 70-6R3. An advance income tax ruling may be requested once you have decided on the structure of your proposal and are able to provide draft documents. Your deposit will be returned in a separate letter.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch