The Canada Revenue Agency (CRA) has changed its longstanding approach to trailing commissions, saying that trailers will be subject to sales tax because they’re payment for ongoing advisory services, rather than for the sale of mutual fund units. The agency’s reversed stance, to be effective July 1, means many dealers and advisors have costly operational changes to make in the short term and could face additional fallout in the long term.
In a tax interpretation provided to the Securities and Investment Management Association (SIMA) in December, the CRA said mutual fund trailing commissions paid by fund managers to both original dealers and new dealers will generally be subject to GST/HST.
The agency “dropped the bombshell” that “trailing commissions are taxable and arguably should have been taxable going back to 1991 when GST first came into play,” said Tariq Nasir, EY Canada’s indirect tax partner in Toronto. EY recently published a tax alert about the change.
“The overwhelming majority [of dealers and advisors] will be potentially required to register, collect and remit the sales tax in a scenario where it’s all just fully recoverable,” once input tax credits are claimed, Nasir said.
For dealers and advisors who aren’t currently GST/HST registrants, the CRA’s new stance means “they’re putting in an entirely new [tax] administration,” said Laura Paglia, president and CEO of the Canadian Forum for Financial Markets (CFFiM) in Toronto.
“It’s a big change,” said Jamie Wilks, tax partner with McMillan LLP in Toronto. Dealers and advisors will have to “set up their accounting and other systems to comply — to track the GST/HST collectible, generate debit notes and invoices for the input tax credit claims, claim their input tax credits, track those, and do their reporting and accounting for their net tax on their GST/HST returns,” he said. “They have these filings now to do.”
Dealers and advisors will also have potential GST assessment risk by the CRA, Nasir said.
“No dealer in their right mind is going to allow hundreds of individual producers to accurately report and remit GST to CRA,” said Mark Kent, president and CEO of Portfolio Strategies Corp. in Calgary. Any discrepancy would create problems between the CRA and the dealer, he said, and “no dealer wants to go down that path.” Kent said he expects the change will mean more cost to dealers in managing accounts.
Large dealers will likely centralize compliance, but how they allocate any economic impact to advisors “could vary widely,” with potential changes to dealer platforms and grids, said Emily Mantle, founder of Compass CPA in Sudbury, Ont., via email.
Mantle also noted that the requirement to register for GST/HST depends on whether total taxable revenues exceed the small supplier threshold of $30,000 over four consecutive quarters. However, if dealers prefer uniform compliance across their networks, that creates “commercial pressure for voluntary registration regardless of the threshold,” she said.
Otherwise, independent advisors under the threshold wouldn’t be required to register, but staying unregistered might “put them in a bind,” she said. “They can’t charge the tax, but they also can’t claim input tax credits on their own business expenses (tech, rent, compliance costs), which effectively raises their operating cost base.”
Mantle further noted that “even administrative changes to GST/HST have the potential to influence MERs over time” at fund managers, “which is why investor advocates will end up watching this [CRA development] closely.”
CRA recharacterizes trailers
The CRA’s longstanding position (confirmed most recently in 2022) was that trailing commissions were exempt from GST/HST because they were paid for helping with the issuance of mutual fund units — an exempt supply of a financial service.
An exception was confirmed at the same time: Trailers were subject to GST/HST when they went to a new dealer of record not responsible for the initial sale.
“That’s been under dispute,” Wilks said. “You could argue that the assignment of the interest in those commissions is also an exempt financial service,” at least in certain instances, such as the sales of advisors’ books.
In 2023, SIMA (then the Investment Funds Institute of Canada) argued against the exception in a submission to the CRA. Nasir said he, along with others, made the submission on SIMA’s behalf. Nasir put the argument this way: “There’s no reason that the transaction magically changes now, from exempt to taxable, just because I’ve transferred my right to receive these [trailing commissions] to another dealer.” From a technical perspective, the industry’s view was that “it doesn’t appear reasonable” or follow the legislation, he said.
Meanwhile, the CRA had been reviewing financial services, Nasir said.
Based on information from EY, Ryan Minor, tax director with CPA Canada in Sudbury, Ont., described what the CRA reviewed: National Instrument 81-105, which prohibits managers from paying trailers to dealers not obligated to make suitability determinations (effective June 1, 2022); Fund Fact documents, which describe trailing commissions as an ongoing cost for services and advice; and dealer billing practices that subtract trailers from fee-based accounts.
In subsequently reversing its stance on trailers and GST, “the CRA is saying … that something is being done to earn [trailers] other than acquiring a security,” Minor said.
EY’s tax alert on the CRA’s ruling letter to SIMA says the CRA’s view is that the provision of “investment account support” servicing and advice generally constitutes taxable asset management services for GST/HST purposes. The CRA told SIMA in December that this change was moving ahead, Nasir said.
The tax alert says upfront commissions (and upfront trading fees) would likely be exempt from GST/HST, given that arranging for the initial issuance of mutual fund units remains an exempt supply of a financial service.
“If the commissions were paid upfront, I don’t think there’d be any dispute that the commissions were earned for selling the units and arranging for the sale of the units and financial services,” Wilks said. “I don’t think the timing” — upfront or ongoing — “should necessarily change that characterization.” Conceptually, what advisors did to earn those fees is the same in either case, he said.
CRA’s interpretation questioned
EY’s tax alert says the CRA’s view is that its changed position correctly interprets the legislation, provides clarity and simplifies tax administration.
The agency’s interpretation is expected to be published in the coming weeks. Ahead of this story’s publication, the CRA didn’t respond to questions about the timeline for publication of the interpretation and whether the interpretation could change in the meantime.
Minor said he was told by the CRA that a GST/HST technical publication is also being drafted and will be published “in the near future.” The CRA’s changed stance is “big enough that they’re publishing a separate document on it,” he said.
“There are going to be a lot of parties … looking at what gets published by the CRA” so as to “really dig in to what they’re basing their new interpretation on,” said Rini Rashid, counsel, GST/HST and international trade, with McMillan LLP in Toronto. “We haven’t seen all of the supports they’re relying on and what their rationale is.”
Wilks said that “the most important thing” to a fund that pays trailers is that the mutual fund units were sold. “That’s what [the fund is] paying [advisors] to do,” he said. Courts have similarly taken this “reasonable” position, he said.
In a Jan. 8 letter to Finance, the CFFiM says, “The jurisprudence has clearly established that, for GST/HST purposes, a supply should be characterized from the perspective of the recipient of the supply.” As such, “it is very clear that the manager is paying the trailing commissions as consideration for the dealer distributing the units of the fund,” the CFFiM’s letter says. “The manager does not receive any separate or independent supply from the dealer; rather, the obligation to pay the trailing commissions arises solely and directly from the issuance of units to investors.”
When interviewed, Paglia said, “There is an inconsistency between what CRA is saying and what the tax case law is saying.” Resolving that so that tax law remains consistent “will likely require a legislative amendment — and that way it’s nice and clean,” she said.
When asked about the CRA’s review of trailers, Paglia noted the ongoing class actions for the payment of trailers to discount brokers. “That litigation focuses on securities law expectations,” not tax law, she said.
Further, “in this tug and pull between tax law and securities regulators’ expectations of services … what is the ultimate goal?” Paglia asked, in reference to net tax benefit revenue.
The CFFiM’s letter says that any GST/HST collectible on trailing commissions “would be fully offset by corresponding input tax credits claimed by the managers, resulting in no net fiscal benefit to the government.”
Moreover, “dealers and financial advisors required to collect GST/HST under the proposed policy change would themselves become entitled to claim additional input tax credits in respect of the costs incurred in providing their services to the manager, further reinforcing the absence of any net revenue gain,” the letter says. “In fact, creating an obligation to collect GST/HST under the proposed policy change may actually reduce government revenues by creating a currently non-existent input tax credit entitlement for dealers.”
A fund acquiring dealers’ services directly could take the position that the dealers’ services remain exempt financial services under the law, despite the CRA’s changed policy, Wilks said. The fund can then apply for the GST/HST paid in error to the dealers on the trailers, pursuant to Section 261 of the Excise Tax Act. If the CRA denied the rebates, the fund can file an objection to that assessment and ultimately even appeal the CRA’s decision to court.
“I do think there’s a good basis for winning at court,” Wilks said. “CRA’s view is not law.”
How taxpayers may challenge the CRA’s new stance is an open question, Rashid said. “I don’t think the CRA is going to publish something and that’s just going to remain as is, without any sort of additional engagement between industry and CRA,” she said.
Implementation deadline looms
As things stand, “there’s a lot of concern around the [July 1] timing” for implementation, said Nasir, in reference to changes to systems and internal processes. (EY’s tax alert provides a list of next steps.) “I’m not sure if the CRA has an appreciation for how difficult a task this will be.”
An emailed statement from SIMA said the association “has concerns that the implementation timeline is insufficient.”
EY’s tax alert says the CRA’s tax interpretation was shared with “relevant stakeholders. “But it hasn’t been shared with everybody,” Rashid said, “and there are probably a lot of stakeholders out there who haven’t seen it, and they will be expected to comply. Everybody gets the same … deadline imposed on them.”
Matthew Latimer, executive director of the Federation of Independent Dealers, said, “Industry-wide changes like this should be prepared for, planned, and enough timeline provided to enable some kind of project planning and implementation.”
This is “a burden issue, and I don’t think it’s been very well thought out by CRA,” Kent said. “I’m just hoping that common sense will rule the day.”