The Canada Revenue Agency (CRA) says it will soon release information about GST/HST being applicable to trailing commissions, effective July 1.
The agency said in an email on Tuesday that it will release a letter to third-party tax publishers in February about the tax treatment of trailing commissions, and will post a notice and GST/HST news article on the CRA website by the end of March.
“These communications aim to clarify reporting obligations and emphasize compliance,” CRA spokesperson Nina Ioussoupova wrote.
The CRA’s email was in response to questions about its tax interpretation, delivered to the Securities and Investment Management Association in December. It said that mutual fund trailing commissions paid by fund managers to both original dealers and new dealers will generally be subject to GST/HST beginning in July.
“The update in the tax treatment of trailing commissions responds to the way the industry describes and regulates the service” that dealers provide, the CRA’s email said — a reference to providing ongoing investment account support and advisory services as opposed to arranging for the sale of mutual fund units.
“[T]he law has not changed. What is changing is the CRA’s administrative position,” said Simon Proulx, a tax partner with KPMG Law LLP in Toronto, in an emailed statement. “It remains to be seen whether or not this new interpretation will be challenged in the courts and by whom.”
Determining whether a supply of a good or service is exempt or not requires, in part, viewing the supply through “the lens of the recipient,” said Bobby Solhi, a partner with Cassels Brock & Blackwell LLP in Toronto. If the recipient — a fund manager in this case — is “receiving services for arranging the sale of a security, based on the tax jurisprudence, that would be an exempt financial service. That’s one part of the test.”
Ultimately, whether trailing commissions are taxable or not will “depend on the particular facts of the taxpayer. A lot of that will … turn on how the dealers or industry characterize their arrangements” in written agreements with fund managers, Solhi said.
If those agreements are characterized “as providing advice or management services,” those services are “likely going to be taxable rather than exempt,” in line with existing jurisprudence, he said. If agreements are “structured to be exempt,” including in the way services are described and operationalized, then trailing commissions may remain exempt.
The CRA’s updated position on mutual fund trailers fits with the agency’s “trend of auditing the financial services space” over the past several years to consider whether fees should be taxable, Solhi said. Whether the trend in this instance “results in positive net tax to the public purse … is to be determined,” he said.
Fund managers will “generally” be able to recover the GST/HST on trailers using input tax credits, the CRA’s email said.
Fund economics
Borden Ladner Gervais LLP has suggested that managers should assume that tax on trailing commissions will impact fund economics, either through unrecoverable tax or increased compliance cost and audit risk.
Proulx said that the potential impacts on the investment industry would be “significant from a tax compliance perspective, since most mutual fund dealers and advisors are not currently registered for the GST. Overall, this complex issue affects different types of businesses in different ways, depending on where they are in the supply chain of investment vehicles.”
Evelyn Jacks, founder and president of Knowledge Bureau in Winnipeg, writes in a recent online post that the CRA’s new position will “bring to the fore a whole new base of tax filers to audit in the future.”
The CRA’s new position doesn’t address a gap in tax collection or deliver a policy improvement, said a Jan. 23 letter to Finance and the CRA from the Canadian Independent Finance and Innovation Counsel Inc. “Instead, it simply transfers the remittance obligation to dealers, imposing additional operational burdens and costs without creating any incremental value or benefit.”
The burden on dealers is “particularly acute,” the counsel’s letter said, given preparations for total cost reporting. Dealers will have to “modify client-facing reporting systems to remove GST/HST amounts from reported costs.”
For investors, the CRA’s change won’t mean higher returns or reduced tax burden, the letter said. “On the contrary, investors are likely to be indirectly negatively impacted, as the significant costs associated with redesigning systems and processes will ultimately need to be absorbed or recovered by dealers.”