The Tax Court of Canada's recent decision in Invesco Canada Ltd. v. The Queen1 confirms that GST applies only to the net management fees paid by a mutual fund trust to its fund manager where the normal management fees are reduced, at the discretion of the manager, as a special distribution paid directly by the mutual fund trust to "large investors" such as pension funds and other sophisticated investors.

Facts and background

Invesco Canada Ltd. ("Appellant") provides management services to various mutual fund trusts (the "Funds"), for which it charges management fees that are fully taxable from a GST standpoint. Typically, a manager will base the fees that it charges for managing the day-to-day business activities of a fund on the value of all of the managed assets. However, in order to attract pension funds and other large sophisticated investors (the "Large Investors"), managers generally agree to reduce the management fees that apply with respect to their investments. The Appellant achieved this result in the present case by granting management fee reductions to the Funds with respect to Large Investors. The Funds then made management fee distributions (the "Management Fee Distributions") to the Large Investors in amounts corresponding to the reductions that they had been granted by the Appellant.

The Appellant had been distributing management fee rebates in this manner since 1995. Prior to that time, it had charged the Funds the management fees on a gross basis and paid the management fee discount directly to the Large Investors. While this method was arguably simpler, it created adverse income tax consequences not only for the Large Investors but also for the Funds. The new method was implemented in accordance with an advanced income tax ruling confirming that it would not trigger adverse tax consequences.

The reassessment

The Appellant collected and remitted GST on the net portion of the management fees only. The issue was whether GST should have been collected on the gross management fees (i.e. fees in the amount that would have been paid to the Appellant by the Funds if there had been no reduction for Large Investors). On the basis that GST should have been collected and remitted on the gross management fees rather than merely on the net fees, the Minister of National Revenue (the "Minister") reassessed the Appellant for the uncollected GST.

The Minister's reasoning

According to the Minister, the Management Fee Distributions were neither the result of a price adjustment in respect of the management services nor a separate supply, with the result that the consideration paid by the Funds for the management services rendered by the Appellant should be equal to (i) the portion directly paid to the Appellant, plus (ii) the Management Fee Distributions. In fact, the Minister alleged that the Funds were assuming a liability of the Appellant that was owed to the Large Investors. In other words, the Funds paid the full management fee, but to two parties rather than one. The Minister argued that, from an economic standpoint, the Funds would never benefit from the fee reduction since they had an obligation to distribute a corresponding amount to the Large Investors.

Response of the Appellant

In response to the Minister's position, counsel for the Appellant argued that a Management Fee Distribution was a separate transaction from the payment of the management fees - a distribution of the trust income or realized capital gains rather than a distribution of a portion of the consideration for the services rendered. The legal documents and the conduct of the parties showed that (i) the fees were reduced at the point of sale, and (ii) by paying the Management Fee Distributions, the Funds were avoiding the adverse income tax consequences that the old method had created rather than assuming a liability of the Appellant that was owed to the Large Investors.

Decision

In order to assess the value of the consideration paid by the Funds to the Appellant for the management services, the Court analyzed and interpreted the legal documentation that was in place and which defined the legal rights of the Appellant, the Funds and the investors. It focused on three documents in particular: (i) the amendment to the declaration of trust, (ii) the amendment to the management agreement, and (iii) the confirmation letter forwarded by the Appellant to the Large Investors (collectively, the "Documentation").

The amendment to the declaration of trust triggered the Funds' obligation to pay the Management Fee Distributions to the Large Investors as a subset of the ordinary trust distributions. In the case of the amendment to the management agreement, it provided that the Appellant had the discretion to reduce the management fees charged to the Funds on the condition that the Funds distribute the corresponding reduction to the Large Investors. Finally, the confirmation letter basically confirmed that the Large Investors would be entitled to the Management Fee Distributions (as set out in the prospectus) as negotiated between the Appellant and the Funds.

The Court mentioned that nothing in the confirmation letter should imply that the Appellant had a legal obligation to cause the Funds to pay the Management Fee Distributions or to pay an amount to the Large Investors. The obligation to pay distributions resulted from the amendment to the declaration of trust and it was the trustee of the Funds who had the ability to determine the timing and amount of the distributions, not the Appellant. Thus, one could not conclude that the Funds were assuming the Appellant's liability through the payment of the Management Fee Distributions, given the discretionary power that the Trustee possessed with respect to such distributions.

Although the amendment to the management agreement specifically provided that the rebate was to be granted to the Funds on the condition that they distribute a corresponding amount to the Large Investors, such mention was only made in order to avoid unwanted tax treatment and to prevent any challenge of the arrangement between the Appellant and the Large Investors by the retail investors.

Based on the Documentation and the surrounding circumstances at the time, the Court held that the consideration paid by the Funds was equal to the net (or reduced) amount of the management fees and that, a fortiori, the Management Fee Distributions paid by the Funds to the Large Investors were not consideration for the management services rendered by the Appellant. Campbell J. stated:

Management Fee Distributions paid by the Funds to the Large Investors were not consideration for the Appellant's supply of management services to the Funds. They were a separate payment made pursuant to the trust declarations governing the relationship between the Funds and the Large Investors. The Appellant, as Manager of the Funds, negotiated a reduced fee with the Large Investors and the Funds paid the money to the Appellant weekly and at the end of each month. That reduced fee was the amount that was charged by the Manager to the Funds and it is the only transaction which is subject to GST. The "cash fees" were the only consideration for the supply of management services that the Appellant was providing to the Funds. No other consideration was paid or payable. The proper interpretation of the legal documents relating to the relevant transactions, when taking into consideration the surrounding circumstances that existed when the contracts were formed, together with the conduct of the parties, is that the Appellant has properly charged, collected and remitted applicable GST based on the correct value of the consideration, which was the reduced amount of management fees charged to the Funds. This is consistent with my interpretation of the Management Agreement between the Funds and the Appellant as well as the Offering Documents.(our emphasis)

Conclusion

This case reminds us of the importance of properly structuring legal relationships between parties. In the case at hand, the line between management fee reductions (paid through distributions) being part of the consideration on which GST/HST (or even QST in Quebec) should have been applied and their not being part of such consideration is thin. The only way to avoid unwanted results is by ensuring that the legal documents are correctly drafted. In this respect, in order to achieve the same result obtained by the Appellant, the legal documents and agreements, as a whole, should provide inter alia that:

  • There is no obligation, legal or otherwise, for the fund manager to pay any amounts (including distributions or other payments) to the investors;
  • the fund (and not the manager) has the legal obligation or liability to pay the special distributions (as management fee reductions), as trust distributions, to the investors; and
  • the fee charged by the manager to the fund and the amount that the fund is liable to pay to the manager for the management services is equal only to the reduced amount, if any. In other words, the fees are discounted at the point of sale.