Ontario and British Columbia have announced that they will be following the lead of Newfoundland and Labrador, Nova Scotia and New Brunswick by harmonizing their provincial sales taxes (each a "PST") with the federal Goods and Services Tax ("GST"), effective as of July 1, 2010, to form a single Harmonized Sales Tax ("HST"). The HST will combine a provincial sales tax component of 8% with the GST of 5% for a combined rate of 13% in Ontario, and a provincial sales tax component of 7% for a combined rate of 12% in British Columbia.
HST and investment funds
While the HST regime promises to simplify the sales tax collection process by implementing a uniform tax base and tax administration across federal and participating provincial governments, it will also result in a significant increase in taxes with respect to certain goods and services to which PST does not currently apply. For example, professional money management services provided to investment funds - which are currently subject to GST but not PST - will be subject, once the new legislation takes effect, to the higher rate of HST.
Investment funds (and thus, indirectly, mutual fund investors) currently pay GST at the rate of 5% on the management fees that they are charged by fund managers. The implementation of the HST in Ontario and British Columbia will mean that those fees will henceforth be subject to the higher HST rate, which will result in lower returns to investors. In Ontario, many industry professionals have noted that this tax will be hidden from investors because the Ontario Securities Commission obliges fund managers to report a single "management expense ratio" (MER) which includes the management fee (and all applicable taxes) and certain operating expenses of the investment funds.
Investment fund managers operating in Ontario or British Columbia will generally be required to charge HST to Canadian investment funds with respect to management services performed in Ontario or B.C. In those cases, the supply of management services will be subject to HST where (i) 90% or more of the services are performed by the investment fund manager in Ontario or B.C., as the case may be, (ii) the place of negotiation of the management services is located in Ontario or B.C. and a significant part (i.e. at least 10% according to the CRA) of the services are performed in that province, or (iii) the services are provided primarily (over 50%) in one or more of the HST provinces. However, a rebate for some or all of the HST (based on use in non-participating provinces) may be available on services consumed primarily outside the HST zone or for management services rendered to mutual funds where their beneficiaries are resident outside the HST zone. Considering that both the rebate and place-of-supply mechanisms are complicated, you are urged to consult a tax advisor to determine the specific tax consequences applicable to your specific situation.
In addition, it is noteworthy that investment funds that are considered to be residents of Ontario or B.C. could be subject to a self-assessment rule when they acquire services for consumption, use or supply primarily in an HST participating province (including Ontario and B.C.). Under the self-assessment rule, the HST is payable to the extent the services are used in participating provinces. A mutual fund company that is resident of Canada will be considered a resident of Ontario or B.C. for HST purposes if (i) it is incorporated or continued under the laws of Ontario or B.C.; (ii) its "mind and management" is situated in Ontario or B.C., or (iii) it has a permanent establishment in Ontario or B.C. (if it has a permanent establishment). Generally, a mutual fund trust that is a resident of Canada should be considered a resident of Ontario or B.C. for HST purposes where (i) the trustee or other legal representative who manages the trust or controls the trust assets resides in Ontario or B.C. (in this respect, it is worth noting that a recent case suggested that the central management and control test should also apply in determining the residence of trusts1) or (ii) the mutual fund trust has a permanent establishment in Ontario or B.C. (where applicable).
To potentially avoid the application of the self-assessment rule, mutual fund companies would have to move their permanent establishment and "central management and control" from Ontario or B.C. to another province (continuation under the laws of provinces other than Ontario or B.C. might also be required) and close their permanent establishment in Ontario or B.C. - a process that would be quite cumbersome. For mutual fund trusts, a change of trustees might be envisaged as well as the move of their permanent establishment, if any, outside Ontario or B.C. However, this will not help the fund in and of itself if the fund's managers are located in Ontario or B.C. and have to charge the HST on their services if the rebate mentioned above is not available. As the tax authorities might in certain circumstances regard such arrangements as unacceptable tax avoidance, investment fund managers are urged to consult a tax advisor to determine the specific tax consequences to them of the new HST regime and to review the options that may be open to them.
GST/HST on portfolio management fees - recent developments
In April 2009, the Federal Court of Appeal released its much-anticipated decision in The Queen v. The Canadian Medical Protective Association (CMPA).2 This decision potentially impacts the application of the GST (and the HST) on portfolio management fees and may affect investment management firms as well as their clients. In CMPA, the Federal Court of Appeal found that discretionary investment management services rendered through the management of either segregated or pooled funds are exempt "financial services" that should not be subject to GST or HST. The decision runs counter to the historical position taken by the federal tax authorities to the effect that investment management services are merely the provision of advice that is taxable for GST and HST purposes. In particular, the Court ruled that discretionary investment management services are directed at the "transfer of ownership or repayment of a financial instrument" and to the "arranging for" such services within the meaning of paragraphs 123(1)(d) and (l) of the term "financial service" in the Excise Tax Act (Canada) (the "Act"), and are therefore exempt from GST and HST under the Act. As a result, the Court concluded that such services do not constitute the "service of providing advice" under paragraph 123(1)(p) that is specifically excluded from the definition of "financial service" and are therefore subject to GST and HST.
Although the Minister did not appeal the Federal Court of Appeal's decision, the tax authorities have recently stated that they disagree with it and are disregarding the case - in other words, they are still of the view that such services currently remain fully taxable. As a result, it would be unwise for investment management firms to stop charging GST/HST on portfolio management fees at this time. Following the CMPA decision, many clients of investment management firms that receive discretionary investment management services and could not or did not claim an input tax credit were advised to apply for a rebate of GST or HST paid on these fees. Considering the tax authorities' position, it is unlikely that they will be granting rebates on this basis - and almost certainly not anytime soon.