The Government of Ontario has announced that, on July 1, 2010, it will replace the current Retail Sales Tax with a Harmonized Sales Tax (“HST”) that will be collected on a base similar to that of the Goods and Services Tax (“GST”). On July 23, 2009 Premier Gordon Campbell announced that B.C. would also be harmonizing its provincial sales tax on July 1, 2010. In Ontario the rate with be 13%, the current 5% federal GST plus the new 8% provincial tax. In B.C. the HST rate will be 12%, the current 5% federal GST plus the new 7% provincial tax. Neither province has offered many details with respect to the implementation of the HST.
Mutual funds will incur an extra tax burden where the fees charged by fund managers are subject to GST/HST, as funds are not entitled to claim input tax credits (“ITCs”) for the GST they pay now and the HST they will begin paying July 1, 2010.
For example on a $10,000 investment in a mutual fund with a 2-per-cent management fee, the combined tax rate would jump to $26 a year from $10 on top of the $200 management fee1.
Management fee is $10,000 @ 2% = $200
GST is $200 @ 5% = $10
total is $210
Calculation with an Ontario harmonized tax:
Management fee is $10,000 @ 2% = $200
HST is $200 @ 13% = $26
total is $226
Implementation of HST
As no implementing legislation has been announced so far, there is uncertainty as to what services will be taxed. However, it is very possible that Ontario and B.C. will follow the rules in the GST legislation that deal with the HST already adopted by three of the Maritime provinces. Based on that assumption, when HST is implemented in Ontario, mutual funds will likely pay an additional 8% on taxable investment management services. The HST will be collected on services where:
- all or substantially all of the service is performed in Ontario; or
- the place of negotiation for the service is in Ontario and 10-per-cent or more of the service is performed in Ontario2.
Based on that assumption, when HST is implemented in B.C., mutual funds will likely pay an additional 7% on taxable investment management services. The HST will be collected on services where:
- all or substantially all of the service is performed in B.C.; or
- the place of negotiation for the service is in B.C. and 10-per-cent or more of the service is performed in B.C..
Accordingly, the location of the offices and employees of the fund manager will provide the initial determination of whether or not HST is applicable.
A mutual fund resident in Ontario or B.C. will be required to self assess and remit the HST3 where the services of the fund manager are provided outside of that particular province. Therefore, the mutual fund will be required to pay HST if either the fund is resident in the province or the services of the manager are performed in the province. The Excise Tax Act (“ETA”) includes specific provisions to assist in the determination of the province of residence of a particular taxpayer. In general, where a corporation has been incorporated or continued under the laws of a particular province, it will be deemed to be a resident of that province. Additionally, a corporation or trust carrying on a business will be deemed a resident of a province in which it has a permanent establishment4. If the deeming rules do not apply, it will be necessary to consider common law principles to determine residency, primarily the location of the mind and management of the particular entity.
Where the services of the mutual fund manager are performed outside the province there is no requirement for that manager to collect the HST. Similarly, where the mutual fund itself is not resident in the province it is not required to self assess and remit the HST. There is currently no mechanism in the ETA whereby the mutual fund is required to self assess and remit a portion of the HST based on the holdings of its unit holders who are resident in an HST participating province. Therefore, if Ontario and B.C. adopt the same rules, there is a benefit to be derived from locating the fund and the fund manager outside of Ontario and B.C. To reduce this benefit, the ETA provides a rebate based on the proportion of the value of the fund held for the benefit of persons who reside outside a harmonized province5. This rebate should be considered in any planning discussions.
Exemption for Investment Management Services
The recent Federal Court of Appeal decision in The Queen v. The Canadian Medical Protective Association6 (“CMPA”) has provided some opportunities to minimize the GST and HST for services provided by discretionary investment managers as those services may be exempt from GST/HST where certain conditions are met.
The Tax Court concluded that the services performed were exempt supplies because the dominant supply was the transfer and the arranging for the transfer of ownership of the securities, and as such the services came under the definition of ‘financial service’7. That conclusion was based on the fact that the investment managers were provided full discretionary powers, that no advice was sought by or given to the CMPA and that the service supplied by the investment managers was the discretionary purchase and sale of securities.
The determining factor was the degree of control the investment manager has over the portfolio. CMPA hired the investment managers to manage the investment portfolio and the investment managers were given full discretion to manage the funds and purchase and sell the securities through the investment manager’s own trading desk or through brokers. Therefore the dominant service being provided by the investment managers was that of the “pick” or the expertise, including the research and analysis that ended in the trade. They used this experience, not to provide advice to CMPA, but to carry out the service it had been hired by CMPA to provide.
However, because of specific rules in the ETA, this decision will not apply where such services are provided to a mutual fund by or through the person who provides management or administrative services to the fund. As the fund manager generally provides all required services to the fund, it is unlikely, without restructuring, that mutual funds will be able to take advantage of this decision. Although CMPA has not been appealed, it is widely speculated that a retroactive amendment may be made to the ETA to legislatively reverse the decision. Accordingly, the possibility of the introduction of this type of legislation must be taken into account when considering taking steps to minimize GST/HST based on this decision.
Exempt Financial Services
In order to better understand the CMPA decision and to plan for the implementation of the HST in Ontario and B.C., the provisions that exempt certain financial services must be reviewed closely.
In order to be exempt, the service provided by investment managers needs to be a service listed in the definition of financial services in paragraphs (a) through (m). Paragraph (d) and (l) are the two provisions that may exempt services generally provided by investment managers.
(d) the issue, granting, allotment, acceptance, endorsement, renewal, processing, variation, transfer of ownership or repayment of a financial instrument,
(l) the agreeing to provide, or the arranging for, a service referred to in any of paragraphs (a) to (i),
Where the service qualifies as a financial service pursuant to paragraphs (a) to (m), then the exclusions in paragraphs (n) through (t) must be considered.
Provision of services to an “investment plan”
An “investment plan” is defined8 to include a number of vehicles in which funds are pooled and invested, such as a trust governed by a registered pension plan, registered retirement savings plan or mutual fund trust. Management or administrative services provided to any investment plan are subject to the GST/HST where paragraph (q) applies:
(q) The provision, to an investment plan (as defined in subsection 149(5)) or any corporation, partnership or trust whose principal activity is the investing of funds, of
(i) a management or administrative service, or
(ii) any other service (other than a prescribed service),
if the supplier is a person who provides management or administrative service to the investment plan, corporation, partnership or trust.
Note that if the investment manager provides its services to the unit holders or other investors the exclusion under paragraph (q) would not apply.
Provision of advice
If the service provided is strictly or primarily advice then it would be excluded from being an otherwise exempt financial service by paragraph (p).
(p) the service of providing advice, other than a service included in this definition because of paragraph (j) or (j.1)9,
Provision of prescribed services
A third exclusion found in paragraph (t) of the definition of exempt financial service excludes prescribed services. A “prescribed service” includes:
(a) the transfer, collection or processing of information, and
(b) any administrative service, including an administrative service in relation to the payment or receipt of dividends, interest, principal, claims, benefits or other amounts, other than solely the making of the payment or the taking of the receipt. Where the service is provided by a “person at risk,” then the exclusion in (t) does not apply, and the service is exempt from GST.
“Person at risk” is defined under subsection 4(1) of the Regulations to mean:
"person at risk", in respect of an instrument in relation to which a service referred to in subsection (2) is provided, means a person who is financially at risk by virtue of the acquisition, ownership or issuance by that person of the instrument or by virtue of a guarantee, an acceptance or an indemnity in respect of the instrument, but does not include a person who becomes so at risk in the course of, and only by virtue of, authorizing a transaction, or supplying a clearing or settlement service, in respect of the instrument.
As the mutual fund manager is not likely a “person at risk”, if the services fall into the exclusion under paragraph (t), the services would be taxable when provided to a Canadian resident and zero-rated if provided to a non-resident. There has been little judicial guidance with respect to the scope of "any administrative service" in the context of paragraph (t), however the Tax Court of Canada in Canadian Medical Protective Association v. R.,10 determined that, in this context, the phrase is to be narrowly construed and is intended to exclude from the exemption "such ancillary services as data processing, record keeping and the like". Accordingly, services which would be taxable under paragraph (q) as "management or administrative" when provided by a fund manager to the fund may not be considered taxable under paragraph (t) as "any administrative service" when provided to a unit holder.
Based on the CMPA decision, mutual fund managers may be able to take steps to minimize the tax charged to funds. If, under the current contracts, the fund manager is providing services which if provided by another entity or provided directly to the unit holders could be exempt, thought should be given to severing the taxable and exempt supplies. Where steps are taken to meet the requirements to exempt investment management fees, it will have a negative impact on the fund managers as the fund managers will no longer qualify to claim back the GST/HST the fund manager pays as ITCs. This cost must be factored into any planning models.
While the effective increase in the rate of GST/HST for funds and managers based in Ontario and B.C. gives greater incentive to consider means of avoiding this tax, caution is advised. Any planning decisions should not be made until after the draft legislation to implement the HST in B.C. and/or Ontario has not been announced; and a thorough review of the income tax impact to both the fund and the fund manager has been performed.