Tax Insights: Canada Revenue Agency confirms that trailer fees, sales commissions and advisory fees paid to dealers and agents are GST/HST exempt

Issue 2022-23

In brief

A recent Canada Revenue Agency (CRA) GST/HST Interpretation has provided additional clarity on the GST/HST status of commissions and fees that are common in the mutual fund industry. The CRA confirmed that, in most cases, because the person receiving the payment is providing an exempt financial service, no GST/HST will be payable on:

• up-front sales commissions and trailing fees that are paid by:
  • a fund manager to a mutual fund dealer
  • a mutual fund dealer to independent sales agents
• up-front sales commissions and ongoing investment advisory fees that are paid by an investor to a mutual fund dealer and any fees that are shared by the dealer with the sales agent that facilitated the sale of shares or units of a mutual fund

The CRA also confirmed that a fund manager is required to charge and collect GST/HST on its provision of management and distribution services to a mutual fund. This is because the definition of a financial service excludes an “asset management service” and virtually all services that are supplied to an investment plan by a person that provides a management or administrative service to the investment plan.

In detail

In GST/HST Interpretation No. 187184, “Application of GST/HST to mutual fund trailing commissions in the mutual fund industry,” the CRA was asked to provide its views on the GST/HST status of various payments that are earned by a mutual fund dealer and shared with independent sales agents. In particular, the mutual fund dealer was requesting confirmation that up-front sales commissions, trailing commissions and certain advisory fees that are earned by a mutual fund dealer and its independent sales agents on the sale of mutual funds are exempt from GST/HST.

Are dealers providing an exempt financial service

Although “arranging for” the sale of a financial instrument (e.g. shares or units of a mutual fund) falls within the definition of a financial service, certain types of services are expressly excluded from being a financial service, including the provision of an “asset management service,” which is broadly defined as a service rendered in respect of a person’s assets or liabilities and that involves one of the following:

• managing or administering the assets or liabilities, irrespective of the level of discretionary authority
• providing research, analysis, advice or reports on the assets or liabilities
• determining which assets or liabilities are to be acquired or disposed of
• acting to realize performance targets or other objectives in respect of the assets or liabilities

As “trailing commissions” are often described in disclosure documents as being paid to encourage dealers to provide “ongoing services” and sales agents are responsible for providing a broad range of services (e.g. financial planning, tax and estate planning, portfolio selection, continuous monitoring and reporting), there has been some concern that the CRA would view these commissions and “advisory fees” as being subject to GST/HST.

By focusing on the essential character of what the dealer and sales agent provide and the reason they are being compensated (i.e. to sell mutual funds), the CRA ultimately concluded that both the dealer and sales agents were providing a financial service. In concluding that the dealer was providing an exempt financial service to the fund manager, the CRA reasoned that:

“[t]he essential character of the supply made to the manager under the dealer agreement would be the distribution of the fund’s shares or units [and that] [t]his would be the service that the manager is essentially paying for. Any other services provided would be ancillary to this purpose [and] [t]hus, the supply by the dealer to the manager would be arranging for a financial service i.e., the sale of shares or units of mutual funds.”

Accordingly, when the distribution agreement between the dealer and the manager entitles the dealer to receive trailing commissions, the CRA confirmed that no GST/HST would apply to trailer fees and only in “exceptional circumstances,” would a trailing commission be subject to GST/HST. Examples of an “exceptional circumstance” are when:

• the dealer receiving the trailing commission was not the person that facilitated the initial sale of the fund’s shares or units
• the dealer that facilitated the initial sale was not entitled to receive the trailing commission at the time of sale or pursuant to the relevant distribution agreement

In these instances, the compensation being paid to the dealer would not be deferred compensation for having “arranged for” the sale of shares or units in the fund and, as such, GST/HST would likely apply.

Fees paid by dealer to agent

In situations when an agency agreement between a dealer and an agent provides that the sales agent is responsible for soliciting potential investors, introducing them to the dealer and assisting the investor in purchasing mutual fund units or shares, the CRA concluded that the agent is providing an exempt financial service. The CRA also confirmed that the status of the service would not change “where the service includes certain ancillary services like meeting with the client, discussing the client’s needs, answering questions and providing other assistance.” Accordingly, the CRA confirmed that both an upfront commission and an ongoing trailing commission should be exempt unless the same “exceptional circumstances” previously described apply.

Investment advisory fees paid by investor to dealer and dealer to agent

For investments in a mutual fund that allow a dealer to charge an investor an upfront commission and an ongoing investment advisory fee (as opposed to a dealer charging a fund manager), the CRA concluded that the dealer is providing a financial service. The CRA stated that:

“[w]here under the agreement the dealer, or agent, solicits the investors for the purpose of investing in the mutual fund units or shares and assists in the purchase, redemption and exchange of mutual fund units or shares, this is considered to be a financial service of arranging for the sale of financial instruments.”

Similar to the CRA’s caveat for “exceptional circumstances,” the CRA confirmed that the ongoing investment advisory fee should be exempt unless there is a clear indication that the dealer is being compensated for supplying a separate and distinct service. For completeness, the CRA also stated that the same treatment would apply with respect to “the portion of the ongoing fee that is paid to any agent that was involved in the transactions.”

The takeaway

The GST/HST Interpretation provides a mutual fund dealer and its independent sales agents clarity that, except in “exceptional circumstances,” up-front sales commissions, trailing commissions and ongoing investment advisory fees that they earn on the sale of mutual funds will not be subject to GST/HST. Dealers and sales agents should review their agreements and consider whether there are any “exceptional circumstances,” which would result in GST/HST being collectible on the commissions and advisory fees that they earn.