Given that financial services are exempt from GST/HST under Part VII of Schedule V of the Excise Tax Act, the “financial services” definition in section 123(1) is subject of regular litigation before the Tax Court.
In SLFI Group - Invesco Canada Ltd. (2017 TCC 78), the Tax Court of Canada recently had another opportunity to deal with these inclusions and exclusions in the financial services definition. In doing so, the Tax Court applied an unexpectedly broad interpretation of the exclusion found in paragraph 123(1)(q), which deals with the supply of “management services”.
On the facts, the appellants were various retail mutual funds (the “Funds”) and their manager, Invesco Canada Ltd. (the “Manager”). The Funds had no employees and the Manager provided management and administrative services (the “Management Services”) to each Fund pursuant to a management agreement (the “Management Agreement”). The Manager charged fees plus applicable GST/HST for its Management Services.
The Funds entered into a single recurring financing transaction (the “Financing Transaction”) which was carried out daily to finance upfront broker sales commissions. Citibank (a US financial institution) established Funding Corp (a non-resident of Canada, performing all of its services outside Canada), whose sole purpose was to participate in the Financing Transaction.
Under the Financing Transaction, Funding Corp agreed to arrange for the funding of the commissions (i.e., payment of the “Funding Amounts”) and, as consideration, the Funds paid a fee (the “Earned Fees”), which consisted of: (1) a percentage of the value of the securities in respect of which the commission was being deferred (the “Earned Daily Fee”) and (2) an amount equal to the redemption fees payable by an investor on early redemption of the securities (the “Earned Deferred Sales Charge (“DSC”) Fee”).
The fee payable by the Funds to the Manager for management of the Funds was reduced by the amount of the Earned Fees (i.e., the amounts that the Funds were paying Funding Corp).
The Funds were assessed on the basis that the Funds were the recipient of an imported taxable supply from Funding Corp, such that they were required to self-assess GST/HST on the Earned Fees (i.e. the Funds were receiving a Taxable Supply from Funding Corp). The Appellants took the position that the Earned Fees were not consideration for a taxable supply on the basis that the supply made by Funding Corp was an exempt financial service.
The relevant portions of the financial services definition in subsection 123(1) of the ETA are as follows:
financial service means
- the exchange, payment, issue, receipt or transfer of money, whether effected by the exchange of currency, by crediting or debiting accounts or otherwise,
but does not include
(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 services to the investment plan, corporation, partnership or trust,
The Appellants took the position that the Financing Transaction was merely the payment of money and not a supply. Alternatively, they argued that if there was a supply, it was an exempt financial service.
The Crown argued that the supply did not fall under any of the categories of financial service in paragraphs 123(1)(a) to (m); however, even if it did, the supply was not a financial service because Funding Corp provided other management or administrative services in accordance with paragraph (q) of the financial services definition, making it a taxable supply.
The Tax Court rejected the Appellant’s argument that the Financing Transaction was not a supply, and concluded that Financing Transaction resulted in the following services: (1) arranging for the funding; (2) receipt, processing and transmittal of the Funding Notices received from the Manager; and (3) depositing the Funding Amounts in an account.
The Court concluded that these services constituted a single compound supply whose dominant element was the daily payment of the Funding Amounts with immediately available funds. Accordingly, the central issue became whether that supply fell within the definition of a “financial service”.
The Court applied the general two-step approach endorsed by the Federal Court of Appeal in Great-West Life Assurance Company v. Canada (2016 FCA 316), by first considering whether the supply falls within one of the services outlined in paragraphs (a) to (m) of the definition; and after concluding that it does, then considering whether the supply also falls within one of the exemptions from the definition in paragraphs (n) to (t), thus making the supply not an exempt financial service.
The Court found that the supply was included in paragraph (a) of the definition; however, the supply was not a financial service because it was also included in paragraph (q). In particular, the supply constituted a “management service” delegated by the Manager to the Citibank entities (e.g., the Funding Corp. etc.).
In support of its conclusion that the payment of the Funding Amounts constituted a “management service”, the Court cited on the following facts:
- The Funds could not borrow money to pay the commissions and could not pay them out of their own assets – the Funds could only pay the Earned Fees because they were allowed to pay management fees.
- A prospectus for the Funds stated that the “Manager is responsible for the day-to-day business and operations of the Funds and for appointing any sub-advisors. We may hire third parties to perform some of our services.”
- The arranging for the payment of commissions was integral to the day to day business and operations of the Funds, and was therefore a management service, regardless of whether the Manager hired a third party to perform that duty.
This is a surprising result based our expected interpretation of paragraph (q) of the financial services definition. In our view, paragraph (q) was designed to (1) ensure that services in the true nature of management services (as opposed to services in the nature of financial services as enumerated in paragraphs 123(1)(a) to (m)) are not considered exempt financial services; and (2) ensure that fees paid to fund managers would always attract GST/HST regardless of whether some of the services provided by the manager could otherwise be considered financial services.
Subparagraph (q)(ii) appears to be designed to prevent the manager from attempting to separate an exempt supply from its taxable supplies, and charge separate consideration for that exempt supply to avoid charging GST. In fact, the Explanatory Notes referable to paragraph (q) state that the paragraph is “intended to ensure that the application of tax to such services is not circumvented by an “unbundling” of services provided to the entity.”
In any event, in light of this decision, funds and fund managers should re-analyze their management agreements, and explicitly indicate that the fund manager is not required to provide financial services that are provided by third parties. It appears that this result may have been avoided by explicitly stating in the management agreement that the payment of the Funding Amounts was excluded from the duties of the Manager.
The decision has been appealed to the Federal Court of Appeal.
* A version of this article appears in the June/July 2017 edition of the GST & Commodity Tax Newsletter.