CRA to postpone enforcement of GST/HST on trailing commissions

Mutual fund dealers, advisors and fund managers now have breathing room to implement changes needed to comply with the Canada Revenue Agency’s (CRA) enforcement of GST/HST on mutual fund trailing commissions, which was slated for July 1.

On Wednesday, the CRA “verbally informed various industry groups that it intends to grant a material extension to the implementation deadline for the application of GST/HST to mutual fund trailing commissions,” an EY tax alert said on Thursday.

According to EY, the CRA also said it will “provide further details with respect to the enforcement of its administrative position in a notice that will be published by the end of the month.” The federal agency didn’t immediately provide requested comment.

“I can’t think of one client that actually said they could comply by the July 1 deadline,” Tariq Nasir, EY Canada’s indirect tax partner in Toronto, said in an interview. Implementing GST administration for trailing commissions, which involves third parties, is like “peeling an onion,” he said.

The CRA heard from and met with industry groups over the past few months to understand why they needed more time to comply, Nasir said. He expects the CRA will announce a future date — longer than “just a few months” — for the enforcement of GST on trailing commissions, he said.

“Assuming there are no surprises” when the CRA releases its notice later this month, the industry is “pretty happy with this outcome,” Nasir said.

Matthew Latimer, executive director of the Federation of Independent Dealers in Toronto, said in an emailed statement that the federation “welcomes the news of an extension to the deadline originally proposed by the CRA, and we look forward to further details as they become available.”

“This extension is a welcome and necessary pause,” Laura Paglia, president and CEO of the Canadian Forum for Financial Markets (CFFiM), said in an emailed statement. “The change imposes administration costs on dealers and advisors without net revenue gain for government.”

“Industry will welcome the extension … and will await the additional details expected in the formal notice later this month,” said Owen Clarke, counsel, national leader, commodity and indirect tax, with Borden Ladner Gervais LLP (BLG) in Calgary, in an email. However, given the “significance” of the operational changes required to comply with the GST reporting, “affected stakeholders should continue their efforts to implement the necessary changes to their tax compliance processes.”

His clients are focused on complying with the CRA’s revised position on GST and trailing commissions, Clarke said.

In a February notice, the CRA had said GST/HST on mutual fund trailing commissions would be enforced beginning in July, and that dealers should apply the tax “as soon as possible,” given trailing commissions were already taxable in some circumstances.

That notice had confirmed a tax interpretation that the agency provided to the Securities and Investment Management Association (SIMA) last December, saying that mutual fund trailing commissions paid by fund managers to both original and new dealers would generally be subject to GST/HST beginning July 1.

Previously, the CRA’s longstanding position (confirmed most recently in 2022) was that trailing commissions were exempt from GST/HST because they were paid for helping with the issuance of mutual fund units — an exempt supply of a financial service. (An exception was when trailing commissions went to a new dealer of record not responsible for the initial sale — a position that SIMA had sought clarity on.)

In changing its position, the CRA said regulatory and operational changes in the mutual fund industry now indicate that dealers generally provide ongoing services in exchange for trailing commissions, as opposed to arranging for the sale of mutual fund units. The agency cited, for example, the prohibition on the payment of trailing commissions to discount brokers (effective June 2022), because those brokers don’t provide advice.

Extra work and cost

The July 1 deadline for the CRA’s enforcement of GST on trailing commissions meant extra work and cost for the industry — and on a tight timeline. Mutual fund dealers and advisors who exceed the $30,000 taxable supply threshold over a 12-month period are required to register for GST/HST and charge, collect and remit the tax on trailing commissions received, as well as track input tax credits (ITCs) and maintain associated documentation. Most fund dealers and advisors weren’t previously registered for GST/HST.

Failure to comply could result in penalties and interest. Dealers would also now face GST audit risk.

The CRA previously told this publication that fund managers would generally be able to recover the GST/HST charged on trailing commissions by using ITCs. But BLG had suggested that managers should assume that tax on trailing commissions will impact fund economics, either through unrecoverable tax or increased compliance cost and audit risk.

Complicating the matter for managers and dealers further was that the CRA’s notice came as the industry prepared for total cost reporting.

Before the CRA published its technical interpretation and February notice, the industry had “clearly articulated” to the agency, during consultations, that the implementation period was too short, Clarke said in his email. As a result, while the CRA’s deferral is ultimately welcome, it “may nonetheless give rise to some frustration within the industry,” he said. “More broadly, the pattern of announcing deferrals to significant tax changes after their initial release is unfortunate.”

In recent years, dropped proposed capital gains tax changes and bare trust reporting have been two such sore spots for taxpayers that resulted in wasted efforts and cost (in the case of bare trust reporting, cumbersome legislation was at fault).

When asked if the CRA’s stance on GST applying to trailing commissions could give rise to court challenges, Clarke said it could.

From a technical perspective, “the fact that this change has been introduced through a CRA ruling rather than a legislative amendment” could provide the basis for a court challenge, he said.

“In particular, existing jurisprudence has recognized trailing commissions as exempt financial services, and has emphasized that the characterization of a supply should be determined from the perspective of the recipient, rather than solely by reference to the supplier’s activities — an approach that appears to have been adopted in the technical ruling underlying this change.”

In a Jan. 8 letter to the Department of Finance, the CFFiM said the jurisprudence “has clearly established that, for GST/HST purposes, a supply should be characterized from the perspective of the recipient of the supply.” As such, “it is very clear that the manager is paying the trailing commissions as consideration for the dealer distributing the units of the fund.”

In her emailed statement on Thursday, Paglia referenced that letter and said the CFFIM encourages policymakers to use the CRA’s deadline extension as “an opportunity to realign the approach [to GST and trailing commissions] with the statutory interpretation framework mandated by the courts, which treat trailing commissions as exempt.”

In an announcement last month, Revenu Québec said it was aligning with the CRA’s tax treatment of trailing commissions for the purposes of Quebec sales tax, enforceable as of July 1.

“Stakeholders will also be watching for corresponding announcements from Revenu Québec” in line with the CRA’s deadline extension, Clarke said.