CRA to enforce GST/HST on mutual fund trailing commissions in 2028

Mutual fund dealers, advisors and fund managers have a year and a half to implement changes needed to comply with the Canada Revenue Agency’s (CRA) enforcement of GST/HST on mutual fund trailing commissions.

In a notice on Tuesday, the CRA says it will enforce GST/HST on mutual fund trailing commissions on Jan. 1, 2028.

Still, the notice encourages dealers to “apply this tax treatment as soon as possible,” adding that “there are circumstances where trailing commissions were already taxable, and the tax status for those supplies has not changed.”

The notice also confirms that independent advisors who aren’t dealer employees will have to register for GST/HST, and apply, collect and remit the tax on trailing commissions.

Tariq Nasir, EY Canada’s indirect tax partner in Toronto, said in an email that based on his conversations with industry clients, “they are pleased with the CRA’s revised timeline to implement its interpretive position … as this will provide them with additional time to comply.”

In an email, Laura Paglia, president and CEO of the Canadian Forum for Financial Markets, said, “The anticipated additional time is appreciated by many.”

The CRA’s enforcement of GST/HST on trailing commissions had previously been slated for July 1 of this year. A CRA notice in February 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.

Then, earlier this month, the agency postponed the July enforcement date after ongoing consultations with the industry. Most mutual fund dealers and advisors haven’t previously been registered for GST/HST. The changes required to update processes and systems are significant, and come as the industry prepares for total cost reporting.

The CRA’s longstanding position on mutual fund trailing commissions (confirmed in 2022) had been that they 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 administrative 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.

Tuesday’s notice says upfront trading fees remain exempt from GST/HST, given that arranging for the sale of mutual fund units generally remains an exempt supply of a financial service.

Legal interpretation about an exempt supply remains a point of contention.

“According to the jurisprudence, [a supply] is to be considered from the fund manager’s perspective,” Paglia said in her email on Tuesday. Fund managers “are paying the commission for units to be issued, held and ultimately redeemed through the dealer. In other words, they are paying for distribution, which is exempt. CRA’s interpretation recharacterizes the same payment.” From the CRA’s perspective, the predominant element is the continuing services that dealers may supply, she said.

The CRA’s notice explicitly states that the industry changed how it characterizes these services in exchange for trailing commissions.

“It is a fundamental difference in whether ongoing services or past distribution is really what ‘earns’ the payment” of trailing commissions, Paglia said.

Potential for enforcement before 2028

In Tuesday’s notice, the CRA said it will enforce GST/HST on trailing commissions before 2028 in cases where the dealer treated the trailing commissions as taxable by claiming input tax credits (ITCs) for GST paid that relates to providing services for the trailing commissions.

That may mean dealers presently registered for GST/HST should be “extremely careful” in determining how they claim ITCs, Nasir said. He gave the example of a dealer that erroneously or inadvertently claims an ITC for GST/HST paid this year on licensing fees for software that’s used in both the dealer’s trailing commissions business and other taxable business (with no apportioning of the licensing fees).

“An error or inadvertent [ITC] claim could trigger a GST/HST collection and remittance obligation that [the dealer] may not be aware of until much later” — potentially during a subsequent audit, he said. “This could result in future significant assessments for non-collection of GST/HST (with interest).”

And if the CRA assesses a dealer for non-collection of GST/HST retroactively, the potential for future GST/HST litigation arises, “especially given that the legislation has not changed,” Nasir said. “Furthermore, this logic could be extended to independent advisors.”

Also, trailing commissions can be paid in respect of other financial products, the notice says. “The tax status of services supplied in exchange for other types of trailing commissions will be considered on a case-by-case basis,” it said.

This statement may require further clarity, Nasir said, “as the existing language may leave it up to auditors to make that determination on whether trailing commissions, outside of mutual funds, should be subject to GST/HST. This could lead to future assessments (and litigation) in other areas, beyond the mutual fund world.”