http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/100158/index.do
Invesco Canada Ltd. v. The Queen (December 23, 2014 – 2014 TCC 375, Campbell J.).
Précis: During the periods under appeal Invesco and its predecessors charged a basic management fee to mutual funds trusts. Where large investors (“Large Investors”) acquired an interest in the trusts, that fee was reduced in respect of those Large Investors (the amount of the reduction related directly to the size of the investment and could vary between Large Investors). Under the terms of the trusts amounts equal to those fee reductions were paid out by the trusts to the Large Investors concerned. At first blush this may seem somewhat byzantine but in reality it was simply a fair way of allocating the savings to the trusts. The savings arose dollar for dollar from the presence of the Large Investors; sharing that saving among all trust unit holders would mean that the Large Investors did not get what they bargained for and the other trust unit holders would get an undeserved windfall. The GST issue arose from the fact that CRA concluded that the distributions of savings to the Large Investors formed additional consideration payable to Invesco and its predecessors for the provision of management services and was therefore subject to GST in their hands.
The Court allowed the appeal with costs. It held that: “The proper interpretation of the legal documents relating to the relevant transactions, when taking into consideration the surrounding circumstances that existed when the contracts were formed, together with the conduct of the parties, is that the Appellant has properly charged, collected and remitted applicable GST based on the correct value of the consideration, which was the reduced amount of management fees charged to the Funds.”
Decision: This is a decision that provides a window into the activities of mutual fund trusts and their managers together with an illustration of the counter-intuitive approach that CRA sometimes takes to GST/HST assessments.
The appellant, Invesco Canada Ltd. (“Invesco”), was the successor corporation to one formed on August 1, 2000 on the amalgamation of Trimark Investment Management Inc. (“TIMI”) and Aim Funds Management Inc. (“AIM”). Originally the appeal covered the pre-amalgamation GST for both TIMI and AIM commencing on April 1, 1999 and the post-amalgamation GST of Invesco to the end of 2006. At trial for whatever reason Invesco elected not to pursue the AIM pre-amalgamation appeal.
During the periods under appeal Invesco and its predecessors charged a basic management fee to mutual funds trusts. Where Large Investors acquired an interest in the trusts, that fee was reduced in respect of those Large Investors (the amount of the reduction related directly to the size of the investment and could vary between Large Investors). Under the terms of the trusts amounts equal to those fee reductions were paid out by the trusts to the Large Investors concerned. At first blush this may seem somewhat byzantine but in reality it was simply a fair way of allocating the savings to the trusts. The savings arose dollar for dollar from the presence of the Large Investors; sharing that saving among all trust unit holders would mean that the Large Investors did not get what they bargained for and the other trust unit holders would get an undeserved windfall. The GST issue arose from the fact that CRA concluded that the distributions of savings to the Large Investors formed additional consideration payable to Invesco and its predecessors for the provision of management services and was therefore subject to GST in their hands.
In order to understand how matters came to this point it is necessary to look at the history which led to the current business model of Invesco and the trusts:
[16] Prior to 1995, the management fee reduction was achieved through a rebate from the Appellant to the Large Investors. Under this approach, the Appellant charged the Funds the full management fee as set out in the Management Agreement. The Appellant then paid the Large Investors a “management fee rebate”. In 1995, the Ontario Securities Commission (the “OSC”), along with other regulators within the industry, became concerned that this method of paying rebates to unitholders could trigger subsection 12(2.1) of the Income Tax Act (the “ITA”) and subject the Funds to a detrimental and unanticipated income tax inclusion. In a 1994 Technical Interpretation, the Canada Revenue Agency (the “CRA”) advised of the adverse income tax consequences and concluded that a double tax – one to the investors in receipt of management fee rebates and another to the trust funds ‑ would be the result.
[17] By correspondence dated June 29, 1995, the OSC wrote to Appellant Counsel with the following request:
4. Please disclose the fact that the repayment of management fees to an investor may trigger negative tax consequences to the investor and/or the Funds and provide an opinion from tax counsel or provide for an indemnification to the Fund from Trimark for any tax liabilities of the Funds with respect to the repayment of management fee.
(Joint Document Brief, Volume 1, Tab 1, page 2)
It became critical for this arrangement, that had been in place until 1995, to be revamped in order to avoid any risk of double taxation through the application of subsection 12(2.1) of the ITA. This provision provides that inducement payments or reimbursements made to beneficiaries of trusts are to be included in the income of the trusts. Since the management fee rebates to the Large Investors could be considered inducement payments meant to reimburse expenses of the trusts, pursuant to subsection 12(2.1), paragraph 12(1)(x) would cause those rebate amounts to also be included in the income of the Funds, resulting in double taxation of the rebate amounts. As a result, changes were introduced in 1995 in order to avoid the potential application of subsection 12(2.1). The Appellant had to alter the manner in which the management fee rebate amounts were made but, in doing so, the trusts were also constrained by subsection 104(7.1) of the ITA. As explained by Appellant Counsel in his opening submissions at paragraph 64:
… You will know that this provision would deny a trust the ability to deduct its distributions of income and net realized gains. The Funds would not want to lose those flow-through deductions for the whole fund in order to solve the large investor subsection 12(2.1) issue.
[18] To avoid these potential income tax consequences, the Appellant changed the method of making management fee rebate payments to unitholders in the Funds and instead, the Appellant/Manager was given discretion to negotiate with the Large Investors for a reduction in the management fee it charged to the Funds. This was in return for the Funds agreeing to make a distribution of the amount of this reduction to the Large Investors. Consequently, the Funds would then have additional resources to make special trust distributions to the Large Investors because the Appellant had reduced its fee for the services it was providing.
TIMI and AIM actually obtained an advance ruling from CRA confirming that the restructuring would not result in adverse income tax consequences; they did not however apply for a GST advance ruling.
[20] The Appellant sought and received an advance income tax ruling to ensure that this proposed new arrangement would not result in double taxation under the ITA (the “Ruling”). The Ruling confirmed the CRA’s view that these special Management Fee Distributions from the Funds to the Large Investors should be treated as trust distributions out of the mutual trust funds. Pursuant to subsection 104(6) of the ITA, the Funds would be entitled to deduct those payments.
[21] For income tax purposes, Management Fee Distributions were to be treated as trust distributions by the Funds and the Large Investors. Although this Ruling dealt only with subsection 104(7.1) of the ITA and the Appellant did not obtain a ruling with respect to potential GST implications, the fee arrangements at issue in these appeals are those that are the subject matter of the Ruling.
[22] The new arrangements were implemented through the following documentary changes:
1. The Declaration of Trust for a Fund was amended to (a) define “Management Fee Distributions” as a special subset of distributions available only to Large Investors and (b) require the Trustee of the Fund to make such distributions to Large Investors. (Joint Document Brief, Volume 1, Tab 5, Second Amendment to Declaration of Trust, paragraphs 2.1, 2.2 and 2.4).
2. The Management Agreement, between the Manager and the Fund, was amended to provide that the Manager may reduce the management fees at an annual rate, which is less than that rate otherwise paid by the Funds under a Management Agreement in respect of a particular unitholder, on condition that the amount of the reduction is distributed to that unitholder by the Fund (Joint Document Brief, Volume 1, Tab 6, Amendment to Management Agreement).
Invesco’s position was quite straightforward:
[23] The management fee paid by the Funds to the Appellant/Manager was the net management fee of “Factor A” (the maximum stated management fee that could be charged according to the Offering Documents) minus “Factor B” (the fee reduction amount offered to eligible Large Investors). This reduced amount was the sole consideration for the Appellant’s single supply of management services. The Management Fee Distributions were a separate transaction occurring between the Funds and the Large Investors and were distributions of trust income or realized capital gains of the Funds to the Large Investors. The Appellant’s fee was reduced at the point of sale and there were no subsequent adjustments or rebates that were paid. Consequently, the distributions were a separate supply and did not form part of the consideration provided to the Appellant for the supply of management services. …
The Crown’s position was somewhat strained:
[26] The Respondent argued that the Management Fee Distributions to the Large Investors did not represent a price adjustment for the management services that the Appellant offered and, therefore, did not reduce the value of the consideration payable by the Funds for the supply of the management services. There was no reduction in the total amount payable by the trust funds under the Management Agreement. The Funds paid the full management fee but to two different parties.
61. … The only change was that instead of being required to pay the total amount payable (i.e. the gross management fee) directly to the appellant (i.e. the supplier), the Trust was now required (or at least permitted) to instead pay one component of the gross management fee to particular investors (identified by the appellant) in the form of management fee distributions.
(Respondent’s Written Submissions, paragraph 61)
The second portion of the fee that was paid to the Large Investors at the Appellant’s direction was therefore part of the value of the consideration for the management services and upon which GST should have been remitted.
The Court reviewed the applicable law in considerable depth. In particular it focused on the recent Supreme Court of Canada decision in
Sattva Capital Corp. v Creston Moly Corp., 2014 SCC 53, dealing with the interpretation of contracts:
[42] Consequently, the Court must consider the commercial purpose, background and context of the transaction as well as the market in which the parties to a contract are operating. This goes back to the very basics of contract interpretation principles: contracts are never made in a vacuum.
[43] Words alone do not have an immutable or absolute meaning. Rather, their meaning should be considered against the backdrop of relevant contextual factors, including the purpose of the agreement and the nature of the relationship between the parties that is created by the contract. At paragraph 48 of
Sattva, Justice Rothstein reproduced the following passage by Lord Hoffman in I
nvestors Compensation Scheme Ltd. v West Bromwich Building Society, [1998] 1 All ER 98 (H.L.) as follows:
[48] …
The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. [p. 115]
[44] However, as Justice Rothstein concludes in Sattva, although surrounding circumstances will be a relevant consideration to contractual interpretation, they cannot be allowed to overwhelm the words contained in a contract. This principle would logically follow from the principle of giving words their ordinary and grammatical meaning, consistent with surrounding circumstances at the time of the contract formation. Otherwise, words in a contract would not be given their ordinary and grammatical meaning. In other words, courts cannot use surrounding circumstances to deviate from the text such that a new agreement is created. Specifically, Justice Rothstein had the following to say in respect to what a court can consider when interpreting a contract:
[57] While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement (
Hayes Forest Services, at para. 14; and
Hall, at p. 30). The goal of examining such evidence is to deepen a decision-maker’s understanding of the mutual and objective intentions of the parties as expressed in the words of the contract. The interpretation of a written contractual provision must always be grounded in the text and read in light of the entire contract (
Hall, at pp. 15 and 30-32). While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement (
Glaswegian Enterprises Inc. v. B.C. Tel Mobility Cellular Inc. (1997), 101 B.C.A.C. 62).
[45] As emphasized by Justice Rothstein at paragraph 58 of his reasons, evidence respecting surrounding circumstances will necessarily vary from case to case and will be limited to the objective evidence of the background facts at the time of formation and execution of the contract. This requires a court to look at the knowledge that the parties possessed or ought to have possessed, again, prior to and at the time of the contract formation. As noted in Sattva, considering surrounding circumstances, as an interpretative aid, does not offend the parol evidence rule, which excludes evidence of the parties’ subjective intentions and precludes considering evidence outside the words of the contract that would result in varying the contract in some manner. Absent ambiguity, the Court cannot consider the subjective intention of the parties to a contract nor their actions subsequent to contract formation. Although the Appellant relied on subsequent accounting documents and tax returns to support its position, since there is no ambiguity present in the documentation, I have placed no reliance on this portion of the Appellant’s submissions.
After a very extensive review of all of the Crown’s arguments the Court concluded that the evidence simply did not support the Crown’s position:
[84] Paragraph 9 of the Reply to the Notice of Appeal, although not an assumption of fact, states the Minister’s assessing position as follows:
9. The Minister determined that the appellant was required to collect GST from the mutual fund trusts (the “fund trusts”) calculated on the total management fees payable by the fund trusts to the appellant. The distribution of fund units or other amounts to certain investors (which the appellant has termed “Management Fee Rebates” or “Management Fee Distributions”) did not reduce the management fees payable by the fund trusts to the appellant. In computing net tax for the reporting periods under appeal, the appellant was required to include the full amount of GST collectible from the fund trusts.
This is consistent with the other referenced assumptions that the guarantee or obligation for the Funds to pay the Management Fee Distributions to the Large Investors had no value. It is not surprising, then, that there was no assumption pleaded that addresses the value of the obligation assumed by the Funds. Assumptions must be clearly worded and precise so that an appellant can know the case it will have to meet. Where none of the over two dozen assumptions address this matter even indirectly, the onus is with the Respondent to bring forward evidence of the value of the guarantee or obligation. The Respondent’s position, based on Roberge, is that the value of the guarantee is the full amount of the Management Fee Distributions paid to the Large Investors based on the purported existence of a legal obligation on the Appellant’s part to pay special distributions to the Large Investors. That purported legal obligation never existed between those parties. Consequently, the Respondent has failed to establish the value of the guarantee.
Conclusion
[85] Management Fee Distributions paid by the Funds to the Large Investors were not consideration for the Appellant’s supply of management services to the Funds. They were a separate payment made pursuant to the trust declarations governing the relationship between the Funds and the Large Investors. The Appellant, as Manager of the Funds, negotiated a reduced fee with the Large Investors and the Funds paid the money to the Appellant weekly and at the end of each month. That reduced fee was the amount that was charged by the Manager to the Funds and it is the only transaction which is subject to GST. The “cash fees” were the only consideration for the supply of management services that the Appellant was providing to the Funds. No other consideration was paid or payable. The proper interpretation of the legal documents relating to the relevant transactions, when taking into consideration the surrounding circumstances that existed when the contracts were formed, together with the conduct of the parties, is that the Appellant has properly charged, collected and remitted applicable GST based on the correct value of the consideration, which was the reduced amount of management fees charged to the Funds. This is consistent with my interpretation of the Management Agreement between the Funds and the Appellant as well as the Offering Documents.
As a result the appeals were allowed, with costs.
Comment: This decision makes a great deal of sense and I would expect it to survive an appeal on the part of the Crown, if one is taken. The structure adopted by Invesco works exactly the same way as if there were two funds, one for Large Investors and one for others. The Large Investors Fund would pay reduced fees and reduced GST; the other fund would pay the basic fees and full GST. [I acknowledge that I am ignoring for the purposes of this discussion the fact that fees payable by Large Investors could vary but this could be dealt with by the rather messy expedient of setting up several Large Investors Funds.] The method adopted by Invesco is simpler and assures that the savings from the fee reductions are passed directly to the persons who bargained for them. It is difficult to understand CRA’s position but that is often the case with GST/HST litigation, hence CRA’s propensity for retroactive legislation in the GST area.