Principal Issues: Whether the CRA would be able to provide an interpretation that a certain rebate to be paid by a dealer to unitholders in a mutual fund trust would not be included in the income of the mutual fund trust pursuant to paragraph 12(1)(x) and subsection 12(2.1) of the Act.
Position: No, the CRA would not be able to provide such a technical interpretation.
Reasons: The wording of paragraph 12(1)(x) and subsection 12(2.1) are such that these provisions might apply in the situation described.
September 8, 2023
XXXXXXXXXX Income Tax Ruling Directorate Trust Section I Judith Harris
2023-098709
Attention: XXXXXXXXXX
RE: Application of Subsection 12(2.1) of the Income Tax Act to Trailer Fee Rebates
We are writing in response to your recent question regarding the application of subsection 12(2.1) of the Income Tax Act to rebates that may be paid by certain securities dealers to unitholders of mutual fund trusts.
This question arises out of recent changes made by Canadian securities regulators to certain rules that deal with mutual fund trailer commissions that are paid to securities dealers. We understand that trailer commissions or trailer fees may be paid by a mutual fund or its manager to dealers that have arranged for their clients to invest in the particular mutual fund. The new securities rules deal specifically with dealers that provide order execution only service (“OEO Dealers”). OEO Dealers do not make a suitability determination before arranging for a client to invest in a mutual fund; they simply execute orders on instructions from the client. The rules that were recently enacted by securities regulators across Canada impose a ban on the payment of trailing commissions to OEO Dealers effective June 1, 2022. This was done through an amendment to National Instrument 81-105 Mutual Fund Sales Practices.
We understand that during the period from June 1, 2022 to a later date specified by securities regulators, (initially November 30, 2023 but now extended in the case of Ontario to May 31, 2025), certain OEO Dealers and mutual funds are exempted from this OEO trailer ban where a trailing commission is paid by the mutual fund or its organization to the OEO Dealer to facilitate the OEO Dealer paying a rebate of such amount to its clients who held their investment in the mutual fund prior to June 1, 2022, and to clients who transferred mutual fund units held by them into OEO Dealer accounts on or after June 1, 2022 (“OEO Rebate”). For example, in Ontario, the Ontario Securities Commission implemented this exemption from the OEO trailer fee ban in the “Ontario Instrument 81-508 - Temporary Exemptions from the OEO Trailer Ban to Facilitate Dealer Rebates of Trailing Commissions and Client Transfers”. We understand that securities regulators in the other provinces and territories have implemented a similar temporary exemption and are providing extensions to the period during which this exemption applies that are similar to that in Ontario.
You have referred to subsection 12(2.1) of the Income Tax Act which can potentially apply to a mutual fund that is a trust where an amount such as a rebate is paid to a unitholder in the trust. Where this provision applies, the amount of the rebate would then be included in the trust’s income under paragraph 12(1)(x).
You have asked for our views on whether subsection 12(2.1) of the Income Tax Act would apply to require that an amount equal to the amount of an OEO Rebate paid by an OEO Dealer to a unitholder in a trust pursuant to the exemption from the trailer ban described above, must be included in the income of that trust pursuant to subsection 12(2.1) and paragraph 12(1)(x).
In our view, whether subsection 12(2.1) of the Income Tax Act would apply would depend on all of the circumstances in each particular situation. However, where an OEO Rebate is paid by an OEO Dealer to a unitholder in a trust, in the circumstances that we understand are involved in the above mentioned temporary exemption, we conclude that it is likely that the OEO Rebate would be considered to be in respect of the activities of the trust or in respect of an expense of the trust. In the result, subsection 12(2.1) would likely be considered to apply and the amount of the OEO Rebate included in the income of the trust pursuant to paragraph 12(1)(x).
Yours truly,
Marina Panourgias, CPA, TEP
Manager, Trust Section I
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch