A recent decision by the Canadian Federal Court of Appeal has thrown into question the practice by investment managers of charging clients GST on discretionary portfolio-management fees. The tax has been in place and routinely charged for 18 years.

The case involving the Canadian Medical Protective Association rocked the investment counselling industry when the federal appeal court decided that portfolio-management services rendered to the organization were “exempt” financial services that should not be subject to GST.

The association is a non-profit organization that provides professional liability protection to medical practitioners in Canada and collects contributions to form a reserve for potential claims. It retains the services of investment managers who invest the reserve funds on a discretionary basis.

The decision, which is not being appealed by the Canada Revenue Agency, contradicts the position taken by the CRA that investment-management services qualify as “advice” and thus are subject to GST. The court found that investment managers buy and sell securities on a discretionary basis and thus provide a “financial service”: such services are exempt from GST.

Thousands of clients may now qualify for a rebate from the CRA on GST collected on discretionary investment-management fees: however, the normal time limit for applying for such a rebate is only two years from the time the tax was paid.

Meanwhile, many investment-counselling firms are in a quandary as to whether they should continue to charge GST, fearing client backlash if the GST is no longer applicable.

“You would expect that taxation would be a black and white issue, but we are in a position where we don’t know if we should collect the tax or not, and trying to explain this to clients is extremely difficult,” says Katie Walmsley, president of the Investment Counsel Association of Canada.

“Most firms are continuing to collect [GST] until new direction is given by the Department of Finance or the CRA,” she continues. “The problem is that if they don’t collect and the CRA says they should, they would be in a position of having to collect back taxes.”

Although the CRA allowed the June 15 deadline to appeal the decision to the Supreme Court of Canada to pass, Walmsley adds, it’s possible that Ottawa could retroactively apply an amendment to the Excise Tax Act that would clearly make discretionary investment-management fees subject to GST.

In the meantime, the ICAC is sending regular communications to Ottawa, asking for clarity and reinforcing its view that the GST should not apply.

“In the absence of any intervention by the Government of Canada,” says Stephen Campbell, the CMPA’s director of finance and investments, “investment managers currently have no legal or statutory basis upon which to assess, collect and remit GST on services that, by definition, are exempt from GST.

“Indeed, given the fiduciary responsibility owed by the investment manager to a client where a fully discretionary relationship exists,” he notes, “the manager is prohibited from removing funds from the client’s account without a clear legal or statutory basis to do so.”

Two Canadian law firms that have commented on the issue, Stikeman Elliott LLP and Fasken Martineau DuMoulin LLP, say that based on the appeal court’s decision in the CMPA case, clients of investment-management firms may want to consider applying for a rebate of GST (or a QST rebate for Quebec clients) on portfolio-management fees as soon as possible to preserve their rights in case of a legislative amendment and because the limitation period to apply for a rebate is normally two years.

It’s possible that the statutory intention was always for portfolio-management fees to be subject to GST, and the CMPA decision has highlighted a loophole that will soon be closed by the federal government. Clients who believe they have paid GST erroneously may apply for a refund using Form GST 189, which is available from the CRA website.

Although the number of clients affected by the case is unclear, Investor Economics Inc. of Toronto estimates assets managed by private investment-management firms, including bank-owned firms, at about $150 billion. Annual fees generally range from 1% to 2% of assets.

Assuming a conservative 1% levy, such accounts would generate a total of $1.5 billion each year for the industry. If the industry collected 5% GST on these fees, that amounts to $75 million per year. IE