December 21, 2012
Fund managers and insurance companies may soon need to change their systems and processes for upcoming GST/HST and QST changes. With these changes coming up in 2013, managers of investment plans, like mutual funds, segregated funds, exchange traded funds (ETFs) and unit trusts, face new challenges relating to indirect taxes.
Your business may have to adjust its systems and processes for the upcoming 2013 GST/HST and QST changes if it:
- Provides investment management services
- Is a mutual fund
- Is an exchange-traded fund (ETF)
- Is a segregated fund.
|Indirect tax changes across Canada|
Investment plans have had to deal with significant changes to the GST/HST rules over the last few years and more changes are coming in 2013.
This TaxNewsFlash-Canada highlights significant changes to the Quebec Sales Tax (QST), British Columbia’s return to the GST and PST and Prince Edward Island’s harmonization with the GST on April 1, 2013, and reviews some of the common indirect tax challenges for investment managers and investment plans arising from both the recent and upcoming changes.
Quebec Sales Tax
Quebec will amend its Quebec Sales Tax (QST) effective January 1, 2013 to further harmonize the QST rules with the federal GST rules. The most significant change is the change to the tax status of financial services from zero-rated to QST-exempt. Financial institutions and other businesses that provide financial services will be affected by this change. Some of the effects of this change are:
- Most entities providing financial services will no longer be entitled to claim input tax refunds (ITRs) for QST paid on costs related to their financial services.
- Many entities will face new QST rules. Many of these new rules apply differently based on the type of financial institutions.
- Many entities will now qualify as Quebec selected listed financial institutions (SLFIs) and as such will be subject to the new Quebec special allocation method (SAM) formula.
- Many pension plans face new QST rules for rebates and new filing requirements.
- Some entities outside Quebec will have to register for QST purposes.
- Some entities in Quebec will either have to cancel their QST registration or apply for GST/HST registration, if applicable.
- The GST/HST and QST of SLFIs will be administered by the Canada Revenue Agency.
SAM formula for Quebec SLFIs
SLFI investment plans that have investors in Quebec will generally have to allocate an amount in the element of “C” of the SAM formula.
As such, SLFIs registered for GST purposes will be required to register for QST purposes as of January 1, 2013 if they will have to allocate to Quebec an amount in the element “C” of the SAM formula. Similar to the federal rules for the provincial component of the HST, Quebec SLFIs will not be entitled to claim ITRs and will instead calculate QST liability or refunds with the Quebec SAM formula, which appears to be similar to the federal SAM formula.
Non-SLFI investment plans that only have investors in Quebec and in another province will also be Quebec SLFIs. As such, it appears that some entities could be Quebec SLFI and non-SLFI for GST purposes.
|KPMG observation |
Quebec recently adopted many new provisions to amend the QST. Unfortunately, many expected QST amendments are still outstanding. We understand that Quebec’s bill to enact the QST changes includes provisions that are currently law for GST purposes and that Quebec will also adopt upcoming federal amendments at a later date and make them applicable as of January 1, 2013. Because more than 100 pages of federal regulations for financial institutions are still in draft form, many details and forms that will apply as of January 1, 2013 are still outstanding.
Businesses should carefully review their obligations for QST purposes and take the appropriate steps to alleviate potential QST issues.
Investment managers’ GST/HST rates
Many managers of investment plans collect the GST/HST on their management fees based on “blended rates” rather than the rate of GST or HST applicable to the province where the funds are actually located. With the upcoming amended QST on January 1, 2013, the transition in British Columbia from the HST back to a GST and a new B.C. provincial sales tax (PST) system and the introduction of the new HST in Prince Edward Island on April 1, 2013, fund managers will have to carefully calculate their blended rates for most funds effective January 1, 2013 and April 1, 2013.
|KPMG observation |
As noted above, the QST legislation is still missing many amendments, including the ones related to some elections for managers and investment plans. Based on Quebec’s news release, the province plans to harmonize its rules with the federal financial institution regulations as of January 1, 2013. As such, managers should conform with the financial institution rules and remit any QST owing to avoid potential penalties and interest. However, it is still unclear at this time how the managers must register and how to remit QST owing.
Understating blended rates could result in assessments of uncollected tax and interest that fund managers may not be able to recover from their investment plan clients. Also, overstating blended rates can lead to overstated management expense ratios (MERs).
Issues for investment plans
Investment managers also have to deal with several different indirect tax-related issues for their investment plans based on the type of their investment plans, the residency of their unit holders and the amount of information they receive from their unit holders, as well as whether they have new or merged plans.
Is the investment plan a SLFI?
One of the first indirect tax-related issues to determine is whether an investment plan qualifies as a selected listed financial institution (SLFI). An investment plan with unit holders in an HST province and a non-HST province will generally be considered a SLFI.
As a SLFI, an investment plan must calculate its liability for the provincial component of the HST (PVAT) in each HST province by using a formula called the Special Attribution Method (SAM). The formula allows for the deduction of the actual PVAT paid by the investment plan during the reporting period.
The result of the SAM formula, either an amount owing or a refund of PVAT, may be transferred from the investment plan to its investment manager who will include that amount in its net tax to be remitted, subject to certain conditions.
If the investment plan does not qualify as a SLFI, the investment plan will have to apply other rules to determine the rebate or payment of tax for goods and services acquired in one province for use in another one.
Calculation of provincial attribution percentages
In order to apply the SAM formula, a SLFI investment plan must first calculate its provincial attribution percentage for each HST participating province.
Many SLFI investment plans require information from their unit holders to fulfill their GST/HST requirements for the upcoming year. Some investment plans are required to make a written request to certain unit holders. However, some other unit holders are required by law to submit some information without receiving a written request from the plans. The requirements differ based on the type of unit holders, and the amount and the total value of the units they hold.
|KPMG observation |
When the draft federal financial institutions regulations become law, severe penalties may apply if unit holders do not provide the required information. Unit holders may wish to carefully review and determine their requirements and responsibilities in light of the expected upcoming release of these final regulations.
Inadequate unit holder information may increase tax liability
Investment managers have to carefully review the information sharing rules that apply to them and request the appropriate information from the appropriate unit holders for their investments plans. Where an investment plan does not have adequate unit holder information, the manager’s calculation of the provincial attribution percentage for the particular investment plan will generally have to allocate a percentage of these unit holders to the province with the highest tax rate, thus increasing the plan’s tax liability.
Should plans make a non-resident investors election?
Investment plans may wish to perform a cost-benefit analysis to determine whether an election related to investors that are non-residents of Canada may be beneficial.
In general, when a SLFI investment plan calculates its provincial attribution percentage, units held by non-residents of Canada are deemed to be held by unit holders resident in Canada in a non-HST participating province. However, to determine input tax credit eligibility in respect of units held by non-residents of Canada, these units are considered to be held by residents of Canada, thus reducing potential input tax credits. Investment plans must establish whether making an election could help them maximize input tax credits.
Different rules for exchange-traded funds
The general rules for the calculation of the provincial attribution percentage for exchange-traded funds (ETFs) have two significant differences from the rules for other investments plans.
First, a series of an ETF or an investment plan that is an ETF has a minimum of two attribution points. The attribution point is the date used to calculate the provincial attribution point.
Second, unlike mutual fund trusts, there is generally no “look through” rule for ETFs with regard to investors. The issue is that a significant portion of ETF units may be held by financial institutions. The residency of these corporations is based on their principal business location, which is used to determine the provincial attribution percentage of ETFs. By using a “residency” test and not a “look through” test that would look through to the specific provincial attribution percentage of these institutions, ETFs can end up with significantly high provincial attribution percentages for the province in which these financial institutions have their principal business location.
However, an ETF may apply to the CRA to use an alternative method to calculate its provincial attribution percentages for the fund or series of the fund where the results using the general method would provide inappropriate results.
New, merged or wound-down investment plans
The rules to calculate the provincial attribution percentage of new plans or new series of a plan will differ depending on whether the new plan or new series is create by way of a merger.
Based on a “reconciliation method”, a new investment plan or series would be allowed to estimate its provincial attribution percentages for a transitional period (i.e., 90 days) and would then be required to do a reconciliation after 90 days.
Other special rules apply for new investment plans or new series of an investment plan created by way of a merger.
Investment managers of new investment plans must ensure that the provincial attribution percentages are determined correctly and that any applicable elections are filed on time.
In general, many financial institutions are not required to register for GST/HST purposes if they don’t make taxable supplies in Canada in the course of commercial activities. However, in some circumstances, some investment plans may be required to register. Where an investment plan is not required to register, it may voluntarily register in some cases.
Some SLFI investment plans may benefit from being GST/HST registered. In many instances, investment plans may choose an annual reporting period instead of monthly or quarterly reporting periods, thus limiting their compliance requirements. Also, some elections are available to SLFI investment plans and their managers that will help alleviate some of their compliance burden by having the managers fulfill specific requirements on behalf of the plans.
However, where an investment plan is not a SLFI, being registered may create an additional annual filing requirement for some entities.
Investment plans should carefully review their obligations and their options to determine whether they are required to register or whether they should apply to voluntarily register.
We can help
KPMG can help fund managers determine the effects of provincial harmonization and deharmonization on their blended rates. KPMG can also help investment plans understand all the indirect tax changes that will affect them shortly. For details, contact your KPMG adviser.
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Information is current to December 19, 2012. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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