16 October 2012 T.I. 2012-0459061E5 - Reimbursement of Management Fee

Principal Issues: Where a management fee is reimbursed to a unitholder, does the amount have to be reported for income tax purposes?

Position: It will depend on the source of the distribution.

Reasons: Where the distribution is out of the income of the fund, it is considered income to the unit holders and is taxable. However, where the distribution is out of the capital of the fund, then it is considered a return of capital and not taxable, instead the adjusted cost base of the units to the unit holder will be reduced by such amount pursuant to subparagraph 53(2)(h)(i.1) of the Act.

XXXXXXXXXX
2012-045906
V. Srikanth

October 16, 2012

Dear XXXXXXXXXX:

Re: Management Fee Distribution

This is in response to your initial letter dated May 7, 2012, our telephone conversation on July 16, 2012 (Kohnen/XXXXXXXXXX) and your follow up letter dated August 9, 2012, wherein you wanted our views on the tax implications to the recipient unitholder of a management fee distribution by an investment company. You are of the view that an amount indicated on a T3 slip as a management fee reimbursement is a return of capital and, therefore, it will not be included in the computation of income of the recipient.

Our Comments

Written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled ‘Advance Income Tax Rulings’, dated May 17, 2002. This Information Circular and other Canada Revenue Agency publications can be accessed on our website at http://www.cra-arc.gc.ca. Your request was not submitted as an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries and we are prepared to provide you with the following comments.

Under certain circumstances, the management fees payable by a mutual fund trust (the “Fund”) to the Fund manager may be reduced in respect of large investments made by qualifying unitholders, and that reduction may be distributed by the Fund directly to those unitholders. The amount may be distributed either by automatic reinvestment in additional units of the Fund or in cash, depending upon the terms that govern the Fund. Generally, such amounts will be distributed first out of income of the Fund, to the extent that the Fund earns such income in the year in which the management fee distribution is made. This normally is to minimize the income tax liability to the Fund under Part I of the Income Tax Act (the “Act”). Otherwise, the distribution will be out of capital of the Fund.

It will be a question of fact whether an amount distributed by the Fund is out of income or capital of the Fund. Where the distribution is out of income for that taxation year, the amount paid or payable to a unitholder must be included in computing the income of the unitholder pursuant to paragraph 104(13)(a) of the Act. Further, where such amount is reinvested automatically in the units of the Fund, it shall be included in computing the cost to the unitholder of the units acquired as a result of the management fee distribution, pursuant to subsection 52(1) of the Act.

Where the amount is distributed from the capital of the Fund, and provided that the units of the Fund constitute capital property to the unitholder, the amount will not be included in computing the income of the unitholder under the Act. However, an amount in respect thereof will be deducted in computing the adjusted cost base of the units held by the unitholder, pursuant to subparagraph 53(2)(h)(i.1) of the Act.

Further to your question on whether the tax implication is the same to the Fund, irrespective of the source of distribution, please note that the Fund will generally be entitled to a deduction, pursuant to paragraph 104(6)(b) of the Act, in computing its income for a taxation year in which such distribution is made, only where such amount is paid or payable from its income and not from the capital of the Fund.

We trust our comments will be of assistance to you.

Yours truly,

Phil Kohnen
For Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch