Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.
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TO:
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XXXXX
XXXXX
XXXXX
XXXXX
XXXXX
XXXXX
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FROM:
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Ivan Bastasic
Director
Financial Institutions and Real Property Division
320 Queen St.,
Ottawa, ON
K1A 0L5
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CASE NUMBER:
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89629
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DATE:
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December 10, 2007
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SUBJECT:
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XXXXX Tax Status of Merger and Acquisition Services
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This memorandum is in response to XXXXX, wherein you requested guidance on the application of the GST to certain services provided by a third party related to merger and acquisition transactions as well as certain reorganization types of transactions (M&A services). You have provided copies of XXXXX engagement letters and related documentation. We are attaching a table, which contains a summary of the key provisions of those XXXXX engagement letters, together with our comments on the GST treatment of the supplies. Our general analysis is set out below.
Issues
1. What is the appropriate GST treatment of fees charged by XXXXX for M&A services, as set out in XXXXX engagement letters submitted.
– In particular, you would like confirmation as to whether the services provided by XXXXX constitute "arranging for" a financial service under paragraph (l) of the definition of financial services in subsection 123(1) of the Excise Tax Act (ETA), and our rationale for their GST treatment.
2. Can the GST treatment of M&A services be analyzed as you propose in your memorandum; in very general terms, can the services be characterized as predominantly advisory in nature, and therefore taxable, with the financial transaction or transfer of shares constituting a minor element of the service.
You have provided background information related to your enquiry XXXXX. A brief summary of this information is set out below.
– XXXXX
– XXXXX
Our Comments
Key Services Provided Under Engagement Letters
The engagement letters submitted generally provided for a fairly broad range of services to be supplied by XXXXX in each case, in a variety of different potential transactions, that generally could involve sales of assets, shares, reorganizations, other business combinations (all of which could be contemplated in one agreement), as well as obtaining financing XXXXX. Nevertheless, we found that there were certain common services that were to provided by XXXXX, as follows:
1. Assist in preparation of documents such as for solicitation of interest;
2. Identifying and negotiating with prospective parties;
3. Marketing, communication strategies;
4. Strategy advice;
5. Financial analysis and advice;
6. Organizing sale process;
7. Assist, advise with respect to negotiations;
8. Assist in preparing documentation with counsel;
9. Fairness opinion;
10. Other financial advisory services upon mutual agreement.
Services that were engaged for less frequently included:
11. Underwriting: act as arranger and placement agent in connection with distribution of securities, lead manager of soliciting dealer/underwriting group (often right of first refusal, if accepted, governed by separate agreement with separate fees).
12. Lending: e.g. fund a portion of floating rate securities.
The services set out in numbers 11 and 12 above would clearly constitute financial services under paragraphs (h) and (d) of the definition of financial service in subsection 123(1) respectively, and therefore are not discussed in detail in the following analysis.
Single or Multiple Supply? Place of Supply?
• Applying the criteria set out in GST/HST Policy Statement P-077R2: Single And Multiple Supplies to the services provided under the engagement letters submitted, a key factor to consider is the fact that there appears to be a very strong relationship among the service elements.
– The overall purpose of the engagement, in terms of the type of merger or acquisition transaction to be contemplated, is set out at the beginning of the engagement letter, and the services to be provided there under are, together, intended to achieve this objective.
– The client does not generally have the option to acquire the elements separately, with certain specific exceptions, such as providing a fairness opinion, set out in the engagement letters.
• Based on these factors, the various elements would constitute a single supply, in accordance with Policy Statement P-077R2.
• However, in some cases, a fairness opinion is only to be provided on request, for a separate consideration. In these circumstances, the opinion would be considered a separate taxable supply.
• Also, many agreements provide for separate agreements to be made with respect to additional services. These are not discussed in this analysis, however they would also generally constitute separate supplies under separate agreements, and you confirmed that no amounts in respect of such services were XXXXX
• Thus, XXXXX should be characterized as making a single supply to its clients under the engagement letters, with the possible exception of providing fairness opinions and other services, if these are provided on request and for a separate consideration.
• For purposes of this analysis, it is assumed that the single supply is made in Canada, pursuant to section 142.
Predominant Element, "Whether Arranging For A Financial Service"
(i) Importance of Predominant Element
• In accordance with case law (i.e. Royal Bank of Canada v The Queen, [2006] ETC 2813 (TCC), Royal Bank Of Canada v. Her Majesty The Queen and The Canadian Bankers Association, intervenor, 2007 FCA 72), in characterizing the single supply under the engagement letters, with its constituent elements, it is necessary to consider the predominant element, or the dominant and essential characteristic of the supply.
• The predominant element of the supply under an engagement letter must be determined on a case by case basis, by examining the relevant facts.
– As can be seen from the summary, while there are elements common to all agreements, the services to be provided under each agreement vary.
– Nevertheless, in most of the agreements, the predominant element is analysis and advisory services, as most of the work to be done by XXXXX falls within this category.
(ii) Degree of Involvement Necessary for "Arranging For"
• The role of XXXXX in whatever transaction is pursued can be determined from the engagement letters, for purposes of determining the predominant element of the supply, and whether XXXXX can be characterized as "arranging for" a supply of financial services.
– In essence, this involves determining the degree of involvement of XXXXX in the ultimate transaction.
– In other words, based on the guidance contained in GST/HST Policy Statement P-239, Meaning of the Term "Arranging for" as Provided in the Definition of "Financial Service", a key element in determining whether XXXXX has arranged for a supply of financial services is whether or not they are closely and directly involved in effecting the eventual transaction by bringing the parties together, rather than providing advice, financial analysis, communications expertise, etc.
• Referring to the elements generally contracted for in the engagement letters you provided, a key element in considering whether XXXXX would be arranging for a supply of financial services, rather than performing an advisory role, would be the following duties outlined in no. 2 above:
2. Identifying and negotiating with prospective parties for the purpose of effecting a supply of financial services: Identify, approach/contact, conduct discussions/negotiations with prospective purchasers; solicit expressions of interest; client may have to give prior consent/request before any contact; present vendor with pre-qualified buyers for vendor's approval.
– In particular, while identification of prospective parties alone would not be sufficient involvement to constitute "arranging for", approaching them, soliciting expressions of interest, presenting pre-qualified buyers to the client, and particularly negotiating with prospective parties (rather than providing advice regarding negotiations), would likely constitute sufficient involvement to qualify as "arranging for" the transaction.
XXXXX
– XXXXX
XXXXX
– XXXXX
(ii) Role of Ultimate Transaction, Predominant Element
• As set out in P-239, particularly example 6, the intention at the time the agreement is entered into is important in determining whether XXXXX is "arranging for" a financial service, under paragraph (l) of the definition of financial service in subsection 123(1), and whether this is the predominant element of its supply.
• As set out in the first page of the engagement letters, in very general terms, the intention of the parties is for XXXXX to perform the role as indicated by the services specified in the engagement in relation to the transaction or transactions/business combination proposed.
• To the extent that different potential transactions are envisaged (as is generally the case), which could constitute a supply of assets (taxable) or of financial instruments (exempt), and part of XXXXX role is to advise on the form the transaction should take, even if XXXXX role could be characterized as arranging for the ultimate transaction, due to its involvement in bringing the parties together (see above), it is unlikely that this would form the predominant element of the supply.
– On balance, examining all of the work done by XXXXX, arranging for the ultimate transaction would likely form a minor part of the supply, whilst analysing options, financial analysis, communications, etc., all of which are taxable elements, would be the predominant element.
• If, however, XXXXX could establish that it was decided near the outset that the ultimate transaction would be a supply of financial instruments rather than assets, and that most of its work involved bringing the parties together for the purpose of effecting the transaction, which would be the predominant element of its supply, it could be characterized as making a supply of arranging for a financial service.
• If only an exempt supply of financial instruments was envisaged at the outset (e.g. mortgage financing), then XXXXX could be characterized as either providing taxable advisory services in relation to this exempt supply, or arranging for the exempt supply, if, as noted above, it played an integral part in bringing the parties together, and its other services supported this role, so that the predominant element of its supply was arranging for the financial service.
Exclusions, zero-rating
• Under the ETA, once it is determined that a supply falls within paragraphs (a) through (m) of the definition of financial service, paragraphs (n) through (t) must be consulted to determine whether the service would, nevertheless, be carved out of the definition.
• In the case at hand, in light of the discussion above regarding the predominant element, if it was determined that the predominant element of the supply by XXXXX fell within paragraph (l), the exclusions in paragraphs (n) through (t) would not apply. This is consistent with the analysis in the Royal Bank cases, supra.
• On the other hand, if, in a particular engagement letter, it is determined that paragraph (l) does not apply, such that the predominant element is a taxable service or services, for example advisory services, it must be determined whether the supply is a zero-rated export under Part V of Schedule VI to the ETA.
• Similarly, even if it is determined that a financial service is being provided, it must be determined whether the service is zero-rated under Part IX of Schedule VI to the ETA.
• In light of the issues that you asked us to focus on, we are not expanding on the analysis of these issues in this memorandum or in the summary attached.
Timing
The general rule regarding timing is that payment of tax in respect of a taxable supply is triggered by invoicing or payment of consideration, as set in section 168.
• If a payment is made before the tax treatment of XXXXX client's ultimate transaction is known, and/or if it is unknown what the predominant element of XXXXX supply would be, then absent proof to the contrary, this would constitute payment for a taxable supply.
• If it subsequently became apparent that XXXXX was, in fact, arranging for a financial service and that this was the predominant element of its supply, so that it was making an exempt supply of arranging for an exempt financial service, or a zero-rated supply, the tax paid on previous payments could be refunded as tax paid in error (see e.g. section 261).
Position Taken
• By way of summary of the key issues to be addressed in determining the GST treatment of the M&A services in the engagement letters provided, it is first necessary to determine whether the transaction to be undertaken by XXXXX client will be an exempt supply of financial instruments.
– If the contemplated transaction will be the exempt supply of financial instruments, and XXXXX is playing an integral part in bringing the parties together, so that they are arranging for this transaction, and this is the predominant element of the services they are providing, in terms of tasks performed and time expended, they would be considered to be making an exempt supply. Otherwise, they would be considered to be making a taxable supply of advisory services.
– If the ultimate transaction is known, at the outset, to be a taxable supply (e.g. supply of assets), XXXXX services would constitute a supply taxable at the zero or standard rates.
• On the other hand, if the ultimate transaction by XXXXX client is not known, then at least part of XXXXX services will consist of advising on the form that the ultimate transaction should take.
• In any case, the onus would be on XXXXX to establish that the contemplated transaction was an exempt supply of financial instruments, and that the predominant element of its supply consisted of arranging for this transaction.
• To the extent that the exempt status of the services provided by XXXXX was determined after initial payments were made, the initial payments should have been characterized as being on account of a taxable supply, and tax would have become payable in accordance with section 168, but this tax could be recovered as tax paid in error.
• To the extent that a fairness opinion is provided as a separate (taxable) supply, timing of liability to pay tax would follow from the provisions in section 168; tax would be payable on the earlier of consideration being paid, and becoming due.
If you require clarification with respect to any of the issues discussed in this memorandum, please call Dawn Weisberg at 613-952-9210.
Ivan Bastasic
Director
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate
2007/12/11 — RITS 88737 — Re: XXXXX; Whether Certain Amounts Are Promotional Allowances For Purposes of Section 232.1 of the ETA
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