Invesco Canada Ltd. v. The Queen

Invesco Canada Ltd. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2014-12-23
Neutral citation
2014 TCC 375
File numbers
2013-385(GST)G
Judges and Taxing Officers
Diane Campbell
Subjects
Part IX of the Excise Tax Act (GST)
Decision Content
Docket: 2013-385(GST)G
BETWEEN:
INVESCO CANADA LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on April 28, 29 and 30, 2014, at Toronto, Ontario
Before: The Honourable Justice Diane Campbell
Appearances:
Counsel for the Appellant:
John Tobin / Stuart Svonkin
Counsel for the Respondent:
Marilyn Vardy / Andrea Jackett
JUDGMENT
The appeals from assessments made under Part IX of the Excise Tax Act for the periods April 1, 1999 to October 31, 1999 (the 2011 Notices of (Re)Assessment dated February 23, 2011) and November 1, 1999 to July 31, 2000, January 1, 2002 to December 31, 2002, October 1, 2003 to December 31, 2003, January 1, 2004 to December 31, 2004, January 1, 2005 to September 30, 2005 and January 1, 2006 to December 31, 2006 (the 2012 Notices of (Re)Assessment dated February 24, 2012) are allowed, with costs to the Appellant, and the (Re)Assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment. In accordance with paragraph 4 of the within reasons, the Appellant did not pursue its appeal of Aim Funds Management Inc. in respect to the periods from April 1, 1999 to July 31, 2000.
Signed at Ottawa, Canada, this 23rd day of December 2014.
“Diane Campbell”
Campbell J.
Citation: 2014 TCC 375
Date: 20141223
Docket: 2013-385(GST)G
BETWEEN:
INVESCO CANADA LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
Introduction [1] The sole issue in these appeals boils down to this: a determination of the value of the consideration paid by various mutual fund trusts (the “Funds”) to the Appellant (also referred to as the “Manager”) for the supply of management services which it provided to each of the Funds. To determine the value, I must look at what the actual consideration consisted of in these circumstances. Ultimately, this will determine whether the Appellant properly collected and remitted the appropriate amount of GST on the fees that were charged to each Fund.
[2] Although several of the Respondent’s assumptions of fact, contained in the Reply to the Notice of Appeal as well as the submissions, address the legal arrangements and cash payments, with respect to both mutual fund corporations and mutual fund trusts as seemingly one and the same, they are, in fact, very different creatures. The appeals before me are restricted to the management fees that were paid by the Funds to the Appellant with respect to the mutual fund trusts. The Appellant did not appeal the assessments respecting the mutual fund corporations.
[3] These appeals are from reassessments made under Part IX of the Excise Tax Act (the “ETA”). The Appellant is appealing three sets of Notices of Reassessment:
(a) those dated February 23, 2011, issued in the name of Invesco Canada Ltd. (“Invesco”) for the period from April 1, 1999 to October 31, 1999 in respect of Trimark Investment Management Inc. (“TIMI”);
(b) those dated June 10, 2011, involving Aim Funds Management Inc. (“AIM”) for the same period, April 1, 1999 to October 31, 1999; and
(c) those dated February 24, 2012, involving AIM and TIMI immediately prior to and following the amalgamation of AIM and TIMI (now referred to as Invesco) on August 1, 2000 for the periods between November 1, 1999 and December 31, 2006.
[4] During the hearing, the Appellant advised the Court that it did not intend to continue its appeal of the reassessments as they related to AIM, for the periods prior to the amalgamation, that is, for the periods from April 1, 1999 to July 31, 2000.
[5] The Appellant provides management services to the Funds within the mutual fund industry (the “Industry”). For the provision of these services, which are taxable supplies, the Appellant charges management fees to the Funds. Goods and Services Tax (“GST”) is charged, collected and remitted on these fees, pursuant to the ETA. The Industry operates within a highly‑regulated environment, according to national and provincial securities laws. This ensures transparency for investors, who place custody of their money with an investor to purchase either shares in a mutual fund corporation or, as in these appeals, units in a trust fund. Such an arrangement permits individual investors access to a wide‑ranging portfolio and professional advice and management in respect to their investments that a smaller investor could not otherwise access.
[6] In exchange for agreeing to manage the day-to-day business activities of the Funds, the Appellant/Manager earns income by charging management fees, which are generally charged against all assets of the fund. In some instances, to remain economically viable players in the market, the Manager must attract and retain the larger, sophisticated investor groups, such as pension funds (the “Large Investors”). As an inducement, the Manager has discretion to reduce the normal management fees that are charged to ordinary investors in the funds. This practice, of management fee reductions, gives rise to special distributions made by the Funds to the Large Investors. These special distributions, equal to the amount of the management fee reduction and paid on a monthly or quarterly basis, are known as the “Management Fee Distributions”.
[7] These appeals concern the GST treatment of those Management Fee Distributions. No GST was collected or remitted on the distributions. The Minister of National Revenue (the “Minister”) reassessed the Appellant/Manager on the basis that these Management Fee Distributions were part of the consideration, in addition to the amount of the Manager’s reduced fee, paid or payable by the Funds for the supply of management services by the Appellant/Manager.
Facts and Background [8] The only witness was David Warren, Executive Vice-President and Chief Financial Officer of the Appellant. Seven “Joint Document Brief” books were filed by the parties. While the testimony and argument focussed on one set of mutual trust fund documents, these were representative of all the documentation at issue in these appeals.
[9] To determine what the Funds actually paid to the Appellant/Manager for the management services, the Appellant focussed on the legal rights that existed among the Manager, the Funds and the Large Investors, as set out in the relevant documentation. To establish the “factual matrix” underpinning the documentation, the Appellant emphasized that I must analyze the evidence before me, with a view to establishing:
(a) the commercial purpose of the transactions;
(b) the context; and
(c) the market in which the parties operated.
[10] The Appellant is in the business of sponsoring, managing and distributing mutual funds. The Appellant wears two hats with respect to the Funds: it is a trustee of the Funds and it also provides investment management services and stock advice to the Funds. On August 1, 2000, AIM, the mutual fund manager for the AIM group of funds, and TIMI, the mutual fund manager for the Trimark group of funds, amalgamated to form Aim Funds Management Inc. (“AFMI”), the predecessor to Invesco. During the relevant periods, Invesco offered mutual funds to public investors under the AIM and TIMI brand names, pursuant to an annual Prospectus and an Annual Information Form (the “AIF”), together referred to as the “Offering Documents”.
[11] The management fee that the Funds paid the Appellant/Manager is fixed by contract in a document called the “Management Agreement”. The fee is charged to each Fund for which the Appellant provided services. They accrue daily and are generally charged against the assets.
[12] The Appellant markets the Funds toward two groups of investors, retail investors and the Large Investors, the latter group being generally comprised of the institutional investors. It is the investors who pay the management fees, although indirectly. These fees, together with other Fund expenses, reduce the profit within the mutual trust funds, thereby reducing the income that will be available to be distributed to investors. The logic is that, if the Manager of a trust fund is able to induce Large Investors to purchase units by offering a reduced fee, then that reduced fee should produce higher distributions to the investors because of the increased monetary base.
[13] Unlike the Large Investors, the retail investors have no ability to negotiate reduced management fees but the Funds do provide them with investment expertise and diversification that would otherwise be unavailable to them in the marketplace. According to Mr. Warren’s evidence, the Large Investors generally do not have a financial advisor but, instead, work through consultants in negotiating a management fee reduction. These investors would receive the benefit of a negotiated fee reduction through a management fee distribution, calculated and equal to the difference between the potential management fee amount that the Appellant could have charged and the amount of the negotiated management fee reduction or discount applied to the “gross” fee. This was referred to as the net management fee (Cross-examination of Mr. Warren, Transcript, Volume 2, pages 230 to 231).
[14] The Appellant was prepared to charge the Funds a reduced management fee for its supply of management services because, overall, the gross amount of fees earned by the Manager against the Funds’ net assets would significantly increase as a consequence of a large investment in the Funds. This was so even though the fees to a Large Investor may have been offered at a lower percentage rate. A fund would also benefit because the size of its investment portfolio increased when Large Investors became unitholders in a fund. If retail investors are also unitholders in a fund where Large Investors are attracted by a reduced fee to become unitholders, the entire fund and all investors are impacted by the increased fund assets available for investment.
[15] Since the trustee has a fiduciary duty to the entire Fund, structuring an arrangement that allows for a management fee reduction to effectively benefit the Large Investors, without negatively impacting other investors in the Fund, has remained an issue that the Industry has grappled with for many years.
[16] Prior to 1995, the management fee reduction was achieved through a rebate from the Appellant to the Large Investors. Under this approach, the Appellant charged the Funds the full management fee as set out in the Management Agreement. The Appellant then paid the Large Investors a “management fee rebate”. In 1995, the Ontario Securities Commission (the “OSC”), along with other regulators within the industry, became concerned that this method of paying rebates to unitholders could trigger subsection 12(2.1) of the Income Tax Act (the “ITA”) and subject the Funds to a detrimental and unanticipated income tax inclusion. In a 1994 Technical Interpretation, the Canada Revenue Agency (the “CRA”) advised of the adverse income tax consequences and concluded that a double tax - one to the investors in receipt of management fee rebates and another to the trust funds ‑ would be the result.
[17] By correspondence dated June 29, 1995, the OSC wrote to Appellant Counsel with the following request:
4. Please disclose the fact that the repayment of management fees to an investor may trigger negative tax consequences to the investor and/or the Funds and provide an opinion from tax counsel or provide for an indemnification to the Fund from Trimark for any tax liabilities of the Funds with respect to the repayment of management fee.
(Joint Document Brief, Volume 1, Tab 1, page 2)
It became critical for this arrangement, that had been in place until 1995, to be revamped in order to avoid any risk of double taxation through the application of subsection 12(2.1) of the ITA. This provision provides that inducement payments or reimbursements made to beneficiaries of trusts are to be included in the income of the trusts. Since the management fee rebates to the Large Investors could be considered inducement payments meant to reimburse expenses of the trusts, pursuant to subsection 12(2.1), paragraph 12(1)(x) would cause those rebate amounts to also be included in the income of the Funds, resulting in double taxation of the rebate amounts. As a result, changes were introduced in 1995 in order to avoid the potential application of subsection 12(2.1). The Appellant had to alter the manner in which the management fee rebate amounts were made but, in doing so, the trusts were also constrained by subsection 104(7.1) of the ITA. As explained by Appellant Counsel in his opening submissions at paragraph 64:
… You will know that this provision would deny a trust the ability to deduct its distributions of income and net realized gains. The Funds would not want to lose those flow-through deductions for the whole fund in order to solve the large investor subsection 12(2.1) issue.
[18] To avoid these potential income tax consequences, the Appellant changed the method of making management fee rebate payments to unitholders in the Funds and instead, the Appellant/Manager was given discretion to negotiate with the Large Investors for a reduction in the management fee it charged to the Funds. This was in return for the Funds agreeing to make a distribution of the amount of this reduction to the Large Investors. Consequently, the Funds would then have additional resources to make special trust distributions to the Large Investors because the Appellant had reduced its fee for the services it was providing.
[19] The Appellant described the new method of paying management fee rebates as follows:
1. The Appellant/Manager calculated the net management fee it charged the Funds by taking “Factor A” (the maximum stated management fee) and subtracting “Factor B” (the fee reduction offered by the Appellant to the Funds calculated with respect to specific Large Investors).
2. The Appellant collected GST on the net management fee calculated according to Step 1.
3. The Funds then made special Management Fee Distributions to the Large Investors out of trust income or trust capital.
[20] The Appellant sought and received an advance income tax ruling to ensure that this proposed new arrangement would not result in double taxation under the ITA (the “Ruling”). The Ruling confirmed the CRA’s view that these special Management Fee Distributions from the Funds to the Large Investors should be treated as trust distributions out of the mutual trust funds. Pursuant to subsection 104(6) of the ITA, the Funds would be entitled to deduct those payments.
[21] For income tax purposes, Management Fee Distributions were to be treated as trust distributions by the Funds and the Large Investors. Although this Ruling dealt only with subsection 104(7.1) of the ITA and the Appellant did not obtain a ruling with respect to potential GST implications, the fee arrangements at issue in these appeals are those that are the subject matter of the Ruling.
[22] The new arrangements were implemented through the following documentary changes:
1. The Declaration of Trust for a Fund was amended to (a) define “Management Fee Distributions” as a special subset of distributions available only to Large Investors and (b) require the Trustee of the Fund to make such distributions to Large Investors. (Joint Document Brief, Volume 1, Tab 5, Second Amendment to Declaration of Trust, paragraphs 2.1, 2.2 and 2.4).
2. The Management Agreement, between the Manager and the Fund, was amended to provide that the Manager may reduce the management fees at an annual rate, which is less than that rate otherwise paid by the Funds under a Management Agreement in respect of a particular unitholder, on condition that the amount of the reduction is distributed to that unitholder by the Fund (Joint Document Brief, Volume 1, Tab 6, Amendment to Management Agreement).
The Appellant’s Position [23] The management fee paid by the Funds to the Appellant/Manager was the net management fee of “Factor A” (the maximum stated management fee that could be charged according to the Offering Documents) minus “Factor B” (the fee reduction amount offered to eligible Large Investors). This reduced amount was the sole consideration for the Appellant’s single supply of management services. The Management Fee Distributions were a separate transaction occurring between the Funds and the Large Investors and were distributions of trust income or realized capital gains of the Funds to the Large Investors. The Appellant’s fee was reduced at the point of sale and there were no subsequent adjustments or rebates that were paid. Consequently, the distributions were a separate supply and did not form part of the consideration provided to the Appellant for the supply of management services. All of the documentation, together with the amendments, the conduct of the parties, the surrounding commercial realities and circumstances support the objective intention of the parties that the management fee was reduced at the point of sale to Large Investors at a rate that matched the rate a Large Investor could have obtained by hiring an investment manager directly. At the same time, the objective intention of the parties was to avoid a payment of funds from a Manager to an investor, either directly or indirectly, so as to prevent potential double taxation caused by the application of subsection 12(2.1) of the ITA.
[24] Appellant Counsel also relied on internal accounting documents and tax returns respecting the payment of fees and interpretation of the contracts.
[25] In the alternative, the Appellant argued that, if this Court concluded that the Management Agreement contained a guarantee or condition that was partial consideration for the supply of management services, the Minister did not plead an assumption relating to the value of that condition or guarantee, which then places the onus on the Minister and not the Appellant. However, the Appellant contends that the Respondent adduced no evidence at the hearing respecting this issue.
The Respondent’s Position [26] The Respondent argued that the Management Fee Distributions to the Large Investors did not represent a price adjustment for the management services that the Appellant offered and, therefore, did not reduce the value of the consideration payable by the Funds for the supply of the management services. There was no reduction in the total amount payable by the trust funds under the Management Agreement. The Funds paid the full management fee but to two different parties.
61. … The only change was that instead of being required to pay the total amount payable (i.e. the gross management fee) directly to the appellant (i.e. the supplier), the Trust was now required (or at least permitted) to instead pay one component of the gross management fee to particular investors (identified by the appellant) in the form of management fee distributions.
(Respondent’s Written Submissions, paragraph 61)
The second portion of the fee that was paid to the Large Investors at the Appellant’s direction was therefore part of the value of the consideration for the management services and upon which GST should have been remitted.
[27] The Respondent submitted that, as long as there is a direct link or connection between the amount payable and the supply that is made, then the amount will be consideration for that supply.
[28] In determining the value of the consideration, both the legal and the “economic reality” of the transactions should be considered. The economic reality of the transactions is that the Funds were in no better position as a result of the management fee reductions. From the perspective of the Funds, there was no difference between the periods before and after 1995 when changes were made. Instead of paying the full fee to the Appellant/Manager for the supply of management services, the Funds now make two payments, one to the Appellant and the remainder to the Large Investors. The economic reality is that the Funds have no additional money in their coffers. According to the Respondent, the legal reality is that the Appellant negotiated agreements with the Large Investors and agreed to cause the Funds to make these payments of Management Fee Distributions in exchange for the investors agreeing to invest in the Funds. It was the Appellant that owed an obligation to the Large Investors equal to the amount of these distributions. Had the Funds not paid the distributions, the Large Investors would have a legal right against the Appellant/Manager for recovery of any unpaid amounts. The Appellant would then have legal rights against the Funds in respect to their obligation to pay the distributions.
[29] As a result, there is both a legal and an economic link or connection between the unreduced gross management fee and the supply of management services to the Funds. The Funds were liable to pay gross fees pursuant to the Management Agreement, provided the Appellant fulfilled its managerial responsibilities. However, the Appellant and the Funds agreed that, instead of the Funds paying the gross management fees, the Appellant would receive part of those fees in cash and the Funds would accept an obligation or condition imposed upon them to pay the negotiated reduced amounts to the Large Investors. This obligation had a value equal to the amounts negotiated between the Appellant and the Large Investors.
[30] In response to the adequacy of the pleadings issue raised by the Appellant, the Respondent contended that the Reply to the Notice of Appeal sets out that the benefit of the negotiated reduction went, not to the Funds, but to the Large Investors with whom the managers negotiated a special deal. The Reply assumed that the Funds did not receive those negotiated amounts nor any benefit from that arrangement and that the management fee was never reduced.
Analysis A. The Legislative Framework and Jurisprudence [31] Subsection 165(1) of the ETA is the charging provision. It provides that tax shall be paid on the value of the consideration for a taxable supply. In these appeals, the taxable supply is the management services provided by the Appellant to the Funds and the Appellant agreed those services are taxable supplies for GST purposes. The recipient of the supply is the Funds. The issue arises in respect to a valuation of the consideration for those services. According to the wording of subsection 165(1), the consideration must be “for the supply”. This means there must be a link or connection between the consideration and the supply itself. Subsection 123(1) of the ETA provides the following definition of “consideration”:
“consideration” includes any amount that is payable for a supply by operation of law;
The Technical Notes that accompanied the introduction of this definition explained the purpose behind the inclusion of the phrase “by operation of law” in the definition:
… [In] some circumstances, amounts can become payable for a supply by operation of law in the absence of a contract. … This would address, for example, situations where services are rendered to a person without having been contracted for and the person is required, by law, to pay fair value for the services received. … [Emphasis added]
(Explanatory Notes to Legislation Relating to the Goods and Services Tax, Department of Finance: February 1993)
[32] The inclusion of the phrase “by operation of law” is intended to encompass those relationships which may not be contractual in nature but that are nonetheless governed by common law doctrine or statute. The explanation, contained in the Technical Notes, mirrors the definition provided by the Federal Court of Appeal in Commission Scolaire des Chênes v Canada (2001 FCA 264, [2001] FCJ No. 1559, at paragraphs 18 and 19).
[33] The Federal Court of Appeal, in its reasons in Commission Scolaire des Chênes, concluded that two factors will be required in order for consideration to have been paid for a supply:
18. Consideration under the Act is easily discernable when the obligation to pay arises under a contract. …
19. Under the Act, in order for a payment to constitute consideration, it must have been made pursuant to a legal obligation (contractual or otherwise) and must be closely enough linked to a supply that it may be regarded as having been made "for" that supply (see the definition of the term "consideration" in section 123). That is why a direct link is required.
The Federal Court of Appeal noted that a payment made pursuant to the terms of a contract will always meet the definition of consideration. However, where a payment is made outside the contract, an analysis will be required to determine whether a direct link exists between the payment and the supply. At paragraph 20 of Commission Scolaire des Chênes, the Court concluded:
20. … [W]hen the payment is made otherwise than under a contract, the purpose of the payment and the circumstances in which it is made must be carefully analyzed to determine whether there is a direct link with the supply; a payment will constitute consideration only where it is made “for” or in return for that supply.
[34] In County of Lethbridge v The Queen, 2005 TCC 809, [2006] TCJ No. 56, Justice Bell confirmed that the definition of consideration for the purposes of the ETA includes any amount that would be consideration under common law:
95. … In Dunlop Pneumatic Tyre Co. Ltd. v Selfridge & Co. Ltd.[1915] AC 847 at 855, HL, Lord Dunedin wrote:
I am content to adopt from a work of Sir Frederick Pollock … the following words as to consideration:
An act or forbearance of one party, or the promise thereof, is the price for which the promise of the other is bought, and the promise thus given for value is enforceable.
At paragraph 100, Justice Bell went on to state:
100. … The test to be applied is not whether there is a “direct link”. This rhapsodic venture into a mire of possibilities is foreign to the common law concept of contractual consideration. The test in this case is whether there was “consideration” as that term, both under the definition in the Act, and under common law, exists.
[35] As a result of the foregoing comments, much of the Respondent’s submissions on “direct link” between the payments and the related caselaw were unnecessary. Pursuant to Commission Scolaire des Chênes and the common law definition of consideration, all that would be required for the Management Fee Distributions to constitute consideration for the taxable supply of management services would be a contractual obligation.
[36] The ETA also provides a definition, in subsection 153(1), for the value of the consideration for a supply as follows:
153. (1) Value of consideration – Subject to this Division, the value of the consideration, or any part thereof, for a supply shall, for the purposes of this Part, be deemed to be equal to
(a) where the consideration or that part is expressed in money, the amount of the money; and
(b) where the consideration or that part is other than money, the fair market value of the consideration or that part at the time the supply was made.
[37] The Appellant contended that, pursuant to subsection 153(1), the only supply was for a dollar amount under the Management Agreement. In respect to the Respondent’s argument that there was additional consideration that was not cash and was in the form of a legal obligation to pay Management Fee Distributions to Large Investors, the Appellant argued that the Respondent must address what the fair market value of that non-cash consideration would be. Appellant Counsel submitted that the Respondent did not adduce evidence respecting fair market value. The Appellant’s position was that the legal obligation to pay Management Fee Distributions to Large Investors is found in the Declaration of Trust. The Management Agreement, according to the Appellant, contains a guarantee that the Funds will comply with their obligation under the Declaration of Trust. However, when viewed within the context of the factual matrix umbrella, this guarantee is not consideration for the management services that the Appellant provided and, even if the Court determines that it was, the Respondent has not established the value of the guarantee.
[38] The Respondent argued that it is the Management Agreement that creates a legal obligation to pay the Management Fee Distributions to the Large Investors on the Appellant’s behalf but that it is the Appellant that has the obligation to pay the distributions to the Large Investors. Under the Management Agreement, when the Funds agreed to accept this obligation, something of value is being provided to the Appellant (Respondent’s Written Submissions, paragraph 62). The value of the obligation, being consideration for the management services, is equal to the Management Fee Distributions, according to the Respondent’s position.
[39] The first step in these appeals is to interpret the contracts and relevant documentation in order to determine the true nature of the legal obligations that were created. If I determine that the only consideration for the management services was the cash amount of the Appellant’s reduced fee, that ends the matter. If, however, I conclude that the Funds had a legal obligation to pay amounts in addition to the reduced fee for the Appellant’s services, then the next step will be a determination of the fair market value of that legal obligation or condition to the Appellant.
B. The Factual Matrix/Contractual Interpretation and the Recent SCC Decision in Sattva Capital Corp. v Creston Moly Corp., 2014 SCC 53, (“Sattva”) [40] The importance of and the role that the relevant factual matrix has in the interpretation of contracts is well established in Canadian jurisprudence and, in particular, tax matters. Subsequent to the hearing of these appeals, the Supreme Court of Canada, on August 1, 2014, released a decision in Sattva dealing with the principles of contractual interpretation. Since this has a direct bearing on the issue before me, that is, the determination of the value of the consideration that the Appellant received from the Funds for the supply of management services, I requested that the parties provide further written submissions in respect to the impact of the Sattva decision.
[41] Overall, the reasons rendered by Mr. Justice Marshall Rothstein and the principles enunciated respecting contractual interpretation are consistent with prior jurisprudence. While Sattva clarifies the basic existing principles of contractual interpretation, it does not change the relevant law, nor my view of the issue before me, based on the already existing jurisprudence. In Sattva, Justice Rothstein endorsed a practical, common-sense approach to the interpretation of contracts not dominated by technical rules of construction. A determination of the intent of the parties and the scope of their understanding should be the Court’s overriding concern and the present-day approach that should be applied. To this end, a contract should be read as a whole, giving the words it employs their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time the contract was formed – often referred to as the “factual matrix”. At paragraph 47, Justice Rothstein describes this approach as follows:
[47] Regarding the first development, the interpretation of contracts has evolved towards a practical, common-sense approach not dominated by technical rules of construction. The overriding concern is to determine “the intent of the parties and the scope of their understanding” (Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada, 2006 SCC 21, [2006] 1 S.C.R. 744, at para. 27 per LeBel J.; see also Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4, [2010] 1 S.C.R. 69, at paras. 64‑65 per Cromwell J.). To do so, a decision-maker must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract. Consideration of the surrounding circumstances recognizes that ascertaining contractual intention can be difficult when looking at words on their own, because words alone do not have an immutable or absolute meaning:
No contracts are made in a vacuum: there is always a setting in which they have to be placed. . . . In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating.
(Reardon Smith Line, at p. 574, per Lord Wilberforce)
[42] Consequently, the Court must consider the commercial purpose, background and context of the transaction as well as the market in which the parties to a contract are operating. This goes back to the very basics of contract interpretation principles: contracts are never made in a vacuum.
[43] Words alone do not have an immutable or absolute meaning. Rather, their meaning should be considered against the backdrop of relevant contextual factors, including the purpose of the agreement and the nature of the relationship between the parties that is created by the contract. At paragraph 48 of Sattva, Justice Rothstein reproduced the following passage by Lord Hoffman in Investors Compensation Scheme Ltd. v West Bromwich Building Society, [1998] 1 All ER 98 (H.L.) as follows:
[48] …
The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. [p. 115]
[44] However, as Justice Rothstein concludes in Sattva, although surrounding circumstances will be a relevant consideration to contractual interpretation, they cannot be allowed to overwhelm the words contained in a contract. This principle would logically follow from the principle of giving words their ordinary and grammatical meaning, consistent with surrounding circumstances at the time of the contract formation. Otherwise, words in a contract would not be given their ordinary and grammatical meaning. In other words, courts cannot use surrounding circumstances to deviate from the text such that a new agreement is created. Specifically, Justice Rothstein had the following to say in respect to what a court can consider when interpreting a contract:
[57] While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement (Hayes Forest Services, at para. 14; and Hall, at p. 30). The goal of examining such evidence is to deepen a decision-maker’s understanding of the mutual and objective intentions of the parties as expressed in the words of the contract. The interpretation of a written contractual provision must always be grounded in the text and read in light of the entire contract (Hall, at pp. 15 and 30-32). While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement (Glaswegian Enterprises Inc. v. B.C. Tel Mobility Cellular Inc. (1997), 101 B.C.A.C. 62).
[45] As emphasized by Justice Rothstein at paragraph 58 of his reasons, evidence respecting surrounding circumstances will necessarily vary from case to case and will be limited to the objective evidence of the background facts at the time of formation and execution of the contract. This requires a court to look at the knowledge that the parties possessed or ought to have possessed, again, prior to and at the time of the contract formation. As noted in Sattva, considering surrounding circumstances, as an interpretative aid, does not offend the parol evidence rule, which excludes evidence of the parties’ subjective intentions and precludes considering evidence outside the words of the contract that would result in varying the contract in some manner. Absent ambiguity, the Court cannot consider the subjective intention of the parties to a contract nor their actions subsequent to contract formation. Although the Appellant relied on subsequent accounting documents and tax returns to support its position, since there is no ambiguity present in the documentation, I have placed no reliance on this portion of the Appellant’s submissions.
The Appellant’s Position after Sattva [46] The Appellant’s position is that its proposed interpretation of the agreements between the parties is further supported by the reasons in Sattva. The objective intention of the parties was to implement the transaction described in the ATR-65 and the Ruling in order to avoid the impact of double income taxation. It could not therefore be the objective intent of the parties to increase GST payable, in respect to the management services, by implementing the Respondent’s complicated, multi-step arrangements (Appellant’s Written Submissions on Sattva, at paragraph 18). The language, contained in the Management Agreements, that refers to the conditionality of the management fee discount, should not be interpreted to mean that the Funds had to “earn” the discount by making a separate supply each time that a discount would be applied (Appellant’s Written Submissions on Sattva, paragraph 19). Essentially, this would thwart the parties’ commercial goals and lead to inconsistencies with the Fund’s treatment of the payment of the Management Fee Distributions as trust distributions (Appellant’s Written Submissions on Sattva, paragraph 19(a) and (b)). Instead, the conditionality of the discount addressed concerns of differential entitlement to income or capital between beneficiaries of a trust, contrary to subsection 104(7.1) of the ITA. It also ensured the integrity of the new arrangement by preventing other investors from challenging these arrangements because the fee reductions were not being used to pay distributions to all of the investors in the Fund (Appellant’s Written Submissions on Sattva, paragraph 20(a) and (b)). The language, contained in the confirmation letters from the Funds to the Large Investors, merely confirms that the Large Investors would receive Management Fee Distributions from the Funds. It was not an agreement by the Appellant to make the distribution itself to the Large Investors (Appellant’s Written Submissions on Sattva, paragraph 21).
The Respondent’s Position after Sattva [47] The Funds were distinct from the Large Investors, to whom the Appellant directed the Funds to pay the distributions (Respondent’s Written Submissions on Sattva, paragraph 9). The Funds were liable under the Management Agreements to pay consideration for the supply of management services by the Appellant, as they were the recipients of the Appellant’s taxable supply (Respondent’s Written Submissions on Sattva, paragraph 10).
[48] The Funds did not realize any savings from the management fee reduction that was negotiated between the Appellant and the Large Investors. The fee distributions were amounts payable by the Funds under the amended Management Agreements, in addition to the cash amounts paid by the Funds to the Appellant/Manager (Respondent’s Written Submissions on Sattva, paragraphs 11 and 12). Consideration is much broader in scope in these circumstances and is not limited to cash paid by the recipient to the supplier (Respondent’s Writ