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Kevin Greenard: Dissecting the tax deductibility of investment costs

The Canadian Securities Association (CSA) regulates securities law in Canada, including disclosure requirements. They have issued several phases of Client Focused Reforms (CFR) to make changes to ensure clients’ interests are put first.
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Kevin Greenard

The Canadian Securities Association (CSA) regulates securities law in Canada, including disclosure requirements.They have issued several phases of Client Focused Reforms (CFR) to make changes to ensure clients’ interests are put first.

On July 15, 2016, Client Relationship Management Phase 2 (CRM 2) came into effect, laying out rules for Canadian Investment Dealers regarding greater transparency on the cost of investing.

We were very excited to see a change made where the full disclosure of all investment costs was required. However, we were subsequently disappointed to find out that not all fees associated with mutual funds are included in this. The fee report for mutual funds only includes the trailing commission that goes directly to the Wealth Advisor — it does not include the embedded fees also paid, and other costs incurred by the mutual funds.

In our opinion, disclosure of the trailing commissions as the lesser amount is even more misleading than not having any disclosure at all. This is because the amount reported is not the full amount of fees charged during the year, but the report gives the impression that it is.

Liquidity without a cost is very important. As a result, we have completed hundreds of proposals over the years for individuals where a component of our proposal discloses 100 per cent of the fees that they have been paying, such as embedded Management Expense Ratio (MER), Trading Expense Ratio (TER), as well as up-front costs such as commissions and Initial Sales Charge (ISC) funds, and costs to redeem, including Deferred Sales Charge (DSC) funds.

In addition to calculating what your total combined fees are, a second component of our analysis relates to the tax-deductibility of our investment counsel fees. As noted above, many fees are embedded. Any embedded fees are never tax-deductible, regardless of the type of account it is in.

Two factors to consider when determining tax-deductibility

1) How do I know if an investment fee is tax-deductible?

When determining the tax deductibility of investment costs, you must first assess if the fee meets the criteria to be deductible for income tax purposes.

The main point on whether the fee is deductible or not is whether there was advice given for the trade, or discretion used for the trade if the investor holds a managed account with a Portfolio Manager.

The second point is that it must be in a fee-based account as transactional commissions and any embedded costs cannot be deducted for income tax purposes.

If it meets the following criteria, you are permitted to deduct the fee and applicable Goods and Services Tax (GST) associated with it:

- The fee is paid for advice on buying or selling a specific share or security by the taxpayer or for the administration or the management of the shares or securities of the taxpayer (including custody of securities, maintenance of accounting records, collection and remittance of income, and the right to buy and sell on their own judgement on behalf of some clients without reference to those clients).

- The service for which the fee is being charged is provided by a person/entity whose primary business activity is giving advice on whether to buy or sell certain securities.

- The fee is not a commission, and was not a charge from a stockbroker.

- The amount of the total fees paid is reasonable.

2) Which accounts can I deduct my investment counsel fees?

As a rule of thumb, if you must pay income tax on the investment income earned within an account, you can deduct the investment counsel fees related to that account. If you don’t have to pay income tax on the investment income earned within an account, because it is in a tax-sheltered account, then you cannot deduct the investment counsel fees.

Some examples of tax-sheltered accounts include:

- Registered Retirement Savings Plans (RRSP),

- Locked-In Retirement Account (LIRA),

- Registered Retirement Income Funds (RRIF),

- Life Income Fund (LIF), and

- Tax-Free Savings Accounts (TFSA).

Taxable accounts, also known as non-registered accounts or cash accounts, include investment accounts owned by:

- individuals,

- in joint name,

- legal entities, and

- trusts.

The one exception to the deductibility of investment counsel fees is for Individual Pension Plan (IPP) accounts. IPPs are registered pension plans for individuals who have corporations. The corporation makes contributions to the IPP on behalf of the owner(s). Investment counsel fees paid by the corporation for the IPP are tax-deductible for the corporation.

Investment counsel fees reduce your total net income. For example, if you held growth stocks in a non-registered account that don’t pay a dividend, and didn’t sell them, you can still deduct your investment counsel fees even though you technically don’t have any investment income for the year.

Other points to consider

Reimbursing registered account fees

While registered account fees are not deductible for income tax purposes, the Department of Finance issued a comfort letter stating that investment counsel fees to be paid outside of the account, or reimbursed to the account would not constitute an advantage. This then allows for further compounding growth in a tax-sheltered environment. For further information on this, refer to the past articles we have written: Extra deposit into your TFSA and Paying RRSP fees from a non-registered account

Account designated billing

With our billing system, we have the ability to designate account fees to be paid from select non-registered accounts.

For example, we have clients, Mr. and Mrs. Smith who are both 75 years of age. They have a Joint With Right of Survivorship account, and each have RRIF and TFSA accounts. They have elected to have their investment counsel fees associated with their TFSAs paid from the Joint With Right of Survivorship account to allow the funds to compound further within their TFSAs.

We have mapped out a plan with Mr. and Mrs. Smith to wind-down their RRIF accounts over the next ten years, so the investment counsel fees related to the RRIFs are charged directly to the RRIF accounts.

Although the TFSA fees are paid from their non-registered Joint With Right of Survivorship Account, they are not able to deduct this portion of the fee as it relates to a registered account. Come tax time, we prepare and provide a tax slip for Mr. and Mrs. Smith to provide to their accountant which contains the amount of investment counsel fees charges for the non-registered (taxable) portion of their investment portfolio so they can deduct it on their income tax return.

Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email greenard.group@scotiawealth.com, or visit greenardgroup.com.