Rules are complicated, but important for advisors to know.
Are an advisor’s management fees tax-deductible? In today’s world, where clients are, perhaps more than ever, seeking to minimize risk and maximize profits, it’s a question many people are asking.
Unfortunately, the answer isn’t so simple – even investment professionals have a hard time fully understanding it, says Michelle Munro, Director, Tax Planning, for Fidelity Investments.
Only some fees count
Essentially, you need to look for the “true nature of the fee,” she says. “Investment counsel fees are deductible as a carrying charge on an individual’s tax return. You need to understand the services received to know whether or not the fee is deductible.”
True financial advice, which is considered counsel on whether or not to buy or sell (or continue to hold) a specific investment or security, is considered a carrying charge – a cost incurred for investment advice or for recording investment income – under the Federal Income Tax Act, so any fees related to that charge are deductible, she explains.
Commissions, though, which are transactional costs, are not deductible as a carrying charge, says Ms. Munro. Fortunately, these expenses are not entirely lost to the investor, because they increase the adjusted cost base (ACB) of securities, which lowers the capital gain that is realized when the security is sold.
Unfortunately, it can be difficult for a client to deduct fees from a fee-only planner who also offers investment advice, because it’s not easy to determine exactly how much to claim. While the financial advice is deductible, commissions for transactions and financial-planning services are not.
Another key determinant of whether management fees are tax-deductible is that they must relate to advice on investments made in non-registered accounts only.
The CRA will disallow any fee deductions that relate to Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Education Savings Plans or Tax-Free Savings Accounts.
“Even if the fee is paid through a non-registered account, the CRA looks at what the fee is for,” says Ms. Munro.
Mutual fund fees
Another consideration surrounding the tax implications of fees is how those fees are paid. Clients do not need to specifically deduct mutual fund fees because they’re part of the management expense ratio and are not paid directly by the investor. Rather, these fees are deducted from the income reported on the annual tax slip.
It’s different for investors in wrap or separately managed accounts. In this case, investors are charged quarterly or annual management fees that they pay directly, so these costs do need to be deducted separately on income tax returns.
The result to the taxpayer is essentially the same, says Ms. Munro. The only difference is whether the fee is deducted on the tax slip reported by the fund company or the client is the one deducting the fees as a separate line item on his or her return.
Keep it reasonable
Another thing to keep in mind is that a fee has to be reasonable in the eyes of the CRA.
“Generally, that’s not a concern,” says Ms. Munro, but the issue does come up where there is a corporate relationship between the investor and the manager or advisor, or when a family member is providing the advice and the investor is claiming the deduction.
Fees are usually considered reasonable if they’re based on a sensible percentage of the fair market value of the underlying investments, and if they reasonably reflect the amount of time spent and type of work done by the person providing the advice or service.
Advisors and clients should also keep in mind that investment fees are subject to HST (or GST and PST), whether inside or outside a fund. The rate depends on which province or territory the investor resides in.
For investors, “It always makes sense to ask an advisor about tax-deductibility of fees,” says Evelyn Jacks, a Winnipeg-based tax expert and founder of the Knowledge Bureau, a financial education company. “Fee disclosure in general is a big issue, and advisors are addressing it.”