John Natale, LL.B., BComm, EPC, CFP
Head of Tax, Retirement & Estate Planning Services
John is the Head of the Tax, Retirement & Estate Planning Services, Wealth team at Manulife. He and his team provide case-level support on tax, retirement, and estate planning matters to advisors across the country.
Some products have built-in fees such as the MER in a mutual fund. Alternatively, some advisors may choose to charge clients an overall fee on the assets they manage for them. Regardless of either scenario, knowing more details about investment fees can be an advantage for you and your clients, especially when it comes to the possible tax deductibility of those fees.
To determine that, I’ll will start with an overview of the requirements for fee deductibility in the Income Tax Act (ITA).1 Next, I’ll look at how the tax status of the investment account, whether registered or non-registered, impacts fee deductibility. Finally, I’ll look at an example of how expenses at the fund level are deducted and how a client deducts their fee for tax purposes.
When is an investment fee deductible?
The criteria for determining the tax deductibility of an investment fee are found in paragraph 20(1)(bb) of the ITA. At a high level, a taxpayer may deduct fees and the applicable sales tax — i.e., Goods and Services Tax (GST), Harmonized Sales Tax (HST), and Quebec Sales Tax (QST)) — if such fees are:
- paid for buy/sell advice on specific securities, or the administration or management of securities held by that taxpayer
- fee amounts paid are reasonable
- fee-based services are provided by a person (e.g., an advisor) or entity (e.g., an investment firm) whose principal business is providing buy/sell advice on specific securities or includes the administration or management of securities.
Provided that the investment fees paid meet these criteria, they’ll be deductible against any source of taxable income earned during the year.2 Alternatively, embedded fees such as MERs are deducted by the fund (i.e., mutual fund or segregated fund) before income is distributed or allocated to investors, reducing the amount of taxable income for those investors.
Commissions paid on the trading of stocks and ETFs, for example, aren’t deductible for the investor under these provisions. However, commissions paid on security purchases are added to the adjusted cost base of those securities, while the commissions paid on a sale are subtracted from the proceeds received. The result is that a capital gain is reduced by the associated commissions, while capital losses are increased. Fees paid for general financial counselling or planning aren’t deductible here either, nor are the subscription fees for financial magazines and newspapers.
Fees in a registered account
Advisory and other investment fees charged on registered assets, regardless of the investments held, are not tax deductible. Such fees can be paid out of the registered account itself or from a taxable account the investor holds. If the registered fee is paid outside the registered account, the advantage rules don’t apply and neither does the 100 per cent advantage tax.3
Should registered fees be paid from inside or outside the registered account? The answer depends on the type of registered account. For example, with a TFSA, where after-tax dollars can grow tax-free, paying the fee outside the account can maximize that tax-free savings as they’re not directly reduced by the fee. However, with RRSPs and RRIFs, where amounts are taxed when withdrawn, the answer will depend on your time horizon, rate of return, and tax rate. These factors would only be known with certainty by reviewing them in hindsight. It’s noteworthy that if the fee is paid inside the RRSP or RRIF, it’s done with pre-tax dollars. While this reduces the value of your tax-deferred investment, it also reduces the amount of tax the Canada Revenue Agency (CRA) will collect on future withdrawals.
Segregated fund contracts
Investment counsel and advisory fees related to entering, or redeeming, segregated fund contracts in taxable accounts are not currently viewed as deductible by the CRA.4 This rationale is based on the view that a segregated fund contract is an insurance contract and not a share or security of the investor, a key requirement for fee deductibility. Finally, the MER of a segregated fund contract, like its’ mutual fund counterparts, can be used by the fund to reduce its income before allocation.
Tax comparison of MER and investment management fees
There are differences between a tax-deductible fee or an MER on your investments. Let’s take a closer look at that with the help of an example.
Assume Stephanie has $250,000 invested in a taxable account. She wants to compare the tax benefits of a mutual fund trust that only has an MER (Series A) and another that has a combination of an MER and an advisor fee (Series F). For simplicity, she uses a fixed-income mutual fund with a 5 per cent return, all of which is interest income. The Series A will have a 2 per cent MER. The Series F will have a 1 per cent MER and 1 per cent tax-deductible advisor fee for the same total fee of 2 per cent. Stephanie’s marginal tax rate is 50 per cent. This table shows the results of her analysis:
| Series A | Series F |
Initial investment | $250,000 | $250,000 |
Interest income | $12,500 | $12,500 |
MER – (2%), (1%) | ($5,000) | ($2,500) |
Distribution | $7,500 | $10,000 |
Advisor fee – (0%), (1%) | - | ($2,500) |
Taxable distribution | $7,500 | $7,500 |
Tax on distribution | ($3,750) | ($3,750) |
After-tax income | $3,750 | $3,750 |
It’s evident that when interest income is earned and the total fee is the same, the fee structure (whether the fund has only an MER or has a combination of MER and advisor fee) makes no difference to the investor’s after-tax income. This is because the total fees ($5,000) are the same, reducing the same total taxable income ($12,500 of interest income).5
For investments held within a corporation, the taxable distribution would be used in the adjusted aggregate investment income (AAII) calculation.
Summary
For investment management fees to be tax deductible, they must meet the criteria set out in the ITA and be paid on investments held in taxable accounts. Fees paid in registered accounts are not tax deductible but can be paid inside or outside these accounts. Investment fees, whether embedded in the product like an MER or tax deductible for the investor, reduce an investment’s taxable income. The difference is that an MER reduces taxable income in the fund and an investment counsel fee reduces the investor’s taxable income.
