With the growing number of exchange-traded funds (ETFs) in the market, the media has been abuzz with discussions about the cost of obtaining investment advice.
While mutual fund management expense ratios (MERs) are designed to incorporate the cost and compensation for an advisor’s professional expertise, ETFs do not include such charges, being more commonly recommended within a fee-based program.
Such programs often tout the tax-deductible nature of their fees, but are they really all that different from the net tax treatment of mutual fund MERs?
Basis for deductibility
While a qualified professional may indeed be providing valuable financial guidance, that in itself is not sufficient to result in deductibility.
In order for investment counsel fees to be deductible, the Income Tax Act requires that such fees are for advice regarding the purchase or sale of specific shares or securities, or for services in respect of the administration or management of shares or securities. Furthermore, the fees must be paid to someone whose principal business is to advise or provide service in such investment matters.
Assuming that the nature of the advice and amount charged for it will be the same whether within an MER or as a separately levied amount in a fee-based program, are the after-tax results any different?
We can use a simplified example* of a 5% interest return where the total cost to the investor will be 2%, either as an MER or as part of an advisor’s fee-based program.
$10,000 invested Mutual fund Fee-based program
Interest income $500 $500
Less: MER $200 0
T3 slip income $300 $500
Less: Investment counsel fee 0 $200
Taxable income reported $300 $300
*Note: A more detailed example is illustrated in our InfoPage “Deductibility of investment fees”
As shown, the investor ends up with the same taxable income by either route. Whereas the mutual fund reports the net amount, the fee-based program gives the investor the opportunity and obligation to actually claim the deduction when preparing the year’s tax return. It is perhaps this active step of claiming the deduction that leads some to the misconception that only those latter fees are tax-deductible.
What is not deductible?
In order for fees to be deductible, the Canada Revenue Agency requires that the amounts claimed must be reasonable; this requirement will normally be met if the fees are paid to an unrelated person. Where the payment is to a related person, there may be closer scrutiny on type of activity and time spent.
Deductibility does not extend to general financial counseling or planning, even though it is carried out by a professional who can legitimately levy investment counsel fees.
Finally, as might be expected, neither MERs nor separate fees are deductible when associated with an RRSP or RRIF. An investor may, however, choose to pay those separate fees from outside the RRSP or RRIF, thereby preserving those tax-sheltered assets even if only to a modest extent.
Note: For Quebec provincial taxes, deductions can only be taken against income earned. For more details, see our InfoPage “Deductibility of investment fees”.