Deduction – Page 2 – Doug Carroll

Per CRA, no fee deductibility for advice on entering into or redeeming segregated funds

At issue

Segregated funds are sometimes described as the insurance industry’s version of mutual funds. This is convenient as a rough reference point, as outwardly their value tracks against an underlying pool of investment assets segregated from the insurer’s other assets.

In truth, however, they are a form of annuity, a type of insurance contract. This is not mere technical phrasing; a host of rights, obligations, protections and restrictions flow from this characterization. Of particular interest are guarantees of future account value or income flow, though the insurer will charge a fee inside the contract for this.

But how are fees charged outside the segregated fund by a financial advisor treated for tax purposes? Specifically, does advice related to segregated funds mirror the tax-deductibility accorded to advice on buying and selling mutual funds?

Income Tax Act (ITA) Canada paragraph 20(1)(bb) – Fees paid to investment counsel

As a general tax principle, an amount may (note the emphasis) be deductible in computing income where that outlay is related to the generation of income. Enumerated under ITA s. 20(1) are deductions permitted in computing income from business or property, with investments falling within the latter category.

Pursuant to ITA 20(1)(bb)(ii)(A), a deduction may be taken for “advice as to the advisability of purchasing or selling a specific share or security of the taxpayer” where fees are paid to a person whose principal business is advising in that respect. Mutual funds pool investors’ capital to invest in shares or securities, and thus qualify under this section.

2014 CALU Conference, Question 5 – Segregated Fund Counselling Fees – May 6, 2014

At the 2014 Conference of Advanced Life Underwriters (CALU) roundtable, representatives of the Canada Revenue Agency (CRA) considered whether a deduction should be allowed for advice related to the purchase or sale of segregated funds. The key part of the response is as follows:

“Paragraph 20(1)(bb) of the Act applies in the context of shares or securities of a taxpayer. A segregated fund policy is a contract of insurance and, in our view, is not a share or security of the taxpayer. Consequently, it is our position that paragraph 20(1)(bb) of the Act does not apply to fees paid by a taxpayer in respect of the advisability of the acquisition or disposition of segregated fund policies, or for the administration or management thereof as the requirements of that paragraph are not met.” [Emphasis added here.]

In the conference report, the CALU editors indicated that Department of Finance officials had expressed some sympathy to a broader interpretation, and that industry stakeholders would continue to correspond with CRA in the hopes of the agency taking a more expansive view of segregated funds.

2014-0542581E5 (E) – Segregated fund counselling fees – August 24, 2016

In an email dated August 6, 2014 (sent 3 months after the CALU conference above), the CRA was asked to reconsider its position that a segregated fund policy is not a security. In its response, CRA redacts the addressee’s name, though it appears to be directed to CALU.

After acknowledging that there are arguments for and against the proposition based on the plain text of the terms, the analysis turns to the context in which the words are used. Specifically, paragraph 20(1)(bb) is an exception to the general limitation on deductibility delineated in paragraph 18(1). The position put forward is that as the exception is narrowly drafted, its interpretation should be similarly narrow.

The author then harkens back to predecessor provisions of the ITA and the definition of the term “security”, both pre-dating the existence of segregated funds. From that perspective, an expansion of that definition could have unintended consequences elsewhere in the ITA.

In the author’s opinion, the inclusion of segregated fund in the definition of security is not supported by the law, so a legislative amendment would be necessary to achieve this result. The letter then acknowledges that the issue has already been brought to the attention of the Department of Finance, presumably by the letter recipient.

Practice points

CRA does not consider counselling fees deductible when paid to an advisor who advises on entering into or redeeming segregated funds.
For clarity, the subject matter of this discussion is the charging of fees directly by an advisor to an investor/client. Any fees charged within a segregated fund cannot be claimed as a deduction by an investor.
Note as well that segregated funds have both insurance and investment elements that may make them well suited to a particular individual, with deductibility being a secondary consideration or non-issue.
Depending on the reception at the Department of Finance, this may not be the end of this issue, though it is ultimately up to legislators whether to make changes to the law.

CRA relaxes position on deductibility of PHSP premium payments

At issue

Claiming annual payments for medical expenses does not often lead to significant tax relief. In addition to being a non-refundable tax credit at the lowest bracket rate, there is a cap on the amount used as the base for calculating the claim.

For business owners, a strategy that may offer a better tax result is to establish a private health services plan (PHSP) for employees. Carefully structured, this entitles the employer to a business deduction for the plan premium, while the employee will have no income inclusion when premiums are deposited nor when qualifying medical payments are eventually paid out of the PHSP.

In November 2015, the Canada Revenue agency (CRA) announced a welcome change in its position on deductibility of PHSP premium payments.

CRA Income Tax Folio S1-F1-C1, Medical Expense Tax Credit (METC)

This is the CRA’s administrative guide to claiming medical expenses. Qualifying expenses are enumerated in the folio, and may be claimed for any 12-month period that ends in the taxation year for which a return is being filed.

As with most tax credits, the credit rate is at the lowest bracket rate (federally 15%) multiplied by the qualifying amount. But unlike most credits, the actual amount expended is not what is used directly for the calculation. Rather, the medical expense total is reduced by the lesser of two figures:

the fixed amount (indexed annually), which is $2,208 for the 2015 tax year, and
3% of the taxpayer’s net income

A similar calculation applies for the corresponding provincial/territorial credit.

Income Tax Act (ITA) Canada

A “private health services plan” is defined in ITA s.248(1). Practical guidance is given in IT339R2 ARCHIVED – Meaning of private health services plan. Though archived, this bulletin continues to be referenced in CRA’s own communications. It confirms that a payment made into a PHSP is a business expense for the employer under ITA s.18(1)(a), but not a benefit to the employee under ITA s.6(1)(a)(i).

Key to being a PHSP is that it is based on an employment relationship. A plan could be at risk of losing PHSP treatment if benefits favour shareholders over employees. On the other hand, it may be acceptable if the benefits of a shareholder-employee are comparable to other employees. Further insight on this issue can be gleaned from Income Tax Folio S2-F1-C1, Health and Welfare Trusts.

CRA roundtable, Canadian Tax Foundation conference – November 24, 2015

CRA’s position has to-date been that in order to qualify as a PHSP, all medical expenses covered under a plan had to be eligible for the METC. The question was posed to the CRA panel whether the agency had an update regarding its position.

The CRA now considers that a plan is a PHSP as long as all or substantially all of the premiums paid relate to medical expenses eligible for the METC. Generally that means 90% or more of covered expenses must be METC-qualified. The reason for the change is to alleviate concerns that nominal or incidental charges (eg., non-prescription vitamins) may put a plan offside, thus allowing for certainty and flexibility in plan design and administration.

The revised position is retroactive to January 1, 2015.

Practice points

A personal tax credit is available to offset qualifying medical expenses. However, due to the structure of the credit calculation, the amount of relief is often limited.
Bearing in mind what costs there may be in establishing a PHSP, a plan of this type will likely lead to a better tax result for supporting medical expenses incurred by employees.
A PHSP is based on an employment relationship. Where shareholders are also employees, expert advice should be sought in order to assure that the proposed plan remains within the PHSP rules.

Deductibility of professional’s run-off insurance post-practice

At issue

In order for someone to claim a tax deduction, our tax system requires that there be an income source to which an expense relates, and that the purpose of the expense is to produce such income.

For a professional who ceases practice, it would thus seem unlikely that deductibility would be available for an amount expended after the business has ceased to exist. However, where that expense relates back to the pre-retirement period when professional services were being rendered, deductibility comes back into the picture.

Income Tax Act (ITA) Canada

ITA subsection 9(2) makes reference to calculation of a taxpayer’s loss from a “business or property” for a taxation year. It requires that a taxpayer’s loss, if any, from that source be determined by applying the ITA provisions for income computation. Put another way, if there is no business or property income for that taxation year, in principle there can be no deduction.

Furthermore, an expense must fulfill the purpose requirement under ITA paragraph 18(1)(a) dealing with business or property, whereby:

18. (1) “… no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property”

A.G. (Canada) v. Poulin, 1996 DTC 6477 (FCA)

Poulin was a real estate broker who had ceased carrying on business in 1984. In 1987, he was found liable to a past client in relation to a transaction from 1976. Poulin sought to deduct the $385,802 adjudged award as a business loss in 1987, and to carry the remaining loss to other years.

The court held that the fact that Poulin was not carrying on the business in 1987 did not preclude him from seeking to claim under paragraph 18(1)(a), “as long as he was engaged in completing the things he had done in carrying on his profession, even though at that point he was no longer carrying on business and could no longer act on behalf of clients.” The claim would have to relate to an impugned act that was necessary in order to carry on a trade or profession, but may have been performed improperly.

Unfortunately for Mr. Poulin, the court went on to determine that the damages in the circumstances related to a tort – an unlawful or deliberate act committed with the aim of causing damages – which it found was foreign to his profession, thereby ruling out deductibility.

2015-0618981E5 – Deductibility of run-off insurance premiums

The question was posed to the Canada Revenue Agency (CRA) whether a retired professional can deduct run-off insurance premiums from business income in the year the premiums are paid, even if the professional has ceased to carry on business in that year.

Citing Poulin as authority, the author of this CRA letter opines that, despite that the taxpayer may no longer be in practice, run-off insurance premiums may be deductible in the year paid. The claim must conform with ITA deductibility requirements generally, and relate to work performed “during the ordinary course of the professional’s business operation.” in the pre-retirement timeframe. Presumably the reference to “ordinary course” distinguishes offside activities such as in Poulin.

Practice points

Tax deductibility requires that an expense relates to producing business or property income, most often with both expense and income arising in the same year.
Bearing in mind that CRA letters are not legally binding, it would appear that CRA’s administrative position is that run-off insurance premiums may be deductible when paid in a post-retirement year.
Irrespective of tax deductibility, a retiring professional would be well-advised to consider run-off insurance coverage if it is available, in order to provide a degree of protection from a post-practice claim.