Deduction – Page 6 – Doug Carroll

RRSP mortgages and interest deductibility

At issue

Generally a mortgage secured against real estate in Canada is a qualified investment for an RRSP. An annuitant may even choose to hold a mortgage on his or her own property, though the qualification criteria are more stringent in such situations.

Essentially, where annuitant and debtor are not at arm’s length, the Income Tax Act requires that the mortgage be administered by an approved lender and that it must carry mortgage insurance. While there are costs associated with these requirements, in a high interest rate environment a RRSP mortgage may be preferable to making payments to a commercial lender, as the interest contributes to the RRSP’s investment return.

Of value to those with rental properties, in the right circumstances it is possible to also deduct interest charges on those mortgage payments made into one’s own RRSP.

CRA 1999-9926175E – Mortgage as a Qualified Investment

The CRA author provides a rundown of the principal sections in the Income Tax Regulations under which a mortgage may be a qualified investment for a RRSP. Though the relevant sections have since been amended and consolidated, the substance remains effectively the same today.

Included is an admonition that an annuitant cannot benefit from the existence of the mortgage. In support, the letter goes on to state that “the mortgage interest and other terms must reflect normal commercial practices.”

In context, this reinforces the purpose of the lender and insurance rules, and should not be taken to suggest that there can be no other benefits whatsoever, such as for example potential interest deductibility where a rental property is involved.

CRA 2011-0413761E5 – Interest

This CRA letter comments on a hypothetical scenario whereby a taxpayer’s RRSP uses a non-arm’s length mortgage to retire an original loan from an arm’s length bank used to purchase some rental properties. It confirms that “as long as the rental properties continue to be held by the taxpayer for the purpose of earning income from a business or property”, interest on this second loan – now held by the RRSP – will indeed continue to be deductible.

Duxbury v. The Queen, 2006 TCC 688

To invest in a business, the taxpayer borrowed from a commercial lender by mortgaging his jointly-held home. Some years later as part of a creditor protection exercise, his RRSP used a mortgage to retire the arm’s length mortgage. At the same time, the house was transferred into his wife’s name alone.

In a subsequent year, the taxpayer sought to deduct the annual mortgage payment as an RRSP contribution for that year. CRA denied this claimed deduction, and its position was upheld in this taxpayer appeal.

Given that the original borrowing had been for a business purpose, the interest would have originally been deductible. Depending on how the RRSP acquired its mortgage from the commercial lender, some or all of that deductibility could potentially have carried through to the RRSP mortgage. Unfortunately, there is no mention in the judgment of the interest component as distinct from the full mortgage payment, so it is not clear whether the taxpayer could not advance this argument based on the facts, or if the issue was simply not raised.

Practice points

The cost of non-arm’s length RRSP mortgages becomes more palatable in higher interest rate environments.
One is not precluded from deducting interest where a rental property or underlying business purpose can be shown.
Good recordkeeping will assist in tracing the use of funds, particularly where a substitute loan is employed.

Deductibility of business clothing expenses

At issue

It would perhaps be more apt to entitle this article “non-” deductibility of business clothing expenses, as fairly narrow qualification rules apply to such claims. Particularly in the circumstance of an independent financial advisor, a successful claim may be a remote possibility.

Still, it is not entirely outside the realm of possibility, and it can be instructive for one’s future reference to have an appreciation of the nature of claims that fail to qualify.

With fingers crossed then, here are some taxpayers who sought to deduct clothing costs, including one that got a little more exposure than may have been desired.

Rupprecht v. The Queen, 2007 TCC 191

Advisor had expended considerable cost building and furnishing an office in the Vancouver suburb of Langley. He testified that he needed suitable clothing to go with the office, claiming over $8,400 through the 1999 and 2000 taxation years for purchases from “Ermengildo Zegna, an exclusive men’s wear shop,” as described by the judge. In support of his position, the advisor even included a letter from a store sales associate.

As the clothing did not fall under claims for uniforms and such, its deductibility would need to rest on being a general business expense, which in turn required the judge to consider the converse condition of what constitutes a personal expense. In denying the claim, the judge held that “expenses relating to one’s personal appearance are the very essence of a personal expense” for which the cost is not deductible.

Rioux v. The Queen, 2007 TCC 82

Advisor sought to deduct just over $2,000 for clothing expenses in each of the 2001 and 2002 taxation years. The claims were based in part on advisor’s argument that he was self-employed, despite his commissions being characterized as employment income on his T4 slip from Canaccord Capital Corporation, and he having likewise disclosed those commissions as employment income in reporting his income in those years.

On appeal, the advisor produced an agreement from 1994 purporting to show a self-employment relationship with the predecessor company that was acquired by Canaccord in 1999. The advisor alleged that Canaccord was bound by the former agreement, but provided no proof of this assertion, and therefore he failed to satisfy the threshold requirement of being self-employed for the judge to even consider the claimed deduction.

Hamper v. Commissioner of Internal Revenue (United States Tax Court Summary Opinion 2011-17)

While lacking precedent value in Canada, cases from other jurisdictions can be illuminating.

In what has infamously become known as the “thong deduction” case, an Ohio television anchorwoman sought to claim various items of clothing allegedly necessary to perform her job duties. In deciding whether an item should be claimed as a deductible business expense, she asked herself “would I be buying this if I didn’t have to wear this” to work. She proposed ‘yes’. The judge replied ‘no’.

Practice points

The cost of uniforms and other clothing consumed in the workplace may be deductible.
As is mentioned in almost all the cases, clothing is prima facie a personal expense, and it is the taxpayer’s onus to prove otherwise.
Undergarments? Hard to imagine, and harder to explain to your clients if you’re later exposed on the evening news.

Deductibility of investment fees, MERs – Six of one, half-dozen of the other?

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”.