Tag: Fees

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”.

Coming to terms with HST

This past holiday season, the kids received a DVD of heritage-era cartoons, not the ones with either of the famous big-eared rodents, but instead a collection of fractured fairy tales.  One in particular caught my attention — a tongue-in-cheek version of the story of the ant and the grasshopper.  

You’ll recall the original pitted the industrious ant against the perpetually procrastinating grasshopper.  The ant stored food for the lean times while the grasshopper consumed and played.  Come winter, the grasshopper either died out or came grovelling to the ant’s storehouse.

Of course this isn’t all that amusing for the wee ‘uns, so the cartoonists exercised their poetic licence and acerbic wit to turn the tale on its head. The grasshopper could do no wrong, and the ant (despite the best of intentions and efforts) ended up worse off for those saving ways.

At one point, my eldest (all of 5 years old) commented between giggles that it didn’t make much sense, but it sure was funny.  And it was, for a cartoon.

Not so funny if savers in reality were to be worse off for their efforts. This would be particularly ill fortuned if it were attributable, even if only in part, to taxes imposed by their own government.

Taxes are innately good

It’s true and it’s an important premise that needs to be stated before continuing.

Taxes are the primary means by which we finance our society. They are the necessary balance to service the expense of providing the infrastructure and public goods that otherwise would be left undelivered or unsupported if we all operated strictly in our respective self-interests. 

Thus, while taxes themselves may be good, the implementation of an effective taxation system struggles with NIMBY.  No, that’s not another classic cartoon character. It’s a classic response to the spectre of new taxes: “Not in my backyard.”  

The problem with NIMBY is it’s totally lacking in principles, while laden with self-interest.  

So the issue is not “if” tax revenue must be raised, but “how” to do so. This then is where political, social and economic values may very well come into conflict, often lining up along political party lines. Although the tension may be unavoidable, its resolution need not be insurmountable.

The impending HST

A broad-based consumption tax like the GST, and in turn the HST, can be an effective way to spread tax need across a population. Though it is inherently regressive in that it imposes a higher burden on low-income payers, the concurrent implementation of a targeted tax credit mechanism can be used to address this equity concern.

Being broad-based is critical. If otherwise taxable units are zero-rated or exempted from tax liability, the tax base may be eroded and remaining taxable units must be charged a higher rate. Whether the distinction arises out of social policy or industry lobbying, it influences consumer actions and has economic consequences. With respect to industry lobbying particularly, the undercurrent of self-interest again surfaces.  

That said, in my opinion there is an even more fundamental concept to be probed, which is whether consumption taxes should apply to savings, directly or indirectly.

Savings as consumption

Savings is not as simple a concept as one might expect. There is a large body of tax and economic literature on the issue, and it is an ongoing debate. Much of this is under the umbrella of income tax — specifically if and how unrealized income should be taxed.  In the Canadian system, we generally defer taxation on unrealized capital gains, and on all types of income and accretions in most registered plans until withdrawn.

So, having taken a position on the taxation of savings in the income tax realm, is that being coordinated on the consumption tax side?

To the person on the street, a reasonable definition of savings might be “that which is not consumed.” Accepting that for the moment, it would seem illogical that a consumption tax might be applied to something that is not consumed, at least in the practical sense.

The counterpoint would hold that GST/HST is not imposed on savings, but rather on services employed in the management of those savings, such as mutual fund management fees. Nevertheless, it is the savings that carry the burden of the tax — though one degree removed — and therefore the distinction may be technically correct but practically indistinguishable.

Presumably, if savings are kept clear of GST/HST (directly or indirectly), there will be more to be consumed later. Arguably then, this may be no more than a deferral of the consumption tax, and potentially an increase in the base upon which to impose that tax when truly brought into consumption in future.   

Is that all, folks?

The precarious state of the pension and retirement income system has been in the forefront as we have worked through the current economic downturn.  In fact, the ministers of finance met to discuss the system this past December and will come together again in May.

While the Ontario HST can be expected to be implemented pretty much intact come July, here’s to hoping that future amendments to the GST and HST take into full consideration the practical impact they have on savings, retirement and the broader economy.