Investment insight
There are many different investments available in the financial marketplace. Most of them charge fees. Some fees are embedded in the product itself, like a management expense ratio (MER) of a mutual fund. Others may be charged outside the product as part of a fee-based program. Which fees are tax deductible for an investor and which aren’t?
To determine that, we’ll start with an overview of the requirements for fee deductibility in the Income Tax Act (ITA).1 Next, we’ll look at how the tax status of the investment account, whether registered or non-registered, impacts fee deductibility. Finally, we’ll look at an example of how expenses at the fund level are deducted and how an investor deducts their fee for tax purposes.
When is an investment fee deductible?
The criteria for determining the tax deductibility of an investment fee is 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 the above 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 trading of stocks and exchange traded funds (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 (ACB) 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. And subscription fees paid for financial magazines and newspapers are also not deductible.
Fees in a registered account
Advisory and other investment fees charged on registered assets, regardless of the investments held, aren’t 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% advantage tax.3
Should registered fees be paid from inside the registered account or outside? The answer depends on the type of registered account. For example, with a tax-free savings account (TFSA), where after-tax dollars can grow tax-free, paying the fee outside the TFSA can maximize that tax-free savings as they’re not directly reduced by the fee. However, with registered retirement savings plans (RRSPs) and registered retirement income funds (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 CRA will collect on future withdrawals.
Segregated fund contracts
Investment counsel and advisory fees related to entering into or redeeming segregated fund contracts in taxable accounts aren’t currently viewed as deductible by 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 it’s mutual fund counterparts, can be used by the fund to reduce its income before allocation.
Tax comparison of MER and investment management fees
You may be wondering if there are differences between a tax-deductible fee or an MER on your investments. Let’s look at that through an example. 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% return, all of which is interest income. The Series A will have a 2% MER. The Series F will have a 1% MER and 1% tax-deductible advisor fee for the same total fee of 2%. Her marginal tax rate is 50%. The table below 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 |
As you can see, 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 you have the same total fees ($5,000), 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 aren’t tax deductible but can be paid either 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 an MER reduces taxable income in the fund and an investment counsel fee reduces the investor’s taxable income.
1 More information on the requirements for fee deductibility can be found in the Canada Revenue Agency’s IT238R2 ARCHIVED - Fees paid to investment counsel - Canada.ca.2 For Quebec tax purposes (for individuals and trusts, not for corporations), the deductibility of the investment counsel fees (as investment expenses under Quebec rules) paid during a year is limited to the total investment income realized during the same year (including interest, taxable capital gains, grossed-up Canadian dividends, and gross foreign income). Investment fees that aren’t deducted in the current year can be used in the three previous years or carried forward for future years. For more information see: Investment Expense Deductibility: Quebec.3 The Department of Finance confirms they have no policy concerns with investment counsel fees for registered accounts being paid with non-registered funds. In their view, it’s not evident that such arrangements are tax motivated. They’re prepared to recommend an amendment to the ITA that these fee arrangements won’t constitute an advantage. 26 August 2019 Comfort Letter - “Advantage”: Exclusion for Investment Management Fees.4 24 August 2016 External T.I. 2014-0542581E5 - Paragraph 20(1)(bb) - segregated funds.5 While an investor’s after-tax interest income is the same regardless of the fee type (MER or tax-deductible fee), small differences in their after-tax income may occur when the MER is used to reduce other types of income distributions– namely foreign income, Canadian dividends, or capital gains.
Important disclosures
Important disclosures
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.
03/23
