Deduction of management fees: are you entitled?

It's a well-known fact: investors can deduct the management fees they pay on their non-registered accounts.

The resulting tax savings are substantial: typically, they will reduce your management fees by 27% to 53%, depending on your taxable income.

But to qualify, the management fee must meet a number of criteria. Do you qualify?

Eligibility criteria for deductible fees

A management fee is deductible only if:

1. It is reasonable
2. It is not a commission
3. It is paid to a person (including a company) whose principal business "(...) is to give advice on the advisability of buying or selling certain shares or securities" or to "(...) provide services relating to the administration or management of shares or securities".
4. It is paid for one or more of the services listed in the previous point.

Ineligible expenses

Here are a few examples that do not constitute a deductible management fee:

• mutual fund management fees ¹
• management fees for a segregated fund (i.e. a fund issued by an insurance company) ²
• fees for financial planning, legal or accounting services ³
• a commission for the purchase or sale of investments ⁴
• a fee paid for the management of a registered account (RRSP, RRIF and TFSA, for example) ⁵

Eligible expenses

A fee eligible for deduction must be negotiated between you and your advisor. If you've never had a conversation about it, your management fee is probably not deductible.

If, on the other hand, you have a management fee with a brokerage firm (such as a stockbroker or mutual fund dealer) for administering your accounts and advising you on the advisability of buying and selling securities, as well as preparing investment and disbursement plans, then your management fees on your non-registered accounts are probably deductible.

Portfolio management fees for non-registered accounts are generally deductible.

The management fee is deductible in the year in which it is paid ⁶ and not in the year for which the fee was incurred.

The advantage of deducting management fees

The advantage of deducting management fees can be significant.

To those who say that if the return is higher, it doesn't matter that the fees have been deducted, we say that the return cannot be predicted, but the fees (and their deduction) can. And they represent a definite return.

If you haven't yet paid attention to deducting your management fees, it's never too late to make sure your advisor does.

A 20-year-old investor who can deduct his management fees will have up to 11.8% ¹ more in his portfolio at retirement than an investor who cannot deduct them (down to 10.4% for the 40-year-old investor).

How to pay management fees - the theory

Management fees can be paid in three ways:

Directly debited from the account for which they are billed

 It's the simplest way. It's easy to track and process each fee for tax purposes.

For all accounts from a single investment account

In this case, the tracking and tax treatment of each fee is complex. If the annual summary of management fees issued by your representative's firm is not precise (for example, by explicitly excluding registered account fees from deductible fees), the risk of error by your tax preparer becomes very high.

By cheque from bank account

Paying expenses from the bank account does not reduce the follow-up required to separate expenses that are deductible from those that are not. The comments in the previous point therefore also apply to this method.

How to pay management fees - a practical guide

In general, here's the best way to pay management fees for each type of account.

RRSPS/RRIFS          

Have the fees deducted from the account. This payment is not considered an ^8-plan withdrawal and is therefore non-taxable. Although the management fee is not deductible, the net tax consequence is similar to a management fee deduction. In fact, you won't have to pay taxes to withdraw this amount from your RRSP at retirement, since it will have been withdrawn directly to pay your management fee.

CELI

Have the fee deducted from a non-registered account or from the bank account. This payment is not considered a new deposit to the plan.⁹ Although the management fee is not deductible, this approach maximizes the value of the TFSA.

Open account (not registered)

It doesn't matter how the management fee is paid. Have the fee deducted from the account to simplify tracking of fees paid.

What you need to do

1. Check with your representative to see if the management fees on your accounts are deductible.

2. Validate the information with your accountant/tax advisor, who is the only person who can confirm whether or not the management fees you pay are deductible.

3. Be sure to provide your tax preparer with an annual statement of your management fees for each account for which fees have been charged.

Avoid using the fee disclosure document that your advisor is required to provide annually, as this document does not determine whether the fees you incur are deductible.

In conclusion

You should spend thirty minutes with your sales representative, and thirty minutes with your accountant/tax advisor, to discuss the deductibility of your management fees and ensure that they are indeed deductible. This investment of time will ensure that you have a very powerful tool for maximizing the growth of your portfolio.

References

CQFF. (2021, 06 08). Deductibility of investment advisor fees. Retrieved from Centre québécois de formation en fiscalité: http://www.cqff.com/liens/honoraires_conseillers.pdf

CQFF. (2021, 08 18). Eligible and non-eligible expenses, including consulting fees. Retrieved from Centre québécois de formation en fiscalité: https://cqff.com/liens/H-10.1.pdf

CQFF. (2021, 06 01). Table d'impôt des PARTICULIERS - 2021. Retrieved from Centre québécois de formation en fiscalité: https://www.cqff.com/tables_impot/tables_impot2021.pdf

Revenue Canada (1998, 92 20). 20 February 1998 Ministerial Letter 963358A - REVISED MGMT & INV COUNSEL FEE POSITION. Retrieved from Tax Interpretations: https://taxinterpretations.com/cra/severed-letters/963358a

Revenue Canada (2003, 06 25). 25 June 2003 Internal T.I. 2003-0021817 - DEDUCTIBILITY OF LUMP-SUM PAID IN YEAR. Retrieved from Tax Interpretations: https://taxinterpretations.com/cra/severed-letters/2003-0021817

Revenue Canada (2016, 08 24). 24 August 2016 External T.I. 2014-0542581E5 - Paragraph 20(1)(bb) - segregated funds. Retrieved from Tax Interpretations: https://taxinterpretations.com/cra/severed-letters/2014-0542581e5

Revenue Canada (2021, 12 23). Income Tax Act. Retrieved from Government of Canada: https://laws-lois.justice.gc.ca/fra/lois/i-3.3/TexteComplet.html

Notes

[1] Manufacturers such as mutual fund companies are not corporations whose principal business meets the eligibility criterion.

[2] Telfonds are insurance contracts, not securities: Technical Interpretation 2014-0542581E5

[3] These services do not meet the eligibility criteria

[4] Specific exclusion from 20(1)bb Income Tax Act

[5] Specific exclusion of 18(1)u Income Tax Act

[6] Technical Interpretation 2003-0021817

[7] Annual savings of $12,000 at the beginning of the year for 45 years, gross returns of 6.4% on an equity portfolio generating 60% of the return in capital gains (tax rate of 22.86%) and 40% in dividends (tax rate of 29.63%), management fees of 1.50%, retirement at age 65, and initial portfolios of $0, $150,000, $300,000, $600,000 and $1,200,000 for ages 20, 30, 40, 50 and 60 respectively.

[8] Interpretation 963358A

[9] Interpretation 963358A