By: Julie Hélène Tremblay, LL.B., M. Fisc., Senior Manager, Tax
Michel Babeu, CPA, CA, M. Fisc., Partner, Tax
The era when financial advisor compensation was invisible to clients is essentially over. Changes in the methods of compensation for financial advisors have had significant effects. Although some advisors, such as mortgage brokers, are still allowed to indicate that their services are “free,” they may do so on a limited basis, taking professional requirements into account. Some advisors are required to charge their clients for services rendered, in which case clients need to know the answer to a pressing question: are such fees paid to advisors deductible?
Taxation of investments: basic rules
Before addressing the issue of whether investment advisor compensation is deductible, let’s take a look at the basic rules for understanding the taxation of investments.
Like its taxation, the return on investment (ROI) of a financial product, be it a mutual fund, corporate stocks, bonds or even tangible assets, can take many forms. There are multiple taxation rules governing the cost of investment, investment expenses, yield distributions and proceeds of disposition.
The taxation of income and gains varies depending on whether it is business or property income  or a gain from the disposition of property. Dividends, which are considered property income, are subject to certain arrangements, however, to consider tax paid on profits made by the company from which they come.
The basic rule for the deductibility of expenses is that all expenses are deductible to the extent they are made or incurred for the purpose of gaining or producing income from a business or property, unless a limitation is expressly provided by the Act. However, a general limitation applies to any capital outlay, except as expressly permitted by the Act (depreciation and other rules). In general, capital expenditures (such as acquisition costs) must be capitalized at the cost of the property. We won’t be surprised if the deduction of personal and living expenses is covered by a general limitation.
Other rules specifically limit the deduction of fees for plans said to be tax-exempt (such as RRSPs, RRIFs, RESPs and TFSAs).
Lastly, special rules apply to allow the deduction of payments to investment advisors that would otherwise be of a capital nature. They are deductible under certain conditions. We will discuss these conditions in more detail below.
How to know if the capital amounts paid are deductible
The rules on payments made to investment advisors are designed to allow the deduction of expenditures that would otherwise be of a capital nature. So, to be deductible, payments made to an investment advisor must offset costs incurred:
A) for advice as to the advisability of purchasing or selling a specific share or security of the taxpayer;
B) for services in respect of the administration or management of shares or securities of the taxpayer.
This applies only to investment advisors whose primary business activity consists in providing such advice or rendering such services.
If the capital payment takes the form of a “commission,” the expense is not deductible, but it is certainly capitalizable. Commissions for the acquisition of investments are therefore not deductible unless they are paid as an expenditure of a current nature, such as when a person’s investment activity is a business, and investments are considered inventory as a result. We are of course thinking of individuals who devote considerable time to actively managing their investments.
Full or partial deduction?
An investment advisor’s method of compensation is immaterial in terms of investment. However, it is very important in terms of net after-tax return, since the method of compensation selected will determine whether or not the amounts paid are deductible.
For example, investment activities in a mutual fund can be charged in several ways: front-end loads, back-end loads, transaction costs and management fees, or a combination thereof. The management fee amount varies depending on the purchase option.
While front-end loads and back-end loads are either acquisition or disposition costs, their impact on the investor’s taxable income amounts to a one-half deduction to the extent that they only increase a gain or a capital loss, taxable or deductible at 50%. However, compensation consisting of a percentage of assets under management, to the extent that it constitutes consideration for “services in respect of the administration or management of shares or securities,” is more advantageous for the investor because it is fully deductible.
Moreover, we must not forget the Quebec limitation on expense deductions for certain investments, which limitation is applicable during years when investment income is insufficient. In such cases, investment expenses can be accumulated and used to reduce the investment income of another year.
Investor deduction of investment advisor fees has been a topical issue since 2014, when a query was formally submitted to Revenu Québec to determine the deductibility requirements for such fees. The information was then disseminated and many advisors had to review their billing practices to ensure the deductibility of their fees for their clients. Some practices had apparently become commonplace, such as charging fees for registered portfolios to non-registered portfolios. The tax authorities stated their positions, confirmed the need for detailed billing and explained which expenditures were deductible.
Since this position expressed by the authorities has now been adopted as a model, it’s up to investment advisors to do their work diligently.
Learn more: Caution: Tax risks ahead!
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 Subsection 9(1) ITA; Section 80 QTA
 As a rule, the equation for property or business income is: income less expenses equals profit (I – E = P). The equation for capital gain is: proceeds of disposition less adjusted cost base (including acquisition costs) less disposition costs equals capital gain (PD – ACB – DC = CG). When an expense is capitalized, the property’s adjusted cost base increases.
 Paragraph 18(1)(a) ITA; Section 128 QTA
 Paragraph 18(1)(b) ITA; Sections 128 and 129 QTA
 Paragraph 18(1)(h) ITA; Section 133 QTA
 Paragraph 18(1)(u) ITA; Section 133.4 QTA
 Paragraph 20(1)(bb) ITA; Paragraph 157(d) QTA
 Paragraph 20(1)(bb) ITA; Paragraph 157(d) QTA. The Canadian Oxford defines “commission” as a percentage paid [...] from the profits of goods etc. sold, or business obtained.
 2015 Congress of the Association de planification fiscale et financière, Provincial Round Table, APFF.