What's tax deductible and what's not

A penny saved is a penny earned. That’s one of the great truisms in life —and in personal finance. But I don’t think the Canada Revenue Agency (the CRA) entirely agrees with it. To them, money spent on earning income is deductible, but money spent on ultimately saving money by arranging financial affairs or doing financial planning for the future is not.

It is one of the great quirks of the Canadian Income Tax Act (ITA). On the one hand you have services like investment counseling that are provided in order to generate income. They are deductible under the act – section 20 (1) (bb). On the other hand, you have services that help with other elements of your financial affairs (accounting, budgeting, financial planning, etc.). These are not deductible.

This brings up some important points for consideration, since we’ve kicked open a bit of a hornet’s nest lately regarding the concept of ‘tax fairness’ in Canada. With the rise of many wealth management service fees being paid separately, consumers often pay a simple household fee based on total Assets Under Management (AUM) for their family unit. This fee generally covers not only (deductible) investment management services, but also (non-deductible) financial planning services.

That means that technically, those clients who get both services bundled together in one fee should probably only be deducting a portion of that fee – the portion that pertains to portfolio management. They should certainly not be deducting the entire amount – assuming that the all-in total cost covers a material amount of related financial planning services, as well.

The issue is especially concerning when it comes to non-registered accounts (investment counselling fees are not deductible for registered plans at any rate). As far as I can see, the CRA’s audits only check to see how much of what’s claimed under ITA section 20 (1) (bb) is for registered assets and how much is for non-registered assets. There is no second-tier audit to determine how much (if any) of that fee relates to services that are separate and distinct from those motivated by the idea of earning income.

For context, please note that trading commissions are not technically deductible (although trading costs can be used to bump up the buyers’ adjusted cost base, which amounts to a de facto deduction on the capital gain incurred upon the sale of the security). One interpretation I have seen by a largish Canadian accounting firm is that if trades are executed at no additional charge (for instance, in a discretionary account) that some nominal value for those trades ought to be applied against the advisory fee, since no advisor would do an unlimited amount of trades at no cost in a traditional commercial setting. Stated differently, those trades have some cost (i.e. commercial value) and to the extent that the cost exists, that cost ought to be applied against the total amount an investor should be allowed to deduct.

Still with me? The easiest solution to the problem – at least from a tax perspective – is simply to unbundle the financial planning and investment management fees. A number of people have suggested the idea, including my friend Rob Carrick at the Globe and Mail. The idea here is that some investors (millennials, perhaps) might be better served by going to a fee-only financial planner to get written planning advice and then taking their portfolio to a robo-advisor for low-cost implementation. Perversely, this kind of clarity regarding deductibility would penalize consumers for seeking out holistic advice and reward advisors for doing only a portion of their overall job.

As it now stands, paying separately for planning and investing would entail the fee-only planner’s fees not being deductible while the robo-advisor’s fees would be. In contrast, if this same investor were to go to a traditional advisor who charges a separate fee (let’s say 1%), that fee would be entirely deductible (whether or not additional services were provided as part of the advisor’s offering or not) since the CRA doesn’t trouble itself with the granularity of the services offered (or not) by traditional advisors.

This would almost certainly be the case whether that advisor did additional planning work or not. In essence, if the CRA was to follow its own logic, what we’d be left with is investors getting a smaller deduction precisely because their advisor was NOT providing additional value-added services.

How’s this for a value proposition? “Work with me: I’ll manage your investments and do absolutely nothing else in order to maximize your tax deduction!”

MORE ABOUT FEES:

John De Goey is a portfolio manager with Industrial Alliance Securities Inc. and the author of The Professional Financial Advisor IV. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund. The opinions expressed herein are those of Mr. De Goey alone and may not be aligned with the opinions and values of Industrial Alliance Securities Inc. or any of its affiliated companies.