Investment management fees for registered accounts such as TFSAs, RDSPs, RESPs, RRIFs, and RRSPs are often paid outside the registered account by the holder or annuitant of the registered account, and in other cases are paid inside the registered account out of the account assets. The option of paying fees outside the registered account was cast into doubt in 2016 when the Canada Revenue Agency (CRA) issued draft administrative guidance announcing a review of the “advantage” rules in subsection 207.01(1) of the Income Tax Act (Act).
The CRA proposed to treat fees paid outside an account to be an “advantage” and subject to tax to the holder or annuitant. Though CRA delayed issuing the guidance, concerns remained because CRA believed that a change in the legislation would be required to avoid an “advantage”.
Both CRA and the Department of Finance (Finance) have now accepted that a payment of investment management fees outside a registered account will not be an “advantage”.
On October 9, the CRA released a comfort letter it received from Finance on August 26 to the public to the effect that Finance will make the changes required to clearly demonstrate that investment management fees paid outside a registered account will not be an “advantage”.
Based on this, we expect that CRA will administer the Act following the comfort letter.
Taxation of “advantages”
The concept of an “advantage” arises in the context of registered accounts. To the extent that an “advantage” in relation to a registered account has been extended to, or is received or receivable by: (a) a holder, subscriber, or annuitant (as the case may be) of the registered account (controlling individual), (b) a trust governed by the registered account, or (c) any other person who does not deal at arm’s length with the controlling individual, then subsection 207.05(1) of the Act imposes a tax equal to 100% of the value of the “advantage”. In effect, the Act operates to confiscate the “advantage”.
Investment management fees paid by the controlling individual
Investment management fees incurred by a registered account trust are commonly paid for by the registered account’s controlling individual.
In 2016, CRA began to take the position that such payments likely constitute an “advantage” conferred by the controlling individual on the registered account trust because investment management fees represent a liability of the registered account trust and would therefore be expected to be paid by the trustee using funds from within the registered account. CRA consistently took the position that: (a) it is not commercially reasonable for an arm’s length party to gratuitously pay the expenses of another party; and (b) there is a strong inference that the motivating factor underlying the payment is to maximize the tax-exempt savings in the account. As such, to the extent that such fees are paid outside the registered account trust, the resulting indirect increase in the value of the plan assets would likely constitute an “advantage” that is subject to tax.
Originally CRA proposed to begin applying this administrative position in January of 2018, but shortly after deferring this date to 2019, CRA announced that this position would again be deferred until Finance had completed its own review of the issue from a tax policy perspective.
The comfort letter
The comfort letter is the result of Finance’s tax policy review. Notwithstanding that the controlling individual paying the registered account trust’s investment management fees results in an indirect increase in the value of the plan assets, the comfort letter is clear that Finance does not have any tax policy concerns with respect to this payment structure. Contrary to CRA’s administrative position discussed above, for Finance, it is not evident that controlling individuals are tax-motivated when they enter into arrangements to pay the registered account trust’s investment management fees. Moreover, Finance found that generally, the direct payment of fees results in either a net loss, or a negligible gain for the controlling individual.
Therefore, Finance expressed its intention in the comfort letter to recommend that the definition of “advantage” in subsection 207.01(1) be amended such that it does not apply to payments by a controlling individual of a registered account, not exceeding a reasonable amount, of the fees set out in subparagraph 20(1)(bb) of the Act (i.e., investment management fees paid to a taxpayer whose principal business is advising on the purchase and sale of specific shares or securities or whose principal business includes providing services in respect of the administration or management of shares or securities and the fee is paid for such advice or such services, as the case may be).
Finance intends to recommend that this proposed amendment apply in respect of the 2018 and subsequent taxation years.
While it is not certain when this change will be implemented, taxpayers can generally rely on comfort letters issued by Finance when determining their filing position. On this point, CRA has taken the following position on comfort letters generally:
“A comfort letter is not considered proposed legislation and usually only reflects the Department of Finance’s views on a particular issue affecting a specific taxpayer. Given that our tax system is on the basis of self‑assessment, taxpayers may decide to file on the basis of a comfort letter. Generally, the CRA will not reassess taxpayers who filed on the basis of a comfort letter, provided that they did so in conformity with the comfort letter”.
While we note that Finance intends to recommend that the proposed amendment will apply in respect of the 2018 and subsequent taxation years, we anticipate that CRA will not assess taxpayers for earlier years based on their statements that they were deferring implementing the 2016 announcements.
If investors choose to pay the registered account trust’s investment management directly, they should ensure that they conform to the wording in the comfort letter. Specifically:
- The comfort letter only addresses payments made by a controlling individual of a registered account. The comfort letter does not address the tax consequences of any other person paying the investment management fees.
- The comfort letter only covers investment management fees set out in subparagraph 20(1)(bb) of the Act. While many investment management fees fall within this provision, investors should consult their tax advisors regarding their particular situation.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
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