Tax & Accounting February 19, 2020
Investment management fees, registered plans, and the advantage rules
Recently, the Department of Finance issued a comfort letter regarding whether the advantage tax under Part XI.01 of the Income Tax Act (the “Act”) applies to investment fees in respect of registered plans that are paid directly by the holder or annuitant of the plan. Initially, the CRA stated that the payment of the fee is an advantage, and therefore a 100% tax would apply to the amount of the fee paid. The implementation of this policy was delayed, pending a review by the Department of Finance. Though the Department agreed with the CRA’s conclusion, it has no tax policy concerns with these types of fee arrangements. Therefore, the comfort letter proposes to exclude these fee arrangements from the definition of an advantage, subject to certain conditions. While a comfort letter does not guarantee that the Act will be amended, the Department of Finance asking the Minister of Finance to do so is a positive development. The advantage rules, the CRA’s position, and the comfort letter and its implications are all discussed in greater detail below.
Part XI.01 of the Act was added in 2009 when the TFSA was introduced. Part XI.01 provides for various penalty taxes, including a tax on advantages under section 207.05. The application of the advantage tax was extended to apply to RRSPs and RRIFs in 2011, and more recently to RESPs and RDSPs in 2017. Sparing you the complex details of the definition of an advantage under subsection 207.01(1), an advantage generally includes:
(a)any benefit, loan, or indebtedness that is conditional in any way on the existence of the registered plan;
(b)a benefit that is the increase in the fair market value of the plan that is attributable to certain kinds of transactions;
(c)a benefit that is income from certain sources (e.g., income from prohibited investments or from a deliberate over-contribution); or
(d)a registered plan strip.
Subsection 207.05(1) provides that a “controlling individual” is liable for an advantage tax in respect of the registered plan that they control. Where the advantage is a benefit, paragraph 207.05(2)(a) provides that the amount of the tax is equal to the amount of the benefit—thus it is a 100% tax.
Generally, investment management fees relate to services of an investment manager for providing custody of securities, maintaining accounting records, collecting and remitting income, and buying/selling securities on the owner’s behalf. Where the fees relate to a registered plan, the investment management fees are a liability of the plan and could be paid using funds from that plan, but the holder/annuitant of the plan may instead pay the fees directly to the investment manager. At the 2016 CTF Annual Conference CRA Roundtable, the CRA was asked whether investment management fees with respect to registered plans paid by the holder/annuitant would be considered an advantage that is subject to the 100% advantage tax. The CRA’s position is based on the following part of the definition of “advantage” under subsection 207.01(1):
(b)a benefit that is an increase in the total fair market value of the property held in connection with the registered plan if it is reasonable to consider, having regard to all the circumstances, that the increase is attributable, directly or indirectly, to
(i)a transaction or event or a series of transactions or events that
(A)would not have occurred in a normal commercial or investment context in which parties deal with each other at arm’s length and act prudently, knowledgeably and willingly, and
(B)had as one of its main purposes to enable a person or a partnership to benefit from the exemption from tax under Part I of any amount in respect of the registered plan …
In the CRA’s view, the value of a registered plan indirectly increases from the fee being paid by the holder/annuitant. This increase in value is an advantage because, in their opinion, it is not commercially reasonable for an arm’s length party to gratuitously pay the expenses of another party, and there is a strong inference that a motivating factor underlying the transaction is to maximize the savings in the plan in order to benefit from its tax exemption. As a result of this new policy, existing fee arrangements would have to change so that the fee is charged directly to the registered plan. Recognizing that investment managers would need to change the fee arrangements with their clients, the CRA stated that it would defer the application of the policy until January 1, 2018. See CRA Doc. 2016-0670801C6 for the full interpretation.
In CRA Doc. 2017-0722391E5, dated September 15, 2017, the CRA provided an update on the implementation of the new policy. Since the CRA was still working with the investment industry, the implementation was further delayed until January 1, 2019. In CRA Doc. 2018-0779261E5, dated September 28, 2018, the CRA revealed that the implementation would be further delayed because the issue was under review by the Department of Finance. The implementation would be deferred until the review was complete. At the 2018 CTF Annual Conference CRA Roundtable (see Doc. 2018-0785021C6), the CRA reiterated that the policy implementation had been deferred until the Department of Finance completed its review.
After completing its review of the policy, the Department of Finance issued a comfort letter written by Brian Ernewein, Assistant Deputy Minister, Legislation, Tax Policy branch. The Department concurred with the CRA’s view that the fee payment could potentially be considered an advantage. However, the letter stated the following:
Even so, we have no tax policy concerns with respect to the payment of investment management fees directly by the annuitant/holder of the registered plan. It is not evident that plan holders are tax-motivated when entering into arrangements to directly pay the investment management fees of their financial service providers. Generally, the direct payment of fees results in either a net loss, or a negligible gain, for the plan holder.
The letter further states that the Department is prepared to recommend to the Minister of Finance that the Act be amended to exclude such fee payment arrangements from the definition of advantage under subsection 207.01(1). Per the recommendation, paragraph (b) of the definition of an “advantage” would be amended so it excludes payments by a controlling individual of a registered plan, not exceeding a reasonable amount of fees described in paragraph 20(1)(bb), which is discussed below.
Fees Described Under 20(1)(bb)
Paragraph 20(1)(bb) allows for the deduction of certain fees (other than commissions) paid to investment counsel, that
(i)is paid by the taxpayer in the year to a person or partnership the principal business of which
(A)is advising others as to the advisability of purchasing or selling specific shares or securities, or
(B)includes the provision of services in respect of the administration or management of shares or securities, and
(ii)is paid for
(A)advice as to the advisability of purchasing or selling a specific share or security of the taxpayer, or
(B)services in respect of the administration or management of shares or securities of the taxpayer.
Though paragraph 18(1)(u) prohibits the deduction of fees paid in respect of an RRSP, RRIF, or TFSA, the fees need only be described under paragraph 20(1)(bb) according to the comfort letter. CRA Doc. 2005-0124131E5 states that “[a] person’s principal business is generally one where more than 50% of the time is spent on that activity or where more than 50% of the gross revenue is generated from that activity.” Therefore, for the investment management fees to be exempt from the advantage rules, the principal business of the investment manager must be the provision of investment advice or administration services mentioned above. Moreover, fees paid by the holder/annuitant must be for those specific types of services. Paragraph 4 of Interpretation Bulletin IT-238R2, Fees paid to investment counsel, states that whether an investment manager’s services meet the principal business requirements is a question of fact. However, the bulletin further states that the following services normally qualify: the custody of securities, the maintenance of accounting records, the collection and remittance of income, and the right to buy/sell on behalf of clients on the person’s own judgement without reference to those clients. Paragraph 3 of the same bulletin also states that fees for general financial counselling or planning are not eligible under paragraph 20(1)(bb), even if the principal business otherwise qualifies.
Ultimately, affected investment managers must assess whether their principal business is described under paragraph 20(1)(bb). Though this letter provided clarity to investment managers and their affected clients, due diligence must be done to ensure that their fee arrangements do not go off-side and trigger a 100% advantage tax to their clients.
Overview of the advantage tax
Part XI.01 of the Act was added in 2009 when the TFSA was introduced. Part XI.01 provides for various penalty taxes, including a tax on advantages under section 207.05. The application of the advantage tax was extended to apply to RRSPs and RRIFs in 2011, and more recently to RESPs and RDSPs in 2017. Sparing you the complex details of the definition of an advantage under subsection 207.01(1), an advantage generally includes:(a)any benefit, loan, or indebtedness that is conditional in any way on the existence of the registered plan;
(b)a benefit that is the increase in the fair market value of the plan that is attributable to certain kinds of transactions;
(c)a benefit that is income from certain sources (e.g., income from prohibited investments or from a deliberate over-contribution); or
(d)a registered plan strip.
Subsection 207.05(1) provides that a “controlling individual” is liable for an advantage tax in respect of the registered plan that they control. Where the advantage is a benefit, paragraph 207.05(2)(a) provides that the amount of the tax is equal to the amount of the benefit—thus it is a 100% tax.
Investment management fees are an advantage
Generally, investment management fees relate to services of an investment manager for providing custody of securities, maintaining accounting records, collecting and remitting income, and buying/selling securities on the owner’s behalf. Where the fees relate to a registered plan, the investment management fees are a liability of the plan and could be paid using funds from that plan, but the holder/annuitant of the plan may instead pay the fees directly to the investment manager. At the 2016 CTF Annual Conference CRA Roundtable, the CRA was asked whether investment management fees with respect to registered plans paid by the holder/annuitant would be considered an advantage that is subject to the 100% advantage tax. The CRA’s position is based on the following part of the definition of “advantage” under subsection 207.01(1):(b)a benefit that is an increase in the total fair market value of the property held in connection with the registered plan if it is reasonable to consider, having regard to all the circumstances, that the increase is attributable, directly or indirectly, to
(i)a transaction or event or a series of transactions or events that
(A)would not have occurred in a normal commercial or investment context in which parties deal with each other at arm’s length and act prudently, knowledgeably and willingly, and
(B)had as one of its main purposes to enable a person or a partnership to benefit from the exemption from tax under Part I of any amount in respect of the registered plan …
In the CRA’s view, the value of a registered plan indirectly increases from the fee being paid by the holder/annuitant. This increase in value is an advantage because, in their opinion, it is not commercially reasonable for an arm’s length party to gratuitously pay the expenses of another party, and there is a strong inference that a motivating factor underlying the transaction is to maximize the savings in the plan in order to benefit from its tax exemption. As a result of this new policy, existing fee arrangements would have to change so that the fee is charged directly to the registered plan. Recognizing that investment managers would need to change the fee arrangements with their clients, the CRA stated that it would defer the application of the policy until January 1, 2018. See CRA Doc. 2016-0670801C6 for the full interpretation.
Deferral of implementation
In CRA Doc. 2017-0722391E5, dated September 15, 2017, the CRA provided an update on the implementation of the new policy. Since the CRA was still working with the investment industry, the implementation was further delayed until January 1, 2019. In CRA Doc. 2018-0779261E5, dated September 28, 2018, the CRA revealed that the implementation would be further delayed because the issue was under review by the Department of Finance. The implementation would be deferred until the review was complete. At the 2018 CTF Annual Conference CRA Roundtable (see Doc. 2018-0785021C6), the CRA reiterated that the policy implementation had been deferred until the Department of Finance completed its review.
The comfort letter
After completing its review of the policy, the Department of Finance issued a comfort letter written by Brian Ernewein, Assistant Deputy Minister, Legislation, Tax Policy branch. The Department concurred with the CRA’s view that the fee payment could potentially be considered an advantage. However, the letter stated the following:
Even so, we have no tax policy concerns with respect to the payment of investment management fees directly by the annuitant/holder of the registered plan. It is not evident that plan holders are tax-motivated when entering into arrangements to directly pay the investment management fees of their financial service providers. Generally, the direct payment of fees results in either a net loss, or a negligible gain, for the plan holder.
The letter further states that the Department is prepared to recommend to the Minister of Finance that the Act be amended to exclude such fee payment arrangements from the definition of advantage under subsection 207.01(1). Per the recommendation, paragraph (b) of the definition of an “advantage” would be amended so it excludes payments by a controlling individual of a registered plan, not exceeding a reasonable amount of fees described in paragraph 20(1)(bb), which is discussed below.
Fees Described Under 20(1)(bb)
Paragraph 20(1)(bb) allows for the deduction of certain fees (other than commissions) paid to investment counsel, that
(i)is paid by the taxpayer in the year to a person or partnership the principal business of which
(A)is advising others as to the advisability of purchasing or selling specific shares or securities, or
(B)includes the provision of services in respect of the administration or management of shares or securities, and
(ii)is paid for
(A)advice as to the advisability of purchasing or selling a specific share or security of the taxpayer, or
(B)services in respect of the administration or management of shares or securities of the taxpayer.
Though paragraph 18(1)(u) prohibits the deduction of fees paid in respect of an RRSP, RRIF, or TFSA, the fees need only be described under paragraph 20(1)(bb) according to the comfort letter. CRA Doc. 2005-0124131E5 states that “[a] person’s principal business is generally one where more than 50% of the time is spent on that activity or where more than 50% of the gross revenue is generated from that activity.” Therefore, for the investment management fees to be exempt from the advantage rules, the principal business of the investment manager must be the provision of investment advice or administration services mentioned above. Moreover, fees paid by the holder/annuitant must be for those specific types of services. Paragraph 4 of Interpretation Bulletin IT-238R2, Fees paid to investment counsel, states that whether an investment manager’s services meet the principal business requirements is a question of fact. However, the bulletin further states that the following services normally qualify: the custody of securities, the maintenance of accounting records, the collection and remittance of income, and the right to buy/sell on behalf of clients on the person’s own judgement without reference to those clients. Paragraph 3 of the same bulletin also states that fees for general financial counselling or planning are not eligible under paragraph 20(1)(bb), even if the principal business otherwise qualifies.
Ultimately, affected investment managers must assess whether their principal business is described under paragraph 20(1)(bb). Though this letter provided clarity to investment managers and their affected clients, due diligence must be done to ensure that their fee arrangements do not go off-side and trigger a 100% advantage tax to their clients.
