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Deductibility of advice fees
Tax deduction is sometimes overstated

A few weeks ago, I reviewed circumstances under which financial advisory fees are tax deductible and Canada Revenue Agency's (CRA) official interpretation of the provisions permitting this deduction. This week, trends in the financial advisory and money management industry are applied to the basic rule to highlight some of the tax risk that may exist.

Before I dig into this topic, I should clarify that I am no tax expert but will offer my view on some industry structures that may pose some risk.

Bundled and 'free' services

Wrap programs generally offer a standard package of investor profiling, portfolio construction, and ongoing monitoring and rebalancing. For this, most sponsors charge a rich fee. Some, however, then make other professional services available to the client for no additional charge. Does it seem reasonable to provide such services - which would normally cost hundreds of dollars per hour - at no charge? No, it doesn't.

Along that same line, some individual advisors offering both investment and financial planning advice may artificially boost the fee for investment advice while charging little or nothing for the other financial planning services.

Neither of these scenarios seems reasonable and, hence, are at risk if clients are deducting the full fees paid (for taxable investments). For clarity, the issue of time spent doing client work only comes into play when fees are paid to related persons (i.e. friends, relatives) but the type of work performed is always a key determinant of the extent of deductibility.

In the above hypothetical cases, clients could only deduct the portion of the total fee attributable to that incurred for "investment counsel" services - and only the portion thereof relating to taxable investments. Investment advice and administration are valuable services and surely a significant portion of the fee may be attributed to "investment counsel" services. However, the provision of other services may reduce the deductible portion of the total fee.

If legal and tax advice is provided in relatively small amounts, it may not be an issue. It could be chalked up to simply giving some "freebies" to good and loyal clients. But if the extent of additional "free" professional services provided is significant and the client treats the entire fee as an investment counsel fee, a good deal of tax risk may be present.

Fee loading

Another situation that I've encountered over the years relates to charging a disproportionate amount of investment counsel fees in such a way as to maximize the deductibility. In other words, in a family situation, fees may be loaded up on the family member in the highest tax bracket and/or charged to taxable accounts. Again, in my view, this does not pass the reasonableness test since certain parties or accounts are being overcharged merely in an effort to increase a tax deduction. This is seemingly a dangerous practice.

Other considerations

It seems to me that since most wraps charge a base fee for most of the actual investment counsel activities that the extra fees added by advisors would be at risk of being mostly non-deductible. My reasoning relates to what the advisors are actually doing for that extra fee (i.e. doing more non-investment activities and/or gathering more assets). However, I'm told that this is unlikely to be a tax risk to clients. The management contract signed by wrap clients is with the wrap sponsor or investment dealer - and it covers only investment advice and administration (i.e. "investment counsel") services. Hence, from a practical point of view, there is seemingly little tax risk in this type of situation.

Surely, the work done by an advisor in a particular case will largely influence the assessment. Also, the structure of fees may have an impact as well. Whatever the case, there appears to be enough uncertainty that advisors should either refer clients to their tax advisors or get some advice themselves on the deductibility of the fees charged to clients in specific instances.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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