If your clients pay their registered-account investment fees from open accounts, revisit that practice with them now.
At the November 2016 Canadian Tax Foundation Conference, CRA told attendees that paying registered plan fees from non-registered, or open, accounts, will incur a tax penalty equivalent to the fee.
CRA views the practice as creating an unfair advantage because it’s an indirect increase in the value of the registered plan — so the agency has changed its administrative position.
Now, “a controlling individual who pays investment management fees with respect to his or her RRSP, RRIF or TFSA outside of the plan could be subject to a tax equal to the amount of fees paid,” says a PwC release on the issue.
CRA will begin taxing people who pay fees in this manner as of January 1, 2018, and the tax will be punitive: based on CRA’s wording, if a person pays $100 in registered fees from an open account, she would trigger $100 in tax.
Michelle Connolly, vice-president, Tax, Retirement and Estate Planning at CI Investments, says people typically pay fees from outside their registered accounts to preserve registered capital and reduce taxable capital and potential income instead. But this tactic is predominantly a deferral, she points out, since the preserved registered capital will eventually be taxed as regular income upon withdrawal.
Some advisors argue preserving registered capital allows for greater compounding, she adds, but “I never viewed [fee redirection] as a top-three planning idea,” she says.
Connolly says there are three main situations where people redirect fees:
- An individual taxpayer pays for her own registered account’s fees out of her open account.
- An individual taxpayer pays for someone else’s registered account fees out of his open account. One example, says Connolly, is a grandfather paying his grandchildren’s TFSA fees out of his open account.
- A joint account pays for one or both of the individual’s registered account fees.
With this administrative change, CRA is focusing on the advantage created by paying the fee from an open account. But there’s another risk to fee redirection: overcontributing to a registered plan.
Let’s say a person contributes the maximum $5,500 to her TFSA, owes $100 in investment fees, and pays those fees from outside the TFSA. Under CRA’s new position, “she will have been viewed to have contributed $5,600,” says Connolly. And, not only will she have to pay $100 in tax due to her fee redirection, she may be penalized $1 per month (1% of the excess) for overcontributing to her TFSA. “Will CRA go that far?” asks Connolly. “Potentially.”
What advisors should do
“An advisor should look at any clients that are redirecting fees on registered accounts and discuss these changes with clients,” says Connolly. “As of January 1, 2018, CRA will now view [fee redirection] much more aggressively.”
If the grandfather in our example wishes to help his grandchildren pay for investment fees for non-tax reasons, he can gift them an equivalent amount in cash after the grandchildren pay the fees out of their registered accounts.
The PwC release says CRA may announce administrative concessions when it releases its tax folio in early 2017. But Connolly says it’s unlikely that there will be any concessions.
Fee deductibility and registered accounts
Fee deductions related to registered accounts, such as RRSPs, RRIFs, and TFSAs, are not permitted by CRA. An investor cannot circumvent this rule by charging fees related to a registered account to a non-registered account.
“That’s because the taxpayer has to pay the fee, and the taxpayer is the trust, not the beneficiary,” says Michelle Connolly of CI Investments.
Melissa Shin is Editorial Director of Advisor’s Edge. Email her at firstname.lastname@example.org.