How sales charges impact registered accounts

What’s the tax impact of DSC fees? The charges may apply to both registered and non-registered investments, but if clients want to withdraw from RRSPs, RRIFs and TFSAs, they should know the tax implications of DSCs.

Read: Does the DSC have a future?

Here’s an example:

Meg’s RRSP has a fair market value of $50,000. Needing cash, she withdraws $10,000 from her plan. At the time of withdrawal, Meg’s redemption request triggered a $600 deferred sales charge, resulting in a $9,400 net payment (ignoring withholding taxes).

Since RRSP withdrawals are subject to tax, how much would be included as taxable income on Meg’s tax return? Would the $600 DSC fee be included in taxable income for a total taxable amount of $10,000? Or, ignoring withholding taxes, would Meg be required to pay tax on the net amount ($9,400)?

Several CRA technical interpretations suggest commission costs incurred by an RRSP in respect of the liquidation of investments would be considered “costs related to the acquisition and disposition of property by the RRSP.”

In other words, a DSC fee is an expense of the RRSP (not the annuitant), and isn’t included in her taxable income at the time of withdrawal. This is good news for RRSP (and RRIF) annuitants.

Because Meg’s DSC fee is considered an expense of the RRSP, the $600 fee would not be shown as a taxable amount on her T4RSP slip. Ignoring withholding taxes, the net amount received ($9,400) would be reported as taxable income subject to tax on Meg’s tax return for the year.

What about TFSA?

Taking this a step further, what impact would DSC fees have on a TFSA withdrawal? Knowing that TFSAs provide tax-free withdrawals, how do DSC fees factor in the use of these plans?

Allen’s TFSA is worth $25,000. Requiring money for a renovation, Allen withdraws $25,000 from his TFSA with the intention of returning it to his TFSA the following year. A DSC fee of $1,500 results in a net payment of $23,500. In addition to $5,000 of new TFSA contribution room granted the following year, how much of Allen’s current year withdrawal can he re-contribute to his TFSA next year? Is it $25,000 (gross amount), or $23,500 (net amount)?

One of the greatest features of the TFSA is the ability to re-contribute withdrawals in the following year without requiring new TFSA contribution room. For every dollar withdrawn from a TFSA, plan holders can re-contribute amounts withdrawn as early as the following year.

Where TFSA assets fund DSC fees at the time of a TFSA withdrawal, like RRSPs and RRIFs, the fees are normally considered expenses of the TFSA and not part of the amount paid to the plan holder. As a result, the sum that can be re-contributed to the TFSA in the following year would not include what’s paid in DSC fees. Unlike for RRSP and RRIF holders, this is not good news.

While Allen’s TFSA withdrawal was not taxable, he was deemed to receive $23,500, despite a request for $25,000. Consequently, beginning the following year, in addition to $5,000 of new TFSA contribution room, Allen can re-contribute $23,500 to his TFSA, the net amount withdrawn, after fees.

What about excess contributions?

When clients over-contribute to RRSPs and TFSAs, a 1% monthly penalty tax generally applies; for example:

In contributing to his TFSA, Junior accidentally exceeds his TFSA contribution limit by $7,000. As a result, a 1% monthly penalty tax applies. To avoid ongoing penalties, Junior tries to remove the excess contribution by requesting a gross withdrawal of $7,000 cash. The withdrawal triggered a $420 DSC fee. Was Junior’s withdrawal sufficient to stop over-contribution penalties from accruing?

When clients withdraw excess contributions from both RRSPs and TFSAs, DSC fees funded by plan assets are not considered part of amounts withdrawn. For these purposes, amounts withdrawn are net of DSC fees, and in the case of RRSPs, gross of withholding tax.

So, Junior’s $7,000 gross withdrawal was $6,580 net of fees. This means he was still in an over-contribution position by $420. To fully cease over-contribution penalties, Junior’s withdrawal request should have been for a net amount of $7,000 – that is, the gross request should have included both the excess amount ($7,000) plus applicable DSC charges ($420) for a total of $7,420.

DSC fees will not apply in all cases. Many issuers of DSC investments offer a 10% free withdrawal amount each year. Also, in many cases clients can transfer investments in-kind from an RRSP, RRIF or TFSA to a non-registered account to avoid fees. Because RRSPs are generally used for long-term purposes – which allows time for DSC schedules to expire – the potential for impact to TFSAs appears to be greater.

Wilmot George

Tax & Estate

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. Wilmot can be contacted at wgeorge@ci.com.