Paying RRSP, TFSA investment fees from outside the accounts not an advantage, Finance says

Nearly three years of tax uncertainty has ended for investors who pay their RRSP and TFSA investment management fees from outside those accounts.

The Department of Finance will recommend that the minister amend the Income Tax Act’s definition of “advantage” to exclude the practice of paying for investment management fees from funds outside of registered plans (including TFSAs), according to an Aug. 26, 2019 letter from Brian Ernewein, assistant deputy minister – legislation, in Finance Canada’s tax policy branch.

The document with the recommendation is called a “Finance comfort letter.” Minal Upadhyaya, vice-president of policy at the Investment Funds Institute of Canada (IFIC), explained that such letters “provide comfort that they are not going to penalize, from a tax perspective, [an] activity.”

In this case, she added, “When they get to making legislative amendments, [the exclusion to the definition] will be included.”

Upadhyaya said she’s pleased the government has recognized that paying investment fees outside of registered plans does not lead to a tax advantage.

“This development will have a positive impact on investors, who will not be subject to penalties for entering into this type of arrangement,” she said.

At the November 2016 Canadian Tax Foundation Conference, the Canada Revenue Agency (CRA) told attendees that starting Jan. 1, 2018, paying registered plan fees from non-registered, or open, accounts would incur a tax penalty equivalent to the fee. For example, if an investor paid a management fee of $500 from outside a registered plan, the investor could be taxed the full $500.

At the time, the CRA said it viewed the practice as creating an unfair advantage because it was equivalent to a tax-free increase in the value of the registered plan. In other words, paying fees from outside registered accounts would preserve registered capital.

The CRA later revised the implementation date of its new position to Jan. 1, 2019, before saying last October that it would delay implementation “indefinitely,” pending a review from the Department of Finance.

Industry groups such as IFIC, the Investment Industry Association of Canada and the Canadian Life and Health Insurance Association have been consulting with the CRA to halt the proposed implementation, saying that clients who pay fees outside registered accounts aren’t usually tax-motivated.

“You don’t knowingly enter into this [fee] arrangement on the basis of an advantage,” Upadhyaya said. “You don’t have a lot of the information you would need to have that intention: you don’t know the length of time the assets are going to be in the account before you de-register them; what your rate of return is going to be is unknown and so is your marginal tax rate.”

Further, when money is eventually withdrawn from a RRIF, it is taxable — so tax is eventually paid on the money not used to pay fees.

The groups also argued that there’s often a non-tax reason to pay fees from a non-registered account. “People are doing it as a matter of convenience,” Upadhyaya said.

In the letter, the Department of Finance acknowledged that investors are generally not tax-motivated when paying registered plans from outside the accounts, noting that doing so can even result in a net loss. Finance also specified that the fees paid cannot exceed a reasonable amount.

Questions remain

Upadhyaya said she’s not sure when the government will amend the legislation, particularly because we’re in the midst of an election. That said, taxpayers can rely on the letter’s substance, regardless of when the changes are made.

Nonetheless, it’ll be important to pay attention to the legislation’s text.

“The letter refers to the planholder paying the fees directly,” Upadhyaya said, yet a client might pay the fees for a group of registered accounts (e.g., client, spouse, children). She wonders if such arrangements will also be excluded from the advantage definition.

“Those sorts of nuances will come out of the actual drafting of the legislation,” she said, “so we’ll have to wait and see.”

Advantages folio update pending

The CRA’s position on registered account fees was to be laid out in the agency’s advantages folio, which came out Oct. 1, 2018. However, the folio’s “fees and expenses” section did not address registered account fees. An update to the folio on April 26, 2019 did not include revisions to the section, either.

In May, CRA spokesperson Dany Morin told Advisor’s Edge: “As noted at the 2018 Canadian Tax Foundation annual conference, the Canada Revenue Agency intends to update the folio to provide additional guidance on fees once the Department of Finance completes a tax policy review of certain types of fees.”

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.