Segregated funds are sometimes described as the insurance industry’s version of mutual funds. This is convenient as a rough reference point, as outwardly their value tracks against an underlying pool of investment assets segregated from the insurer’s other assets.
In truth, however, they are a form of annuity, a type of insurance contract. This is not mere technical phrasing; a host of rights, obligations, protections and restrictions flow from this characterization. Of particular interest are guarantees of future account value or income flow, though the insurer will charge a fee inside the contract for this.
But how are fees charged outside the segregated fund by a financial advisor treated for tax purposes? Specifically, does advice related to segregated funds mirror the tax-deductibility accorded to advice on buying and selling mutual funds?
Income Tax Act (ITA) Canada paragraph 20(1)(bb) – Fees paid to investment counsel
As a general tax principle, an amount may (note the emphasis) be deductible in computing income where that outlay is related to the generation of income. Enumerated under ITA s. 20(1) are deductions permitted in computing income from business or property, with investments falling within the latter category.
Pursuant to ITA 20(1)(bb)(ii)(A), a deduction may be taken for “advice as to the advisability of purchasing or selling a specific share or security of the taxpayer” where fees are paid to a person whose principal business is advising in that respect. Mutual funds pool investors’ capital to invest in shares or securities, and thus qualify under this section.
2014 CALU Conference, Question 5 – Segregated Fund Counselling Fees – May 6, 2014
At the 2014 Conference of Advanced Life Underwriters (CALU) roundtable, representatives of the Canada Revenue Agency (CRA) considered whether a deduction should be allowed for advice related to the purchase or sale of segregated funds. The key part of the response is as follows:
“Paragraph 20(1)(bb) of the Act applies in the context of shares or securities of a taxpayer. A segregated fund policy is a contract of insurance and, in our view, is not a share or security of the taxpayer. Consequently, it is our position that paragraph 20(1)(bb) of the Act does not apply to fees paid by a taxpayer in respect of the advisability of the acquisition or disposition of segregated fund policies, or for the administration or management thereof as the requirements of that paragraph are not met.” [Emphasis added here.]
In the conference report, the CALU editors indicated that Department of Finance officials had expressed some sympathy to a broader interpretation, and that industry stakeholders would continue to correspond with CRA in the hopes of the agency taking a more expansive view of segregated funds.
2014-0542581E5 (E) – Segregated fund counselling fees – August 24, 2016
In an email dated August 6, 2014 (sent 3 months after the CALU conference above), the CRA was asked to reconsider its position that a segregated fund policy is not a security. In its response, CRA redacts the addressee’s name, though it appears to be directed to CALU.
After acknowledging that there are arguments for and against the proposition based on the plain text of the terms, the analysis turns to the context in which the words are used. Specifically, paragraph 20(1)(bb) is an exception to the general limitation on deductibility delineated in paragraph 18(1). The position put forward is that as the exception is narrowly drafted, its interpretation should be similarly narrow.
The author then harkens back to predecessor provisions of the ITA and the definition of the term “security”, both pre-dating the existence of segregated funds. From that perspective, an expansion of that definition could have unintended consequences elsewhere in the ITA.
In the author’s opinion, the inclusion of segregated fund in the definition of security is not supported by the law, so a legislative amendment would be necessary to achieve this result. The letter then acknowledges that the issue has already been brought to the attention of the Department of Finance, presumably by the letter recipient.
- CRA does not consider counselling fees deductible when paid to an advisor who advises on entering into or redeeming segregated funds.
- For clarity, the subject matter of this discussion is the charging of fees directly by an advisor to an investor/client. Any fees charged within a segregated fund cannot be claimed as a deduction by an investor.
- Note as well that segregated funds have both insurance and investment elements that may make them well suited to a particular individual, with deductibility being a secondary consideration or non-issue.
Depending on the reception at the Department of Finance, this may not be the end of this issue, though it is ultimately up to legislators whether to make changes to the law.