Tax Treatment of Investment Costs
Sometimes investors see the income tax impact of the investment costs they pay every year and sometimes they are unaware that they incur investment costs, let alone, how they are treated for income tax purposes.
Note: This discussion applies to investments held in taxable accounts. It does not apply to tax sheltered accounts, such as registered accounts, Tax Free Savings Accounts (TFSAs), and pension plans.
There are three basic types of investment costs, each of which is outlined below:
- transaction costs
- embedded annual management costs
- annual fee costs
Transaction-based investment costs are those such as commissions paid to buy and sell shares, ETFs, mutual funds, segregated funds, bonds, etc. These costs are treated as an adjustment to the investments capital cost, thereby increasing or decreasing capital gains or losses eligible for income tax.
Example: If $10,000 is invested in an ETF and the purchase commission was $250.00, then the investments Adjusted Book Value, for tax purposes, will be $10,250.00.
If this investment is subsequently sold for $12,000.00 and the transaction commission was $300.00, then the capital gain would be $1,450.00 ($13,000 - $300 -$10,250.00). The taxable gain would be 50% of the total capital gain or $725.00.
Conversely, if the investment was sold for $8,000.00 and the transaction commission was $200.00, then the capital loss would be $2,050.00 ($10,250 - $8,000 - $200). The taxable loss would be 50% of the total capital loss or $1,025.00.
Embedded annual investment costs are those that are paid directly by the investment itself. They do not appear in the account’s statement and you never see a fee statement for the year. Investments with embedded annual costs include mutual funds, segregated funds, pooled funds, Exchange Traded Funds (ETFs).
These annual investment costs are paid by the investment from the investment’s dividend interest income stream or the invested capital if no income is generated.
If the annual costs are deducted from income earned by the investment then you will receive a T5 income tax slip for the investment’s annual investment income less the annual investment costs. As a result, the investment expense is deducted directly from your investment income.
Investors that pay an annual fee through their account are able to enter the amount paid on their Canadian Income Tax Return and receive an income tax credit for the expense. The actual amount of the income tax credit will depend upon the individual investor's income tax rate.