Tax deductible financial planning advice

Regular readers, and that should be every Dover adviser, know we focus on financial strategies rather than financial products. This is because ultimately financial planning is all about strategies. The best financial product in the world is useless without a financial strategy.

Clients must have financial strategies.

A strategy based financial planning practice is far more viable and valuable than a sales based practice.

The client time frame should be thirty years, not thirty days, and, what is best for your clients is also best for you: it's a beautiful collision of interests. Everyone wins.

Long term relationships are what it is all about, for both clients and advisers.

One advantage of a strategy based practice is that there are more fee notes.

Another advantage of a strategy based practice is your fee is likely to be tax deductible for your client. (We have to say “likely” because, ultimately, deductibility depends on the facts of the case.) The fee notes tend to be for lesser amounts, and paid more frequently, say once a quarter, for monitoring and reviewing the strategy, rather than large up-front, once off, fee notes. This means they tend to be more tax deductible assuming, of course, that they relate to assessable income producing investments.

If a client is paying tax at 45% a deductible fee note costs much less than a non-deductible fee note. So, if a tax deductible fee note is $1,000, it's after tax cost becomes just $550. That's a 45% discount, and that's great.

This fee note tax deductibility gives your practice a big advantage over your competitors. Your fee notes will be tax deductible, because they relate to on-going assessable income. And their fee notes aren't. Your clients win.

Obviously you should be aware of the issues and, within the parameters of professional propriety, ensure your fees are as genuinely as deductible as possible in your clients' hands.

Pointing this out to clients in the first meeting helps reduce fee resistance and helps make sure your clients get the on-going service and attention they deserve.

Fee note deductibility is maximised by:

1. allocating time appropriately over different tasks and, in particular, making sure the time allocated to deductible tasks is accurately recorded and able to be verified if the ATO calls;
2. charging smaller multiple recurring fees over a period rather than larger once off up-front fees, and connecting the smaller multiple recurring fees to on-going advice and services over time that produce assessable income, rather than a large up-front job;
3. careful wording of tax invoices to:
   1. emphasise/affirm the genuine connection with existing income sources and business and investment activity
   2. emphasise the “review of existing investments” aspect of your advice and
   3. de-emphasise any non-deductible work completed for your client;
4. addressing tax invoices to a business entity where the work relates to that business entity;
5. ensuring your SOA content genuinely emphasises deductible matters such as tax advice, business advice, employee remuneration issues, employer super, existing sources of assessable income, business issues, investments generating recurring assessable income, business succession planning; and
6. ensuring SOA content genuinely de-emphasises non-deductible matters such as wills.

The tax law includes apportionment rules for dual purpose expenditure. This means your fee note may be partly deductible and partly non-deductible, with the apportionment completed on the amount of time you spend on each purpose, or some other sensible basis.

One simple strategy is to send two fee notes. For example, if 80% of your costs related to deductible on-going/continuing advice about assessable income producing investments and the other 20% related to non-deductible one off advice about wills then send two fee notes. One for the deductible work and one for the non-deductible work. Make sure you can substantiate each fee note if asked to do so by the ATO.

Summary table

Your fees will be generally deductible in your client's hands to the extent they relate to your client's assessable income and they are not private or domestic in nature. The following table summarises the position, but should not be accepted as stating hard rules because each case is different and subtleties and technicalities abound.

Specific legal advice should be sought before concluding a cost is tax deductible.

Table summarising the deductibility of fee for service financial planning fee notes

An example of a tax deductible fee note

The narration of a tax deductible fee note may read as follows:

1 December 2014

Monthly fee charged for on-going monitoring and review of share investments and property investments owned by Your Name Investments Pty Ltd: $500

The narration of a non-tax deductible fee note may read as follows:

1 January 2014

Fee for setting up your share investments: $6,000

The ATO released Taxation Determination 95/60 on 6 December 1995. This determination deals generally with the deductibility of investment fees. It was requested by the FPA.

Taxation Determination 95/60 is a relatively short determination and is reproduced below.

You can also access it at the ATO website at ATO TD 95/60

Income tax: are fees paid for obtaining investment advice an allowable deduction under subsection 51(1) of the Income Tax Assessment Act 1936 (‘the Act') for taxpayers who are not carrying on an investment business?

1. When a taxpayer seeks advice in relation to the most appropriate investment or investments to make, the taxpayer may participate with an investment adviser in developing an investment plan. In many cases there will be a continuing relationship with the investment adviser. A fee is payable for drawing up a plan. A ‘management fee' or ‘annual retainer' is payable if advice is provided over the period of the investment(s), usually upon an annual or semi-annual review of the performance of the investment(s).
2. In discussing what makes expenditure deductible under subsection 51(1), Lockhart J said in F C of T v. Cooper 91 ATC 4396; 21 ATR 1616 (at ATC 4399, ATR 1620):‘The phrase “incurred in gaining or producing assessable income” in the first limb of s. 51(1) has been construed to mean incurred in the course of gaining or producing assessable income…‘For expenditure to be an allowable deduction as an outgoing incurred in gaining or producing the assessable income, it must be incidental and relevant to that end; …This test of deductibility has been explained in subsequent judgments of the High Court, so that to be deductible the expenditure must be incidental and relevant in the sense of having the essential character of expenditure incurred in the course of gaining or producing assessable income … The essential character test is also applied to determine if the expenditure is of a capital, private or domestic nature…'
3. In view of the above, we do not think that the fee for drawing up the plan is deductible for income tax purposes. This is because it is not expenditure incurred in the course of gaining or producing the assessable income from the investment(s). It is too early in time to be an expense that is part of the income producing process. It is an expense that is associated with putting the income earning investment(s) in place, in the same way as certain kinds of investments attract entry fees, and has, therefore, an insufficient connection with earning income from the investment(s). See F C of T v. Maddalena 71 ATC 4161; (1971) 2 ATR 541 and the discussion of that case by Hill J in Cooper , (supra) at ATC 4412, ATR 1635.
4. Expenditure on drawing up the plan is incidental and relevant to outlaying the price of acquiring the investment(s) , and is so associated with the making of the investment(s) as to warrant the conclusion that it is capital or capital in nature: see Sun Newspapers v. Federal Commissioner of Taxation 5 ATD 87 per Dixon J especially at ATD 95. The expenditure may qualify as an incidental cost to the taxpayer of the acquisition of the assets(s) [i.e., the investment(s)] for capital gains tax purposes. See subsections 160ZH(1) and 160ZH(5) of the Act.
5. On-going management fees or retainers are deductible under subsection 51(1). In Taxation Ruling IT 39 we discussed expenditure incurred in ‘servicing' an investment portfolio. The Ruling discussed the decision in F C of T v. Green (1950) 81 CLR 313 which allowed a taxpayer a deduction in relation to the management of the income producing enterprises of the taxpayer. The Ruling concluded that expenditure in ‘servicing' the portfolio should be regarded as incurred in relation to the management of income producing investments and thus as having an intrinsically revenue character. However, to be wholly deductible, all of a management fee must relate to gaining or producing assessable income. If the advice covers other matters or relates in part to investments that do not produce assessable income, only a proportion of the fee is deductible.
6. Over the period of an investment plan advice may be received suggesting changes be made to the mix of investments held. This would normally be part and parcel of managing the investments in accordance with the plan. This advice may be from the original investment adviser or from a new adviser. Provided the advice is not in relation to drawing up an investment plan it will be an allowable deduction as set out in paragraph 5 above.
7. We have been asked what is the position where a taxpayer has existing investments and goes to an investment adviser to draw up an investment plan. For example, a taxpayer nearing retirement may have a number of small investments, is expecting a super payment (eligible termination payment (ETP)) and decides to put in place a long term financial strategy incorporating the investments arising from the ETP. In our view, a fee paid to an investment adviser to draw up an investment plan in these circumstances would be a capital outlay even if some or all of the pre-existing investments were maintained as part of the plan. This is because the fee is for advice that relates to drawing up an investment plan. The character of the outgoing is not altered because the existing investments fit in with the plan. It is still an outgoing of capital for the same reasons as set out in paragraphs 3 and 4 above.

Commissioner of Taxation

06/12/95

You can read an article written by Tony Negline and published by the CPAs in “In the Black” on 17 February 2014 here: When are financial advice fees tax deductible?.

Let me know if you need a hand drafting your fee notes to make sure you get the tax implications right.