Fee-for-service ‘not in clients’ interests’

Peter Bobbin

If financial planners want to act in the best interests of their clients then Australia’s tax regime means they should impose commissions rather than charge fee-for-service, according to leading financial services lawyer Peter Bobbin.

In a column that will be published in full in next week’s Money Management, Bobbin argues that taxation represents the key to who really benefits in the commissions versus fee-for-service debate and that, from a client’s point of view, commissions are more tax-effective than fee-for-service.

He said that, currently, Australia’s taxation system discourages fee-for-service and encourages commissions, “at least if you accept the views of the Australian Taxation Office (ATO)”.

Bobbin said that the December 1995 view of the ATO contained in Tax Determination 95/60 was that “expenditure on drawing up the plan is incidental and relevant to outlaying the price of acquiring the investment, and is so associated with the making of investments as to warrant the conclusion that it is capital or capital in nature”.

He said on that basis, the cost of an initial financial plan is not tax deductible.

Bobbin underpinned his argument that commissions were in the better tax interests of clients with the example of a family with investment funds of $150,000 who faces an annual cost for advice of $1,000.

“It is in the best interest of the client to charge a 0.66 per cent trailing commission and not a fee-for-service of the same amount,” he said. “This is because the trailing commission is taken out of the client’s income prior to it being credited to them.

“If in a good year a client was to get a gross 10 per cent return, adopting the commission basis would mean that they would be credited with $14,000. Any tax that must be paid will be applied to the after-tax investment return.”

Bobbin said this could be compared to a fee-for-service client who received the same gross return of $15,000, with the big question being whether they would be able to claim the $1,000 fee as a tax deduction and be no worse off than being under the commission structure.

“Will the taxable amount be $15,000 or $14,000 or some amount in between?” he asked. “The correct answer is: the assessable amount might be less than $15,000, but it is likely to be more than $14,000.”

Bobbin said faced with this conclusion, the only moral thing that a financial planner could do was charge on a commission basis.

“They have a fiduciary duty to do so. The Australian Securities and Investments Commission should applaud them, as it is in the client’s best interest,” he said.