The investment dealers Association of Canada is working on a bylaw change that would allow retail brokers to structure their businesses as personal corporations.

This type of set-up would allow a salesperson to flow his or her commissions through a corporation and potentially gain tax advantages by paying some portion of his or her taxes at the corporate rather than the personal rate. And if regulators approve the move, it could give independent firms one more incentive with which to woo top performers.

Personal corporations have been around in the fund dealer world for some time, largely as a result of an oversight by regulators. Because of securities law, the IDA has required advisors at the investment dealers to be employees of the dealer, keeping advisors from entering into arm’s-length arrangements with their firms, such as principal/agent structures. However, the fund dealers, before the advent of the Mutual Fund Dealers Association, were regulated directly by the securities commissions, which permitted them to operate in principal/agent relationships. Apparently the commissions didn’t apply the law as stringently as the IDA did.

As a result, if advisors at mutual fund dealers could meet the tests imposed by the tax authorities, they could structure themselves as personal corporations. The same situation prevails in the insurance world.

The price of the IDA’s vigilance was a playing field for its members that isn’t level when compared with other parts of the industry. The disparity between the investment dealers and fund dealers was to be corrected when the MFDA came into existence. For a time, it appeared as if the MFDA would not allow personal corporations, either.

However, threatened with the abolition of the more tax-efficient structure, fund dealers raised such a stink that regulators relented — a bit. They would not allow any new personal corporations, but the existing ones would be grandfathered for a transition period. That period has since been extended (in all provinces except Alberta and New Brunswick) and is now set to expire at the end of 2006.

In the meantime, the SROs are looking for a way to allow personal incorporation to persist. The IDA took the first step in that direction in 2003, when it finally approved the use of principal/agent structures for its members. However, at the time, it explicitly forbade the use of personal corporations. Now, it’s changing its tune.

“We are looking at a proposal that would allow salespeople at IDA member firms to carry on business using a personal corporation,” confirms Paul Bourque, senior vice president of member regulation at the IDA in Toronto.

As with the introduction of the principal/agent model, the regulators’ concern is preserving dealers’ liability — so firms can’t hide behind their reps’ personal corporations if reps find themselves in legal or regulatory trouble.

“The regulatory challenge is to ensure the supervision responsibility flows down from the firm to the salesperson, and the civil and regulatory liability flows up from the salesperson to the firm,” says Bourque.

Also, Bourque explains, “The personal corporation would not hold client assets. [It] would have to be controlled by the registrant and would not itself be a registrant.”

Peter Bailey, president of Toronto-based Raymond James Ltd., who was the driving force behind getting regulators to approve the use of the principal/agent model for the brokerage industry, is similarly pushing for permission to use personal corporations, too.

“Now that the regulators allow agents, there is no regulatory reason not to allow incorporation of those agents,” he insists. “The agent, by contract, cannot hide behind the personal corporation.”

Larry Waite, president and CEO of the MFDA, indicates that the proposed IDA bylaw would impose requirements similar to the MFDA’s regarding the use of personal corporations, although it may go further in some areas. For example, he says, it may make the dealer and the personal corporation responsible for ensuring that arrangements between the rep and the personal corporation comply with tax laws.

The trick will be getting the authorities to go along with it. Despite the temporary exemption for fund dealers, the use of personal corporations by investment advisors is outlawed in most provincial securities legislation.

Tax authorities onside

After fighting several cases on the issue, the tax authorities seem to be taking the stand that they will allow these structures if the industry’s regulators will. Jamie Golombek, vice president of taxation and estate planning at Toronto’s AIM Funds Management Inc., points to an opinion from the Canada Revenue Agency on the issue, handed down in the fall of 2004, which said: “It is the CRA’s general position that if an insurance agent, realtor, mutual fund salesperson or other professional is legally, whether contractually or by statute, precluded from assigning his/her commissions to a corporation, then the commission income must be reported by the individual, and cannot be reported through a corporation. Where there is no such legal restriction on the transfer of commissions to a corporation and the corporation is actively carrying on the business, the income must be reported by the corporation.”

@page_break@Bourque indicates that allowing personal corporations throughout the securities industry will require legislative changes or SRO rule changes — which must, in turn, be approved by the securities commissions. He says that the IDA is discussing the content and timing of its proposal with the Canadian Securities Administrators; however, he declines to speculate whether the regulators are likely to go along with it.

This is one situation in which the industry would probably be very happy to have a single national regulator. Instead, the personal incorporation issue is being examined by a CSA working group as part of its registration reform project. There are real concerns for regulators to consider — such as whether investors’ rights could be harmed by these structures; the tax risks to the dealers are understood; the industry contingency fund can accommodate these corporations; and, what the practical requirements for the structure and governance of these companies should be.

One very powerful sector of the industry that may not be happy to see the introduction of personal corporations is the bank-owned investment dealers. “The banks will not go to this model, as they would never admit that the agent controls the client book,” suggests Bailey. The widespread use of personal corporations could also be a huge administrative headache for firms with large sales forces.

However, for dealers that do embrace the model, it would give them one more carrot to dangle in front of a broker considering a jump from one of the more restrictive firms on the Street to one of its more entrepreneurial shops.

Bailey says that allowing personal incorporation will make the move from employee status to agent status even more compelling because it will offer both pretax and after-tax advantages to brokers who make the leap.

It remains to be seen whether the SROs can win the provincial authorities over. If they do, it will be another arrow in the quiver of the independents — and an issue for reps to consider. IE