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Rogers Group Financial (RGF) publishes a quarterly newsletter, The Financialist, which is written by the advisors of our firm. The articles are aimed at providing meaningful information relevant to the specific needs of our clients, and each covers a variety of topics (including specific investment strategies and the details of individual investment products).  The latest issues of The Financialist are below; for a complete archive and access to printable .pdf articles, please click here

Do Corporate Class Mutual Funds Still Make Sense?

The Financialist • Issue 132 • January 2017

BY JON KNUTSON, BA DiplT (Fin Mgt) CFP

Canadian mutual funds can take the legal form of a trust or corporation.  While most funds are structured as mutual fund trusts, some are structured as mutual fund corporations. The latter are also known as corporate class funds.

As you may know, the federal budget that was tabled on March 22, 2016 announced changes to the tax treatment of fund switches within mutual fund corporations (corporate class funds). Originally, this change was effective October 1, 2016; however, an extension was granted to change the effective date to January 1, 2017.

Under the old rules, a corporate class investor could exchange units of one fund for those of another and not report a capital gain or loss on the transactions. Capital gains would eventually have to be reported when units were redeemed from the corporate class structure.

Last year’s budget, however, made intra corporate class transactions reportable as realized capital gains. As a result, half of the gain is subject to tax at the investor’s marginal tax rate in the year  a transaction takes place.

Now that the rule has changed for corporate class funds, is there still a benefit to purchasing them going forward? The short answer is yes, as a number of tax-advantaged conditions will continue to exist for corporate class investors. In order to take full advantage of the corporate class structure, these funds should be held in non-registered accounts (outside of registered plans).

Corporate class funds offer the likelihood of reduced taxable distributions compared to conventional (trust format) mutual funds. In a mutual fund corporation, the income and expenses of all the different mutual fund classes are pooled, rather than being managed and reported separately. As a result, corporate class funds can share income, gains, losses and expenses to reduce taxable distributions that are generated by the corporation as  a whole. In addition, some mutual fund corporations have capital loss carry forwards that can offset current gains across all of their corporate class funds.

Distributions from corporate class funds tend to be more tax-efficient than distributions from trust structure mutual funds. This is due to the fact that corporate class funds are only allowed to distribute Canadian dividends and capital gains dividends. Both of these types of income are taxed more favorably than regular income. Any interest or foreign income is retained within the corporation, where it is subject to taxation unless it can be offset by expenses.

Whether in the form of a trust or corporation, a mutual fund is allowed a tax deduction for expenses it incurs to earn income. Expenses are first applied against the least preferred income (interest and foreign income), leaving more tax-preferred income for distribution. An investor does not personally claim a tax deduction but benefits from the deduction at the fund level. A mutual fund corporation will first use expenses that have been paid by all funds within the structure to offset interest and foreign income that have been earned by all funds within the structure. An example of this would be that foreign income  from a global equity fund might be offset by the expenses of a Canadian equity fund that had no foreign income.


Since interest and foreign income can’t be distributed by a corporation, these amounts are retained and serve to increase a funds’ net asset value. (Alternatively, a mutual fund trust is required to pay out all types of income that remain after expenses have been paid.) This results in an ongoing tax deferral for this income as long as there are sufficient expenses to offset. When the corporate class units are eventually sold, all of this income will be effectively taxed as capital gains, not as interest, foreign income or dividends. Capital gains that are earned from transactions made within a corporate class fund do not have to be distributed to unit-holders. This can be of particular interest to seniors who want to keep their net income below the clawback threshold for Old Age Security (OAS) and other income tested government benefits.Another benefit of corporate class funds is their T-Series income option. This version of a fund can provide tax-efficient cash flow through return of capital (where an investor’s original investment capital is paid out as opposed to dividends, interest or capital gains). This return of capital is not immediately taxable but it does reduce the investor’s adjusted cost base.

As with trust funds, exchanges between different series of the same corporate class fund can continue to be made on a tax-deferred basis. Also, corporate class funds tend to cost the same as the trust versions of the same underlying fund.

To summarize, although corporate class funds no longer have the benefit of exchanging units of one fund for another without triggering a capital gain, they still maintain several benefits that
offer tax-efficient growth and tax-efficient income for non-registered accounts.

 


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