Taxation of Corporate Class Funds Has Changed
Starting January 1, 2017, corporate class mutual funds have lost the benefits of tax-deferred switching among the various funds held within the corporate class structure. In the past, the capital gains that would normally be triggered when units in a fund are sold at a profit, could be deferred until the year in which the unitholder sells all his/her holdings in the corporation. However, after the end of 2016, switches among different corporate class mutual funds will result in capital gains or losses, and the tax treatment of switches between different corporate class mutual funds will be the same as conventional mutual funds that are structured as trusts.
Despite this change in taxation, corporate class mutual funds continue to offer other major tax advantages compared to conventional mutual funds.
One of the primary benefits of corporate class funds which will continue is the ability to pool the income and expenses of all funds in the fund family. By doing so corporate class mutual funds offer the ability to minimize or defer overall taxable distributions.
The corporate class structure is particularly beneficial to income funds that tend to produce returns in the form of fully taxable interest income or for foreign equity funds that produce dividends that are ineligible for the Canadian dividend tax credit. The corporate class structure can reduce taxes by offsetting fully taxable income with unused expenses and loss carry-forwards transferred from other funds in the corporate class fund family.
Since Canadian corporations can only distribute dividends and capital gains, distributions from corporate class mutual funds are only in the form of eligible Canadian dividends or realized capital gains, which are taxed at a much lower rate than regular income.
The corporate class structure has many benefits for high net-worth individuals who own non-registered funds held outside registered plans such as RRSP or tax-free savings accounts. This kind of structure also provides tax advantages for small-business owners who invest their excess cash in corporate accounts owned by their operating or holding companies that are subject to high corporate taxes.
The corporate class structure is also of benefit to parents and grandparents who hold units of mutual funds in informal in-trust accounts for their children or grandchildren. Normally, any interest or dividends paid by a conventional fund are taxable in the hands of the parent or grandparent who contributed to these accounts, while capital gains are attributed to the child (who normally has no income and hence pays no taxes). Corporate class funds are ideal vehicles for in-trust accounts as their distributions are in the form of dividends or capital gains and hence can minimize the taxes payable.
The corporate class structure can also be of benefit to retirees who have set up systematic withdrawal plans and regularly withdraw funds from their non-registered portfolio to create an income stream. Retirees can not only enjoy tax efficient income earned within the corporate-class funds, but they can also realize tax efficiency on their regular withdrawals as their income stream could be set up in a way that it is considered return of capital until the adjusted cost base of the units grinds to zero and this would allow them to defer taxes and create a more tax-advantaged stream of income.
Note: Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the Fund Facts and consult your financial advisor before investing.
Tina Tehranchian, CFP, CLU, CHFC, is a senior financial planner at Assante Capital Management Ltd. in Richmond Hill, and a financial educator, speaker and author, specializing in philanthropic tax planning. She can be reached at 905-707-5220 or through her web site at www.tinatehranchian.com.