Corporate Class Funds

 

A Mutual Fund Corporation is a single taxable entity consisting of several classes of shares, with each class representing a different mutual fund. This allows Mutual Fund Corporations to offer several tax benefits to those investors with non-registered funds.

As an investor, you can buy into the overall corporate structure by purchasing one or more classes (funds). Once invested into the corporation, you can then switch between funds without triggering capital gains or paying redemption fees. A transfer of one class of shares for another class of shares is not considered a taxable event.

However, it is important to keep in mind that although the funds switch itself does not trigger a capital gain, any capital gains realized by the corporation to finance the fund switch (to the extent not offset by capital losses) will have to be distributed at year end.

Since a corporation computes its net income and net capital gains as a single entity it can offset the income and capital gains of one fund with the expenses and capital losses of another thereby providing more flexibility in reducing potential taxable distributions.

Any net income or capital gains generated within a corporate fund are paid out as taxable distributions to investors, either in the form of an ordinary dividend, or a capital gains dividend (which is taxed as a capital gain). Since a corporation cannot flow through ordinary income it usually coverts the ordinary income to capital gains, if there is any left over after expenses. Even though there is a cost to converting to capital gains, this is still preferable because only 50 percent of the capital gains are taxable.

 

These Tax Advantages Are Attractive To the Following Individuals

Non-Registered Investors

Since RRSP, RRIF’s and Tax Free Savings Accounts already provide tax deferred growth, a corporate class fund could be an ideal choice to consider. This provides greater potential to accelerate the rate of growth of your portfolio by deferring taxes on capital gains when investing in a non registered environment.

Fixed Income and/or Foreign Investors

Fixed income and foreign investors can be assured they will not receive distributions of interest or foreign income that are taxed at a high rate. If the fund earns this type of income it will usually either be offset by other expenses or converted to capital gains which can be reduced by other capital losses, if there are any, or if there aren’t sufficient losses, will be distributed to you as capital gains. So with fixed or foreign income funds either nothing will be distributed to you at year end or capital gains will be distributed or which only 50% will be taxed.

Investor Frequently Making Switches

Each time you sell an investment in your non-registered portfolio, a tax liability from capital gains may be realized. This leaves you with less of your investment to reinvest. If you find yourself frequently switching between investments, for example to re-balance your portfolio, you may want to consider a corporate class structure in order to reduce those taxable gains and leave more of your money to invest.

Seniors

Actively managing your taxable income in retirement can have a significant impact on both the tax you pay and whether or not you qualify for certain government income tested benefits. If you are collecting Old Age Security for example, this benefit can be clawed back if you have too much taxable income. Using a corporate class structure you can help reduce the amount of income reported on your tax return, and potentially reduce any OAS clawback.

Trusts for Minors

Often, a parent or a grandparent will set up a trust account to hold investments on behalf of their minor children or grandchildren. On benefit of this is the potential to income split with the minor. The Income Tax Act attribution rules cause any income (interest, dividends, and foreign income) to be taxed in the hands of the parent or grandparent. However, capital gains are taxed to the minor, who normally is in a lower tax bracket resulting in little or no taxes being paid. In order to maximize the benefits of income splitting you should attempt to generate capital gains vs. other income.

Incorporated Business Owners

Many business owners have built up significant after tax profits within their corporation and rather than withdrawing those funds and investing them personally they are being invested by the corporation. Since corporate tax rates on passive income are generally higher than the top marginal rates for individuals, reducing the amount of investment income the corporation reports is very beneficial. Using corporate class funds for corporate investments can keep taxable distributions to a minimum, and since they can only be either ordinary dividends or capital gains dividends this can reduce the amount of investment income that is subject to the high passive income rates.

Investors Looking for Income

Many corporate funds also provide a Series “T” option which can provide the income oriented investor with a regular stream of tax efficient cash flow from monthly distributions. All or a significant portion of the distribution is likely to be considered a tax free return of capital (ROC), this essentially defers the triggering of capital gains from monthly withdrawals. However, there may still be taxable distributions of ordinary dividends or capital gains dividends as mentioned earlier.

Each time the corporate fund distributes ROC, the adjusted cost base of the investment decreases. When the adjusted cost base reaches zero, all further ROC distributions are taxable as capital gains, which is still tax efficient since only 50% of the capital gains are taxable.

If you would like more information on this topic or would like a review of your current financial plan, please call 778-478-9759, or e-mail [email protected]

 

This column is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, or life insurance, and should not be taken as providing, investment, financial, legal, accounting or tax advice. All services provided through NorthBay Financial Services. Mutual funds are provided through Sterling Mutuals Inc. Insurance is provided through multiple carriers. The opinions expressed are those of the authors and do not necessarily reflect the views or opinions of Sterling Mutuals Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds and Segregated funds are not guaranteed, their values change frequently and past performance may not be repeated.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.