Q. The 2016 Budget included a big change by eliminating the tax benefit on capital gains for corporate class (C-Class) mutual funds. First, how do these funds work and who uses them? Second, will all these corporate class funds (including ETFs) be affected? And, third, didn’t Ottawa already start doing this back in 2013?
A. Corporate class funds have had broad appeal for their tax advantages, especially by seniors and higher net worth investors. In recent times, their investment returns have struggled within an extended period of low interest rates, inflation, currency fluctuation, market volatility and now, new high income tax brackets and rates. Corporate class funds offered an important hedge against all of those risks for non-registered account holders, through their tax efficiency.
Corporate class funds offered an opportunity to diversify income earnings and most importantly, the ability to switch between individual funds held within the structure on a tax-free basis.
However, corporate-class mutual funds may still be important, despite recent budget changes that eliminate the tax-free switching after September 2016.
Still right for a family in which each member has maximized RRSP room, or in cases where taxpayers are no longer age-eligible, the selection of corporate class funds meets several criteria of tax-efficient investing:
- The fund itself manages the timing of its distributions, share redemptions and capital gains and losses across the family of funds, which means the individual investor benefits by receiving minimal taxable dispositions in non-registered accounts.
- Interest income earned in the fund, which is otherwise subject to full income inclusion, can be used to offset expenses
- Upon disposition of the fund itself, capital gains can be offset by capital losses of current or prior years; only 50% of net capital gains are then reported as income
- Until September 30, investors can still rebalance the corporate class mutual fund, and avoid triggering capital gains by moving from one corporate class fund into another
- There are a limited number of ETFs structured as corporate class funds. They will be subject to all the new rules, as well.
The result for the family who uses corporate class funds is the opportunity to structure taxable income from non-registered accounts to keep more of the first dollars invested, avoid high marginal tax rates and limit clawbacks of social benefits like the Old Age Security.
Evelyn Jacks is president of Knowledge Bureau, which offers e-learning at knowledgebureau.com. Evelyn tweets @evelynjacks and blogs at evelynjacks.com