The federal government’s proposed elimination of tax-free switching between classes of funds held in a corporate-class mutual fund structure introduced in Tuesday’s budget may not end the life of the structure entirely as it still allows some useful benefits.
In particular, there continues to be opportunity to share or transfer expenses among funds held in a corporate-class family, allowing the taxable gains or income earned by some funds to be offset by losses or expenses on others, says Jamie Golombek, managing director of tax and estate planning with the wealth strategies division at Toronto-based Canadian Imperial Bank of Commerce.
“There are still some ancillary benefits, such as the ability to share expenses among the various classes of funds and minimize taxable distributions,” says Golombek. “I expect the corporate class structure will stay – but the major benefit of tax-free switching has been eliminated.”
The government proposed to amend the Income Tax Act in Tuesday’s budget so that any mutual fund investor switching funds within a corporate-class structure as of Sept. 30 will be considered to have made a disposition at fair market value for tax purposes. Thus, any gains in value beyond the cost base will be taxable.
See: Liberals kill tax benefits of corporate-class mutual funds
See: Budget 2016
The corporate-class structure has been particularly useful for investors holding income-oriented funds that tend to produce distributions in the form of interest, which is normally fully taxable. Some deferral of taxes has been achieved by lowering these taxable distributions by offsetting them with costs from other funds in the corporate class family — and this will continue.
Taking a page from the mutual fund industry, the corporate-class structure has also been adopted by a few providers of exchange-traded funds, including First Asset Management Inc. and Purpose Investments Inc., both of Toronto.
Corporate-class structures have primarily benefited high net-worth clients with significant fund assets outside of tax-advantaged registered plans, Golombek says.
“Primarily, this affects wealthier clients,” he says. “The average Canadian doesn’t have any money outside of non-registered accounts. Their money is in their home, their RRSP or their TFSA.”
According to the Investment Funds Institute of Canada (IFIC), data from Toronto-based Investor Economics Inc. show that assets in corporate-class mutual funds total $138.7 billion, a small share of total investment fund assets of $1.2 trillion. IFIC said in an earlier statement the budget announcement has “triggered concern” and, as a result, the organization is currently analyzing the implications of the change with a view to seeking further discussions with the government.
Meanwhile, Golombek points out that advisors and their clients have six months to do any desired switching among funds without triggering taxation.
“They were generous in grandfathering it for six months, as they could have shut it down yesterday,” he says. “Until the end of September, you can switch away. It’s a good idea to take a look at portfolios and decide whether to engage in any switching activities before the change.”
It’s important to note that the new budget measure does not apply to certain mutual fund switches outside a corporate-class structure, providing the new fund has an identical investment portfolio, Golombek says. For example, a client may continue to switch on a tax-free basis from one class of mutual fund to a different series of the same fund, but with lower management fees or expenses.
With greater fee disclosure and growing client awareness of the impact of fees on returns, there may be more push to make this kind of switch to lower-fee funds.
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