When it comes to non-registered investing, tax efficiency should be top of mind. Corporate class mutual funds aren’t widely understood, but they can offer an effective tax-efficient strategy for non-registered investments.
There are two types of fund structures in Canada. Mutual funds can be structured as either trusts or corporations. Both structures are bought and sold in the same way, priced daily and carry similar fees.
Mutual fund trusts – the most common structure – are considered separate entities and therefore must deal with taxes on their own. Corporate class funds are connected and belong to the same parent corporation and therefore taxes are all managed as one single entity. As a result, corporate class mutual funds can share income, expenses, gains, losses, and loss carry-forwards to reduce taxable distributions generated by the corporation as a whole.
Each investment strategy, like the Canadian Equity Class, represents a single class of share in the overall fund corporation. There is no limit to how many classes of shares can be included in a single mutual fund corporation.
To understand the potential tax benefits of using corporate class mutual funds, it is important to first understand how a fund earns income, and the way in which this is passed on to the investor.
Mutual funds generate income through interest, capital gains, Canadian dividends and foreign dividends. Unlike a mutual fund trust, corporate class funds can only distribute income in the form of Canadian dividends or a capital gains dividend (taxed as capital gains). These types of income are taxed much more favourably than interest and foreign income. Corporate class funds may also issue distributions in the form of return of capital, which is completely tax deferred. With taxes being minimized or deferred, more money is left to benefit from compound growth.
Since interest and foreign income earned within corporate class funds cannot be passed on to investors, it remains within the corporation and subject to taxation if not offset by expenses. Corporate class funds are managed with this in mind.
The lower taxable distributions reduce your overall taxable income which is important for retirees trying to avoid OAS clawbacks, and maximize supplements and tax credits.
For more information on the importance of tax efficiency within your non-registered portfolio, contact Elizabeth de Groot of RBC Dominion Securities at email@example.com or 705-444-4742 or visit her website at www.edegroot.ca
This article is supplied by Elizabeth de Groot, CFP, FCSI, CIWM, FMA, Vice-President, Investment & Wealth Advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund. This information is not intended as nor does it constitute tax or legal advice. Readers should consult their own lawyer, accountant or other professional advisor when planning to implement a strategy.