Segregated Funds & Mutual Funds – A Taxation Comparison Enter Name Enter Title Enter Date
Jan 24, 2016
Segregated Funds & Mutual Funds – A Taxation Comparison
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Segregated Funds & Mutual Funds – a taxation comparison
Distributions in a down market
Taxation of guarantee top ups
Agenda
Fund manager buys and sells securities
Unit value fluctuates with the underlying securities
Similarities
Fund distributes all taxable income and capital gains realized to unitholders
Interest, dividends, capital gains flow through
MORE Similarities
Treatment of capital losses realized by the fund
All taxable amounts reported on T3 for segregated funds
Differences
Distributions versus allocations
Change in unit value after distributions and/or allocations
MORE Differences
Treatment of Capital Losses
Gains = $2,000
Losses = $3,000
Distribution to investor = $0
$1,000 losses carried forward by the fund
In a mutual fund
Gains = $2,000
Losses = $3,000
Allocation to investor = $2,000 gain & $3,000 loss
$1,000 losses carried forward (or back) by the investor
In a segregated fund
Redemptions
Mutual Funds Does not receive
distributions
Capital gain/loss realized on disposition is not shown on the T3
Disposing of units before the distribution date
Mutual Funds Investor must
calculate gain/loss and report on tax return
Disposing of units before the distribution date
Mutual Funds Fund reports
details of disposition to CRA on T5008
Disposing of units before the distribution date
Segregated Funds Allocation
realized as of the date of disposition
Capital gain/loss realized on disposition is shown on T3
Disposing of units before the allocation date
Segregated Funds Acquisition fees
are deemed to be capital losses and are also reported on a T3
Disposing of units before the allocation date
Distribution and/or Allocation
Must actually distribute income & capital gains
Investor can choose to receive distribution in cash or reinvest in funds
Mutual Fund distributions
If reinvested, the investor is deemed to have received the cash and then purchased additional units
Mutual Fund distributions
Deemed to have distributed – no need to actually pay it out – thus allocation
No additional units are purchased
Segregated Fund allocations
Allocations cannot be paid in cash like distributions (must request withdrawal)
Segregated Fund allocations
Both methods are ways to pass tax liability from fund to investor
Does not affect fund returns or tax payable
Both first reduce the distribution and/or allocation by the expenses of the fund in the order of the highest type of taxable income
The tax impact
Changes in unit values
Unit value decreases after a distribution
In a mutual fund
The purchase of additional units returns each investor back to the original total value held before the distribution
In a mutual fund
Unit value remains the same after the allocation
In a segregated fund
$500$500T3 amount$5,000 $5,000**Market value
-11*New units
$50$45/unitUnit value on Dec. 31
$5/unit$5/unitDec. 31 distr./alloc
100100# units
$50$50Unit value
$5,000$5,000Investment
Dec. 31Dec. 31Date
Seg FundMutual Fund
*(100 x 5)/45 ** $45X$11
Distribution vs. Allocation
They received extra units equal to the taxable amount
REALITY – they traded in a dime for two nickels
Mutual Fund investor’s perception
They only get the tax slip
REALITY – and they get to keep the dime
Segregated Fund investor’s perception
Investor A Investor B
Date Dec. 28 Jan. 2
Investment $5,000 $5,000
Unit value $50 $45
# units 100 111
Dec. 31 distr. $5/unit -
Unit value on Dec. 31 $45/unit -
New units 11* -
Market value $5,000 $5,000
Taxable income $500 -
*(100 x 5)/45
Distribution – timing is everything
Why is there tax to pay when my value has gone down?
Manager often forced to sell some stocks
Unrealized gains become taxable when underlying investments are sold
Common questions
Don’t confuse fund value with taxable income
Taxable income applies to the investor or fund manager activity
Common misunderstanding
Investor buys $100
Investor sells $180
Investor’s capital gain equal to $80
Investor activity – an example
Fund manager buys at $60
Investor buys at $100
Value of the investor purchased units decreases to $70
Fund manager sells at $70
Capital gains distributed of $10
Fund manager activity – an example
Taxation of Guarantee Payments
Taxable as RRSP/RRIF income when it is paid out of the contract
Top ups – Registered contracts
Taxable as “capital gain” when paid
Top ups – Non-registered contracts
Capital losses, if applicable, will be applied against capital gains
Top ups – Non-registered contracts
Non-registered
1. Initial investment $100,000
2. Guarantee $100,000
3. Market value $80,000
Top-up gain (3-2) $20,000
Capital loss (3-1) $(20,000)
Total taxable amount $0
Let’s look at an example
Non-registered
1. Initial investment $100,000
2. Guarantee $140,000
3. Market value $130,000
Top-up gain (3-2) $10,000
Capital gain (3-1) $30,000
Total capital gain $40,000
Let’s look at another example
Mutual Fund Corporations (Manulife Corporate Classes)
Interest & Foreign Income
Ordinary Dividends
Capital Gains Dividends
Tax efficiency
Corporations investing in Corporations
Tax free fund switches
Tax efficiency
A number of expenses, & deductions are first applied against this type of income
Balance, if any, taxed within the corporation Taxes may be reduced by foreign tax credits, if
any
After-tax earnings may be distributed as ordinary dividends
Interest & Foreign Income
Flow through to shareholders Grossed up with
dividend tax credit
Ordinary Dividends
Reduced by capital losses of all share classes
Reduced by CGRM* for those leaving Corp
*Capital Gains Refund Mechanism
Capital Gains Dividends
Balance flows through to shareholders Treated as capital
gains
Capital Gains Dividends
Each fund is a class of shares of a multi-class Mutual Fund Corporation
Moving between share classes (funds) doesn’t trigger tax to investor
However, liquidation of underlying assets to do the transfer may cause flow through of capital gains dividends Can’t offset taxable gains with CGRM for those who haven’t left
corporation
Tax-Free Fund Switching
Proactive Tax management
Tax expert assigned
Tax-free, DSC-free switching between multiple managers
Taxation of Manulife Corporate Classes
Educate your clients
Manulife Funds and Manulife Corporate Classes are managed by Manulife Mutual Funds, a division of Elliott & Page Limited.
Manulife Investments is the brand name identifying the personal wealth management lines of business offered by Manulife Financial (The Manufacturers Life Insurance Company) and its subsidiaries in Canada.
Manulife and the block design are registered service marks and trademarks of The Manufacturers Life Insurance Company and are used by it and its affiliates including Manulife Financial Corporation.
Important notes