The Liberal government is eliminating the tax-deferral benefit available in the corporate-class mutual fund structure, removing one of the primary reasons Canadians have had to invest in these vehicles, as part of this year's federal budget.
The government is proposing to make changes to the Income Tax Act so that an exchange of shares of a mutual fund corporation that results in a mutual fund investor switching between funds in that corporation will be considered a disposition at fair market value for tax purposes.
The measure will apply to dispositions of shares that occur after September.
"After September, when an investor moves from one class to another within the corporate structure, that switch will be considered to be a disposition, and capital gains would be payable," says Jamie Golombek, managing director of tax and estate planning with Toronto-based Canadian Imperial Bank of Commerce's wealth strategies division.
The deferral benefit available to taxable investors in corporate-class mutual funds, the government argues in budget documents, is not available to taxpayers investing in mutual fund trust structures or investing on their own accounts directly in securities. This change will "ensure the appropriate recognition of capital gains," the government says.
Most Canadian mutual funds are structured as trusts, but some are structured as corporations. Many of these mutual fund corporations are set up as "switch funds," also known as a corporate-class funds. Investors are able to exchange shares of one class of the corporation for shares of another class in order to switch between the mutual fund corporation's different funds. Under a provision in the Income Tax Act that applies to convertible corporate securities, these exchanges have been deemed not to be a disposition for income tax purposes.
The six-month grace period associated with the proposed change, Golombek says, represents a generous measure of flexibility on the part of the government, which could have proposed that the change be effective on the budget date rather in September.
"This gives advisors six months to work with clients to rebalance clients' portfolios," Golombek says, "crystalizing any capital gains prior to the effective date."
The proposed measure will not apply to switches made between different series of shares within the same class, otherwise deriving their value from the same portfolio or mutual fund within the mutual fund corporate structure, and where the only difference is in respect of management fees or expenses to be borne by investors.
The Investment Funds Institute of Canada opposes the change. "The announced policy holds potential impact for a large number of investors, including some of modest means," said Joanne De Laurentiis, president and CEO of IFIC, in a statement. "We will be analysing the potential impact and seeking further discussions with Finance Canada in the months ahead."
Ian Russell, president and CEO of the Investment Industry Association of Canada, is less critical. "The change puts mutual funds within these structures on the same footing as individual stocks, where a disposition or switch can trigger a taxable capital gain," he said in an interview with Investment Executive, "which we think is fair."
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