Corporate-class mutual funds, once heralded as a tax-saving vehicle for non-registered accounts, have lost appeal amid legislative changes, fee compression and a shift to global investing.
In mid-February, IG Wealth Management said it will wind up Investors Group Corporate Class Inc. in May, affecting 60 mutual funds. Those funds will be merged into equivalent funds, managed by the same subadvisor, on a tax-deferred basis at no cost to investors.
The corporate structure found itself making more dividend distributions, which are taxable, and “the straw that broke the camel’s back … is that the structure itself became taxable” toward the end of 2022, said Jon Kilfoyle, senior vice-president of IG Investments.
Taxes payable must be allocated to each of the classes, negatively affecting returns, so IG decided to wind up the structure “in the best interest of investors,” a release stated.
Mackenzie Investments, Ninepoint Partners LP and RBC Global Asset Management Inc. are some of the other manufacturers that have wound up or liquidated corporate-class structures. According to Morningstar Direct, more than 6,600 corporate-class share classes have closed over the past five years, with only 1,174 launching over the same period.
The first corporate-class funds were launched in 1987 by CI Financial Corp., and touted as a tax-efficient vehicle for non-registered investing. Chief among their advantages was the ability to switch on a tax-deferred basis between share classes, as well as to file one tax return for the entire corporation — allowing for fund expenses to be matched against income from all share classes, ideally putting the corporation in a tax-neutral position.
Corporate-class funds lost the first tax advantage in 2017, when legislation first proposed in the 2016 federal budget took effect and made switching between classes a disposition at fair market value for tax purposes.
The tax-return advantage remains. A mutual fund corporation typically takes the highest-taxed income and uses it to pay expenses, and applies capital gains against capital losses.
Kilfoyle said that in IG’s case, the shift toward fee-based accounts as well as lower management expense ratios led to lower expenses generally for the mutual fund corporation, leaving more income that couldn’t be applied against expenses. The trend toward stronger equities returns over the past decade — recent downturns aside — is also creating more income and capital gains in general.
Increased ownership of foreign securities also contributed to increased taxable income, Kilfoyle said, since foreign dividends are fully taxable.
In this environment, the number of corporate-class share classes has fallen to 5,743 as of Jan. 31, according to Morningstar Direct. That’s down from a recent peak of 11,724 in 2018.
The 2017 legislation that stripped corporate-class funds of their switching advantage also allowed mutual fund corporations to merge with mutual fund trusts on a tax-deferred basis for the first time. (IG Wealth is using this provision for its windup.)
Closures then spiked in 2019, as “it likely took fund companies some time to settle into these new rules,” said Danielle LeClair, director of manager research with Morningstar Canada.
She explained that 2017’s spike in launches was due to a few fund companies launching a large number of different share classes of the same funds that year.