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Unitholders who have become unsecured creditors of five Emerge ETFs must take extra care when filing their taxes for 2023.

On Jan. 5, Emerge Canada Inc. told unitholders of five Emerge ARK ETFs that the fund manager would be unable to pay its outstanding receivables on those ETFs, which it terminated on Dec. 29. For example, unitholders of the flagship Emerge ARK Global Disruptive Innovation ETF (EARK) are owed $0.3982 per unit.

Jason Rosen, managing partner with Rosen and Associates Tax Law in Toronto, suggests prudent unitholders should assume the receivable will be repaid when calculating their capital gains or losses for the 2023 tax year.

“The receivable is a right to receive,” Rosen said. “In a typical business setting, you have to go through the proper steps to be able to write [a receivable] off as a bad debt.”

The Canada Revenue Agency (CRA) defines a bad debt as “a debt owed to you [that] remains unpaid after you have exhausted all means to collect it.”

Based on a Jan. 5 announcement date, “the receivable hasn’t necessarily gone bad; there is still the opportunity to collect,” Rosen said. “It is more conservative to hold that portion off a capital loss claim for the time being, because not enough time has passed — not even 90 days.” (For a capital gain, the receivable would be included in the gain calculation.)

“Unitholders can only deduct the receivable portion of the proceeds if they determine it’s become uncollectible,” agreed Ray Loucks, director of tax in the Vancouver office of Crowe MacKay LLP. “[But] the unitholders don’t necessarily have enough information to make that determination at this stage.”

Rosen suggested erring on the side of caution, “because the penalties for misreporting could be up to 50% gross negligence penalties,” he said.

So did Loucks. “I would recommend that the unitholders account for the receivable as proceeds of disposition of the ETF, and if it turns out they do not collect that receivable, they can take what would be a capital loss in most cases,” he said.

Loucks noted that for very active or day traders, the unitholder’s proceeds from the ETF would be treated as fully taxable business income, and an uncollectible receivable would be treated as a deductible business expense.

The CRA pays particular attention when a loss leads to lower taxes owing, Rosen said: “It could be subject to a processing review [or] line-item review, and that could lead to a full-blown audit. You need to make sure you’re doing everything above board and compliant, and if you’re not sure, get a recommendation, opinion or assistance from [an expert].”

Loucks said there’s no spot on a T5008 slip to indicate receivables from a fund, although a fund company could put such an amount in the notes section. As a result, unitholders and their advisors should be prepared to calculate the size of the Emerge ETF’s receivable applicable to their holdings.

The funds’ termination has created other tax wrinkles that may require unitholders to seek professional advice.

Some investors may have seen the proceeds of their ETFs marked as a “dividend” in their online brokerages. Loucks cautioned that even if the distribution is labelled that way, unitholders should consult their T slips for the true nature of the income.

Further, since the holdings of all 11 Emerge ETFs were liquidated on Oct. 31 and held in an interest-bearing account until the proceeds were distributed, Rosen said that interest income could flow through to unitholders. Distributions of interest income from ETFs and mutual funds are fully taxable to the unitholder if the ETF is held in a non-registered account.

On May 11, the Ontario Securities Commission (OSC) suspended Emerge Canada’s registration for capital deficiency, highlighting a receivable owed to five of its Emerge ARK ETFs that had grown to $5.5 million. The receivable totalled $4.69 million as of Dec. 29, including interest.

Emerge stated in January that it will make any receivable payments through the Canadian Depository for Securities and will notify unitholders on its website when payment has been completed.

Capital losses in a registered account

If investors incur a capital loss, they’re only able to deduct that loss against a capital gain, and only if the loss occurred in a non-registered account. Therefore, losses within a TFSA or RRSP cannot be deducted.

“The rationale for that is any capital gains or income realized in your RRSP or TFSA is also not taxable. So on the flipside, you don’t get any deduction on the losses,” Loucks said.

Capital losses can be deducted against capital gains in the current tax year, carried back for three preceding years or carried forward indefinitely.

However, a capital loss cannot be deducted if a taxpayer purchased an identical security 30 days before or after the settlement date of the sale (including a sale forced by a termination) of the security with a loss, due to what’s known as the superficial loss rules.

Factors the CRA would consider when determining if a security is identical property include the currency of the security, similarities between fund managers and/or subadvisors, and similarities in holdings, Rosen said.

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