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