2018 was a poor year for most Canadian stock funds and you may have received some shocking tax reporting slips this month. But now, it’s too late to do anything but find the money and pay the taxes.
At this time of the year, you’ve probably received various tax-information slips. And some mutual-fund investors may have been shocked when they received those information slips from their fund companies.
Calendar-year 2018 was a bad one for Canadian equity funds. The average fund in the category lost 9.4 per cent of its value during the year. In one way, that might be considered a good thing. After all, had it been a good year for the Canadian stock market, your fund manager might have felt it appropriate to sell some long-term winners during the year. In that case, you could have ended up with a nasty income-tax liability. But, keep in mind that though equity funds didn’t perform well in 2018, you might still end up with a tax liability for the year.
The simplest way to think of your mutual fund is as a partnership in a portfolio of investments. In most cases, that’s exactly what it is.
Technically, mutual funds don’t pay dividends. Rather, they distribute to unit holders all interest, dividends and realized capital gains received by the fund each year.
Realized gains may mean taxes
Everything that happens in the fund will be taxed to you according to your share of ownership. The fund simply passes on the cash and your pro-rata income-tax consequences. So when your manager sells a long-term holding for a large gain (possibly accrued over several years), the gain becomes taxable (as a capital gain) in the year of the sale, even though the fund reported the gain month by month as it happened.
But if your manager also held a large number of investments that lost value during 2018, these will have dragged down the performance of the fund during the year.
The result can easily be a fund that lost value in 2018 yet whose unit holders face alarming income-tax liabilities. Further, if you’ve had your distributions automatically reinvested in the fund, you’ve simply made a new investment with the money. Most funds state in their prospectuses that unless you specifically request otherwise, they will automatically reinvest all distributions.
Every fund’s management expenses, of course, are tax deductible. Most funds realize enough gains to pay these expenses. So the taxable distribution you receive comes after these expenses have been paid.
But administrators simply divide any further cash receipts pro-rata among a fund’s unit holders. You receive a form showing your straight income, dividend income and capital gains or losses. What’s more, the Canada Revenue Agency will also receive copies of these forms, and expect you to declare the income.
Since mutual funds must distribute all realized capital gains every year, consider your income-tax situation before you automatically request dividend reinvestment. Obviously none of this applies to investments in your RRSP, RRIF or TFSA.
This is an edited version of an article that was originally published for subscribers in the February 1, 2019, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
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