Tax planning and the mutual fund investor

Mutual fund investors should be prepared for tax advice slips which will report their income, eligible Canadian dividends and capital gains and losses when doing their tax planning.

At this time of year, many mutual fund investors may express shock when they receive tax forms pertaining to their fund investments.

A partnership in an investment portfolio

The simplest way to think of your mutual-fund investments is as a partnership in an investment portfolio. Everything that happens in the portfolio is taxed to you according to your share of ownership. Your tax planning should take that into account.

The fund will calculate any income it receives, be it interest, dividend or net realized capital gains or losses. It will then offset as much as possible of this income with fund expenses (i.e., the management expense, which is reported as the management expense ratio or “MER”).

The remainder is simply divided on a pro-rata basis among the fund’s shareholders. You’ll receive forms showing your straight income (interest or foreign dividends), Canadian dividends and capital gains or losses. What’s more, Canada Revenue Agency will also receive copies of these forms, and expect you to pay your share of the income tax and capital gains tax.

The downside of dividends

Many investors are familiar with the Templeton Growth Fund’s advertisement that shows the results of a $10,000 investment at the inception of the fund in 1954. Today, that investment is worth over $8 million.

That record is one of the reasons we consider the fund to be one of the better global equity funds available to Canadians. But that accumulation of assets assumes full reinvestment of all dividends over the past 60 years. In order to have $8 million worth of the fund today, the investor would have had to pay all the tax on those dividends from other money.

Another source of tax pain: funds’ realized capital gains

You pay capital gains tax only on realized gains. However, over the past 60 years, even Templeton Growth Fund has realized many, many capital gains, requiring hefty income tax payments from time to time on these as well.

Mutual funds must distribute realized gains every year, so when you consider having your dividends reinvested automatically, remember to consider all possible consequences when doing your income tax planning. After all, you don’t want to be forced to sell at a disadvantageous time to pay your taxes.


The TaxLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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