Come this fall, Canadian investors will no longer be able to switch money between corporate class mutual funds without incurring a taxable gain.
The changes, which were part of Tuesday's federal budget, are slated to come into effect on Oct. 1 and came as an unexpected surprise to the investment industry, said Jamie Golombek, managing director of tax and estate planning at CIBC Wealth Strategies Group.
"While it was one of the more unexpected changes in the budget, there were always some rumblings that the Department of Finance was not happy with this structure from a policy perspective – even going back 20 years, it was discussed," Mr. Golombek said. "The department believed if you had a portfolio of securities, and you owned them individually, then you should pay tax when you rebalance your portfolio."
The announcement states the government's intentions to prevent the deferral of capital gains tax by investors in mutual fund corporations structured as "switch" funds.
Approximately $120-billion of industry assets under management (AUM) are in corporate class funds, representing 10 per cent of total mutual fund assets in Canada, according to CIBC.
Mutual fund corporations are typically structured in various classes of shares, with each class representing a different investment mandate. Under a corporate class fund, an investor is allowed to switch among classes without any tax implications, such as moving assets from a Canadian equity fund into a small cap fund.
Currently, such transactions do not attract tax because they are treated as a switch between two funds in the same family, rather than a sale of one fund and a subsequent purchase of another – and are seen as one of the biggest advantages of corporate class funds.
Investors looking to switch between different series of shares (such as moving from an adviser class series to a fee-based series) within the same class will not be affected, Mr. Golombek said.
The change will be felt by some of Canada's wealthier clients, who typically use corporate class funds within their non-registered investment portfolios.
"Unfortunately for people who are trying to achieve financial independence through their own discipline and savings and thrift, this is one more tool that is gone, and that is too bad," said Darren Coleman, a portfolio manager with Raymond James Ltd. who uses corporate class funds with his clients as a tax planning tool. "The budget included a lot of stuff for the middle class, but for those who wanted to have options to grow their money independently, it just got a little bit harder."
The Investment Funds Institute of Canada is among several parties in the investment community that are not happy with the impact the proposed changes will have on investors.
"The announced policy holds potential impact for a large number of investors, including some of modest means," Joanne De Laurentiis, president and CEO of IFIC, said in a statement. "We will be analyzing the potential impact and seeking further discussions with Finance Canada in the months ahead."
The changes will also directly affect Canada's mutual fund companies – especially those holding larger percentages of corporate class funds, such as CI Financial Corp. and Mackenzie Financial Capital Corp.
"We believe the prohibition of capital gains tax deferral will significantly impact the demand of corporate class funds for investors," Scott Chan, a research analyst with Canaccord Genuity Corp., said in a research note posted Wednesday. "Among large cap asset managers, we believe CI Financial has the most exposure among retail peers."
Mr. Chan says CI's exposure is estimated at well over 30 per cent of total retail AUM.
Other major holders of corporate class funds include AGF – with approximately 22 per cent of corporate class exposure, according to data from IFIC. Mackenzie Investments and Investors Group (both under parent company IGM Financial Inc.) have about 23 per cent and 9 per cent corporate class exposure, respectively.
Purpose Investments Inc. has about 50 per cent of its AUM in corporate class funds, with 11 of its 17 funds in corporate class structures. While the proposed change came as a surprise to Purpose Investments CEO Som Seif, he said it won't affect his business, as many clients do not invest in the funds for the switch function.
"We chose the corporate class structure primarily for its tax benefits of consolidating expenses and income and gains and losses within the corporation to make all the funds more tax efficient – and that will have no change under the new rules," Mr. Seif said. "Our clients buy our corporate class funds for the tax efficiency of the investment itself, less the switching function, so we don't see this as a major impact to our products or business."
Despite minimal impact to his business, Mr. Seif said he doesn't see the changes driving significant tax revenue for the government.
"I don't see much in the way of tax revenue being lost through the switch structure, but more importantly, once again this is retail investors being impacted," he adds.