Skip to main content

The Royal Bank of Canada (RBC) logo is seen on Bay Street in Toronto on Jan. 22, 2015.

MARK BLINCH/REUTERS

When Bernie Bellan opened his wife's T3 tax slip recently, he had to do a double take: In box 21 was an unexpected capital gain of $21,923.93 courtesy of the RBC Managed Payout Solution – Enhanced Plus mutual fund.

The size of the gain was what floored him. In the 10 years his wife had owned the fund, it often distributed no capital gains at all. When it did, the amounts were usually small. Now, his wife was facing a tax hit of more than $4,000.

After digging through documents online and spending an hour on the phone with a Royal Bank of Canada representative, Mr. Bellan finally figured out what had happened: RBC had triggered the capital gain – and a related one in 2014 – when it sold the fund's individual stocks and bonds and replaced them with RBC's own mutual funds.

Story continues below advertisement

"I was shocked and dismayed," said the Winnipeg resident, who promptly complained to his wife's financial planner and to RBC's ombudsman.

The episode, which has elicited complaints from other unitholders, highlights what can happen when a financial institution changes one of its products without fully explaining the potential consequences to investors. RBC is now dealing with the fallout.

"There has been an uptick in questions and concerns," said Jonathan Hartman, vice-president and head of investment solutions for RBC Global Asset Management. "It's an education process for advisers and for clients, and with the feedback we're getting from investors on how we communicated this to date, an education process for us as well."

Ironically, the fund was popular with many investors precisely because of its supposed tax benefits. With about $2-billion in assets, the RBC Managed Payout Solution – Enhanced Plus fund is one of three RBC "managed payout" mutual funds. It aims to deliver an annual cash distribution of about 7 per cent, consisting of dividends, interest, realized capital gains and – when those aren't sufficient to generate the cash flow target – a portion of return of capital, or ROC.

Some investors see ROC as a benefit because, instead of getting taxed in the year it is received, ROC is subtracted from the investor's cost base. This gives rise to a larger capital gain (or smaller capital loss) when the investor eventually sells his or her units, effectively pushing out the tax liability to a future year.

RBC's motivation for changing the fund's composition was twofold. First, it wanted to bring the fund in line with its two other two "managed payout" products that were already investing in other RBC funds. Second, the managers wanted to increase the fund's exposure to U.S. equities and international bonds in an effort to boost the fund's returns. Having the flexibility to invest in other RBC funds – instead of executing a large number of individual securities trades – would make the process more efficient, Mr. Hartman said.

Such a "material change" of the fund's investment objectives required the approval of unitholders. RBC announced the proposal – which also affected the RBC Asian Equity Fund – on March 31, 2014, and mailed a management information circular to unitholders, inviting them to vote at a meeting in Toronto on June 20. Investors who were unable to attend could mail in a proxy ballot or vote by phone or Internet.

Story continues below advertisement

In the information circular, RBC encouraged investors to vote in favour because it "believes that the proposed change is in the best interests of security holders." It also attached a Q&A in which one of the questions was: "Will the proposals result in increased costs to me as a security holder?" The answer stated: "All costs and expenses associated with the proposed changes (including the costs and expenses incurred in connection with this mailing and the meeting itself) will be paid by RBC GAM. The management fees for each of the funds will not increase and the management expense ratios will remain substantially the same as a result of the proposed changes to the funds."

However, nowhere in the circular or Q&A was there any mention of potential tax consequences. Unitholders approved the proposal and the fund subsequently began selling individual securities and replacing them with RBC funds (a process which did not result in any financial gain for RBC, Mr. Hartman stressed). Why weren't the potential tax consequences mentioned? RBC had performed its own tax analysis, but because market conditions are constantly changing it could not know in advance the precise level of any capital gains, Mr. Hartman said.

Asked if RBC could have included a general statement in the Q&A indicating the move might result in unspecified capital gains, he responded: "That's a fair comment … and something we'll have to think about in terms of similar circumstances, and not just in the management information circular but how we talked about it with advisers and clients and the communications that we put forward."

Mr. Hartman said RBC did try to mitigate the tax hit by spreading the selling over two years, resulting in capital gains distributions of 44 cents and 85 cents a unit in 2014 and 2015, respectively (for Series A units). The 2015 capital gain was equivalent to about 12 per cent of the fund's $7.02 unit price immediately prior to the December distribution.

Even so, the upshot for unitholders was that a supposedly tax-friendly fund became anything but. Because of the gains realized in 2014 and 2015, the fund distributed no ROC in either year, compounding the frustration of investors such as the Bellans, who had bought the fund partly for its tax-deferral advantages.

Why didn't the Bellans object when the proposal was announced? Mr. Bellan conceded neither he nor his wife read the information circular and she did not vote on the proposal. But even if they had read the circular, they probably would not have understood the potential tax implications, he said.

Story continues below advertisement

According to Mr. Hartman, the change to the fund's composition did have at least one positive consequence: It improved the fund's return in 2015 because U.S. stocks outperformed Canadian stocks that year and – on a Canadian-dollar basis – U.S. stocks also benefited from a falling loonie.

But that's of little comfort to the Bellans, who are still smarting over their hefty tax bill. "I suppose it was legal. But was it ethical or moral? … No. I say absolutely not," Mr. Bellan said.

Report an error Editorial code of conduct
Tickers mentioned in this story
Unchecking box will stop auto data updates
Comments

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

  • All comments will be reviewed by one or more moderators before being posted to the site. This should only take a few moments.
  • Treat others as you wish to be treated
  • Criticize ideas, not people
  • Stay on topic
  • Avoid the use of toxic and offensive language
  • Flag bad behaviour

Comments that violate our community guidelines will be removed. Commenters who repeatedly violate community guidelines may be suspended, causing them to temporarily lose their ability to engage with comments.

Read our community guidelines here

Discussion loading ...

Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.
Cannabis pro newsletter