Some financial advisors are taking a second look at corporate-class investment funds for their clients’ portfolios now that a new crop of the tax-efficient investment products are set to hit the market.
Toronto-based Horizons ETFs Management Canada Inc. recently announced plans to restructure about half of its assets into corporate-class funds, including its flagship $1.9-billion Horizons S&P/TSX 60 Index ETF (HXT-T). The switch comes after the federal Liberal government announced plans in the 2019 federal budget to close a tax loophole being used by certain exchange-traded funds (ETFs).
Various providers of investment funds have been offering corporate-class funds for years because of their ability to minimize and defer taxes. The structure is still considered beneficial even after the government eliminated tax-free switching between corporate-class funds in 2016.
“It’s not as effective as it used to be, but it can still be a very efficient tool in deferring taxes,” says Simon Tanner, principal financial advisor with the Dynamic Planning Partners team at Investia Financial Services Inc. in Vancouver.
The advantage of corporate-class funds is that they can hold many of the same investments as trust structures but are pooled together under one corporation for tax purposes. The structure enables the fund to share expenses and spread profits and losses from the different fund portfolios across the underlying funds in a way that’s more tax-efficient for unitholders. What’s more, corporate-class funds can only distribute Canadian dividends and capital gains dividends, which are currently the most tax-efficient forms of income.
Corporate-class funds are only beneficial for non-registered investments held by clients who are looking to defer taxes over the long-term, including people who have used up their contribution room in registered retirement saving plans (RRSPs) and tax-free savings accounts, Mr. Tanner says. The structure can also be helpful for people looking to set up trust accounts for children or grandchildren and retirees trying to avoid or reduce Old Age Security clawbacks.
Mr. Tanner also uses the structure for many of his business-owner clients looking for more tax-efficient options in their corporate investment accounts. It’s of particular interest to those who are likely to be affected by Ottawa’s new passive income rules that kicked in this year, which target investment income generated in a corporate investment account.
“If you’re a buy-and-hold, long-term investor looking for more control of your income stream, looking to reduce and defer some income distribution, then corporate class is still the most effective investment tool in the managed money market,” Mr. Tanner says.
A key benefit is the compounding of the tax-deferred income, similar to the advantages of an RRSP, Mr. Tanner says.
“Ultimately by deferring … you’re left with more money to compound,” he says.
Horizons is planning to hold a unitholder meeting in mid-November seeking approval of its proposal to convert 44 of its ETFs into a corporate-class structure. If approved, as expected, the company said the rollover is expected to happen in late November.
“Unitholders will be able to elect for a section 85 rollover when they file their 2019 taxes, which would ensure they don’t have to pay taxes on the disposition of the units during the conversion process,” says Mark Noble, senior vice president, ETF strategy, at Horizons in, an e-mail.
Horizons has said the switch will affect about $5.2-billion of its overall $10-billion in assets under management and that unitholders will have the same tax efficiencies under the new corporate-class structure and that investment mandates, fees and ticker symbols of the ETFs affected will stay the same.
Terry Shaunessy, president and portfolio manager at Shaunessy Investment Counsel Inc. in Calgary, has been using the Horizons ETFs that were targeted in the last federal budget in his clients’ portfolios.
He plans to convert those funds to the corporate-class structure as long as they can be rolled over without triggering a tax event.
“The biggest thing to ensure is that … it’s a tax-free rollover,” Mr. Shaunessy says, adding that the tax-deferral benefits of the corporate-class structure are attractive for his clients who are long-term investors.
Purpose Investments Inc. launched the first corporate-class series of ETFs in Canada in 2013. Today, about half of that company’s funds use this structure, including its flagship equity fund, Purpose Core Dividend Fund (PDF-T).
“Really, it comes down to the tax-efficiency of the vehicles,” says Som Seif, Purpose’s chief executive. “We continue to feel strongly about the way we can manage our holistic corporate tax structure and make sure our customers are getting a better end net return, net of taxes, because that’s really what matters. That’s been a really powerful part of what we’ve been doing in our corporate class.”
Mr. Seif also believes advisors are choosing corporate-class funds for their clients based on their mandates, not just the tax efficiency.
“Clients want tax efficiency no matter what,” he says. “They’re looking for good investment products. The strategy matters more than anything else.”
Dan Hallett, vice-president and principal at Oakville, Ont.-based HighView Financial Group, says the tax advantage shouldn’t be the only driver behind buying corporate-class funds for clients.
He says some corporate-class funds can be more costly and the mandate has to suit the client’s long-term objectives.
“The level of returns and yields, and cost, will tell you whether there’s a real benefit for a particular client. It’s not always the case. It can be very client-specific,” Mr. Hallett says.
“The priority should be to get the exposure that you’re looking for at a cost that makes sense. If it’s available in a corporate class, then that’s a nice bonus,” he says.