How to Reduce Taxes through the Corporate Class Structure

In 1789, during the establishment of the US constitution, Benjamin Franklin quoted: “nothing is certain in this world except for death and taxes.” Although we agree with Mr. Franklin, since 1789 many advancements have allowed us to live longer lives and pay taxes much later in the future. We will eventually succumb to both, but the question is when?

For high-net worth individuals and business owners who invest through their holding companies, investing in corporate class mutual funds in a non-registered account could be extremely valuable for your bottom line. The information below allows individuals with money outside of a registered account to lower their tax bill, generate tax-efficient income and potentially withdraw money out of their company tax-free.

How corporate class mutual funds work

Corporate Class mutual funds are legally structured as a corporation, not a trust. Trusts can generally distribute all forms of income including interest and foreign income, which are taxed at the highest rate. Corporations on the other hand cannot distribute interest income, they can however distribute Canadian dividends which have preferential tax treatment.

How this investment strategy can help save you tax

As an example, if you were to purchase the Verizon stock?in your corporation or in your non-registered account, the dividend would be taxed at the marginal tax rate (which is over 50% in a holding company). If you were to purchase a US corporate class mutual fund, it may potentially distribute nothing on a yearly basis or it would only distribute Canadian dividends and/or capital gains, which all have favorable tax treatment.

Tax-free withdrawals are another benefit of investing in corporate class mutual funds. By converting the interest income and foreign income into deferred capital gains, you are essentially creating a larger capital gain in your corporate class position. The day you decide to sell and trigger that capital gain, you will be allowed to withdraw half of the net capital gain out of your company tax-free through a notional account called the Capital Dividend Account.

How to distribute tax-efficient income

There are many types of incomes: interest, foreign income, dividends, capital gains and the less talked about return of capital. Return of capital allows the shareholder of the corporate class fund to distribute capital back to the shareholder. That capital is not immediately taxable. However, it does reduce the average cost base of the fund. In short, that means the shareholder will not pay taxes on the revenue today, only in the future.

Corporate Class in practice

One of our biggest investment holdings is: Fidelity Canadian Growth Company Series F which made a 47.08% rate of return in 2020.

The mistake that we often see is under which structure advisors and clients purchase funds. This fund is available in corporate class (tax-efficient) or in a regular trust version (not so tax efficient).

The corporate class version generated ZERO dollars of distributions in 2020 while the trust version generated a capital gain of 10.97%. If you had $1,000,000 invested in the corporate class version in 2020, your tax bill would be ZERO $ versus a capital gain of $100,970 for the trust version. Are you utilizing the corporate class structure?

Conclusion

In conclusion, the key to a sound plan is dotting the I’s and crossing the T’s. It is important to utilize the corporate class structure because over time, the savings may amount to hundreds of thousands of dollars.

If you want to discuss investment options, I am here to help. Let’s talk about how corporate class mutual funds fit into your investment strategy and can help save on taxes.

?Mutual funds are not guaranteed and information on returns is based on past performance which may not reflect future performance. Mutual funds may be associated with commissions, trailer fees, management fees and other expenses. Please read the prospectus. Important information regarding mutual funds may be found in the simplified prospectus. To obtain a copy, please contact Joseph Alfie.

This information has been prepared by Joseph Alfie who is a Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.