Is the tax deferral on corporate class funds worth paying the additional fee?

Jamie Golombek, vice-president of taxation and estate planning at AIM Trimark Investments, has the answer.

Jamie Golombek 18 September, 2003 | 1:00PM
Dear Expert:

I am revising my investment portfolio and considering buying into one company's suite of mutual funds that are structured sections of a corporation and thus allow me to move assets from one fund to another without incurring immediate capital gains. We all know that an investment scheme that offers a tax deferral is usually a good route to take, especially in Canada, the land of high taxes. However, when I compare these funds' annual fees to those of the same funds outside of the tax-deferral "umbrella", I note that I will be paying an MER that is as much as one-quarter of a percent more than if I invested in the no-deferred version of the fund. Is it necessarily worth paying the additional fee just to gain a tax deferral?

Expert Answer:

Mutual funds can be set up in one of two legal structures: mutual fund trusts and mutual fund corporations. A mutual fund corporation itself can be further sub-divided into single-class or multi-class structures. In a multi-class mutual fund corporation, each class of shares represents a different investment portfolio with different investment objectives. For example, one class could represent an international small cap equities portfolio while another class could be exclusively invested in technology shares. A multi-class mutual fund corporation allows investors to exchange one class of shares for another on a tax-deferred basis. This allows any capital gains tax to be deferred until the money is withdrawn from that structure.

It would be an overgeneralization to state that the MER of a corporate class fund is necessarily higher than a similar fund held outside a corporate structure (i.e. in a trust structure.) A case in point would beAIM Global Technology (a mutual fund trust), which had an MER of 3.16% for the year ending December 31, 2002, andAIM Global Technology Class, (a class of shares of a mutual fund corporation), which had an MER of 2.99% over the same period. That being said, shares of some mutual fund corporations may indeed have higher MERs than a trust version of the fund primarily because the corporate funds may have to pay some corporate capital tax. Capital tax is a tax that is imposed on mutual fund corporations to the extent that they hold non-eligible investments, but it would not be imposed on the same portfolio if it were held in a trust structure. This additional tax can result in a higher MER for the fund.

Whether it is worth paying the potential extra MER may depend on the proposed switching activity of the particular investor. If you plan to switch periodically between funds, you will defer the capital gains tax liability upon the switch, while potentially paying for that benefit through the higher MER. If, however, you are an infrequent trader and rarely switch among mutual funds, you may be better off investing in the non-corporate class version of a particular fund, especially if the MER is substantially lower. This is because the additional MER may impact your returns more than the time value of your money related to paying your tax early due to switching activity.

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No statement in this article should be construed as a recommendation to buy or sell securities or to provide investment advice or individual financial planning. Morningstar Canada does not provide specific portfolio advice and recommends the use of a qualified financial planner when appropriate.

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Jamie Golombek

Jamie Golombek