Corporate class mutual funds: A smart tax play for your clients’ portfolios

The small business deduction (SBD) allows corporations to pay a low rate of tax (approximately 11% but it varies by province) on the first $500,000 of active income (16% for active income between $500,000 and $600,000 in Saskatchewan). However, for every dollar of passive investment income over $50,000 in a year the SBD is clawed back or reduced by $5 ($6 in Saskatchewan). Once your passive investment income reaches $150,000, your SBD is completely clawed back and all of your active income is now taxed at a higher rate (approximately 25-30% depending on the province). Corporate class mutual funds help mitigate this risk by providing a tax-efficient investment vehicle that can minimize reportable investment income, enabling corporations to preserve their SBD. This strategic advantage makes these funds a practical solution for advisors aiming to optimize corporate clients’ tax positions.

• Retirees wanting to maximize benefits: Seniors, too, can find value in corporate class mutual funds. By lowering taxable income, they can reduce the taxes they pay and can potentially preserve income-tested benefits like Old Age Security (OAS). “I’ve seen seniors at a casino who are fine with losing a couple hundred dollars, but if they lose a few hundred to an OAS clawback, they’re up in arms,” Natale says.
   
• Families engaging in income splitting: For clients who want to set up trusts for minor children or grandchildren, corporate class mutual funds are particularly appealing. By avoiding funds that could distribute Canadian dividends you can ensure that the only potential distributions are capital gains or return of capital. “This is important because capital gains can be taxed in the hands of the minor as they are not subject to the attribution rules” says Natale. “This helps clients execute income-splitting strategies more effectively.”
   
• High-net-worth individuals avoiding U.S. estate tax: Canadian residents who are not U.S. citizens may face U.S. estate tax exposure on their U.S. situs property (aka U.S. situated property) if the value of their worldwide estate at the time of death is above a certain threshold. Canadian corporate class mutual funds offer a solution by being classified as Canadian situs property, even if the fund invests in U.S. securities, thereby shielding clients from U.S. estate tax on those assets. “Clients are often surprised to learn that owning U.S. equities directly could expose them to U.S. estate tax,” Natale explains. “Canadian corporate class funds help avoid that by keeping the investment classified as Canadian property.”

Why advisors should revisit corporate class funds

The belief that corporate class mutual funds lost all of their value after the elimination of tax-deferred switching between funds is a misconception. While that particular benefit may have disappeared, Natale emphasizes that many tax advantages remain intact and relevant. “The ability to switch between funds without a taxable event was a big selling point, but that’s not all these funds had to offer,” he says. “The enduring tax efficiencies can still significantly boost a client’s after-tax returns.”

For advisors, this means the opportunity is still very much alive. Whether you’re helping a corporate client save tax and preserve their small business deduction, guiding retirees on how to avoid OAS clawbacks, facilitating tax-efficient income splitting, or avoiding U.S. estate tax, these funds provide practical solutions that can be tailored to meet diverse client needs.

“In a landscape where tax efficiency can sometimes feel like an afterthought, corporate class mutual funds give advisors a way to deliver real value,” Natale concludes. “They’re not just a relic of the past; they’re a sophisticated tool for today’s tax-aware investor.”

Important disclosure

This communication is published by Manulife Investment Management. Any commentaries and information contained in this communication are provided as a general source of information only and should not be considered personal investment, tax, accounting or legal advice and should not be relied upon in that regard. Professional advisors should be consulted prior to acting based on the information contained in this communication to ensure that any action taken with respect to this information is appropriate to their specific situation. Facts and data provided by Manulife Investment Management and other sources are believed to be reliable as at the date of publication.