Corporate class mutual funds: a trust for minors

Case Studies

Scenario

Brian and Sarah are successful business owners who recently sold their company for several million dollars. As they’ll now have more than enough investment income during their planned retirement, they’re looking for ways to reduce their tax bill and provide a legacy for their grandson, Andrew, who just turned three years old. Brian and Sarah approached their advisor about setting up a trust for Andrew but are concerned about the possible tax implications, as they‘ve heard there are complex rules that can prohibit income splitting with minors.

Attribution rules

Under the Income Tax Act (Canada) attribution rules,1 any income (interest, ordinary Canadian dividends, and foreign income) from property transferred to a minor or a trust for the benefit of a minor is taxed to the gifting parent or grandparent. However, capital gains can be taxed to the minor, who’s normally in a lower tax bracket resulting in little or no taxes being paid.

Brian and Sarah explain that they want to invest their funds in a diversified and balanced investment. They’re fairly risk-averse and want to make sure that the capital is preserved for Andrew when he becomes an adult. However, given the attribution rules, they’re unsure how this can be done without being taxed on the income themselves.

Solution

Their advisor explains how investing in a corporate class mutual fund can help, since a mutual fund corporation can only distribute ordinary Canadian dividends, capital gains dividends, or return of capital (ROC). A good strategy would be to transfer funds to a trust with Andrew as the beneficiary and have the trust invest in corporate class mutual funds that aren’t expected to distribute ordinary Canadian dividends. This way, all the return would be either capital gains or ROC and wouldn’t be attributed back to Brian and Sarah.

The chart below illustrates the effective tax payable on $10,000 of income from different sources, invested in a trust for the benefit of a minor child or grandchild.

This chart illustrates the efffective tax payable on $10,000 of income, from different sources, invested in a trust for the benefit of a minor child or grandchild. In this example, if $10,000 of income was earned as interest income, the effective tax payable by the parent or grandparent would be $4,500 and the after-tax income would be $5,500. If the income was recharacterized by the mutual fund corporation as ordinary Canadian dividends, the effective tax payable by the parent or grandparent would be $3,000 and the after-tax income would be $7,000. And in the case of capital gains in this example, there would be no taxes payable by the parent, grandparent or minor child and the after-tax income would be $10,000. For illustration purposes only.

Outcome

Manulife’s corporate class mutual funds can enable the trust to earn capital gains that can be taxed to Andrew instead of Brian and Sarah. This can result in tax savings that can be repeated each year.

In addition, Brian and Sarah can take advantage of the other benefits of Manulife’s corporate class mutual funds, such as tax-efficient income and tax-efficient cash flow using Series T.

For more information on Manulife’s corporate class mutual funds and how they can help, speak to your advisor or refer to our related article, “Ideal candidates for mutual fund corporations.”

1 For more information on income splitting and attribution rules, read our “Income splitting — the facts” (MK2612) article. 2 Assumes grandparent has a marginal tax rate of 45% on interest income and 30% on ordinary Canadian dividends. 3 Assumes grandchild has no other income and a basic personal exemption of at least $10,000.

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts as well as the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The payment of distributions is not guaranteed and may fluctuate. If distributions paid by the fund are greater than the performance of the fund, then your original investment will shrink. Distributions should not be confused with a fund’s performance, rate of return, or yield. You may also receive return of capital distributions from a fund. Please consult with your tax advisor regarding the tax implications of receiving distributions. See the prospectus for more information on a fund’s distributions policy. 

Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

MK2842E 07/20

Tax, Retirement & Estate Planning Services Team

Tax, Retirement & Estate Planning Services Team

Manulife Investment Management

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