Corporate class mutual funds: a trust for minors

Updated as of May 3, 2022

Case study

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.

Consider the after-tax income

Source of income Interest ($) Ordinary Canadian dividends ($) Capital gains ($)
Gross income 10,000 10,000 10,000
Effective tax payable by parent or grandparent2 –4,500 –3,000 n/a
Effective tax payable by minor child or grandchild3 n/a n/a 0
After-tax income 5,500 7,000 10,000

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” article. 2 Assumes parent or grandparent has a marginal tax rate of 45% on interest income and 30% on ordinary Canadian dividends. 3 Assumes minor child or grandchild has no other income and a basic personal exemption of at least $10,000.

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MK2842E 05/22

Tax, Retirement & Estate Planning Services Team

Tax, Retirement & Estate Planning Services Team

Manulife Investment Management

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