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A Less Taxing Way to Make Money…
Written by Matthew Aston, CFP, CLU
Over the last decade, I have had opportunity to sit down with people from all walks of life in all different
sorts of life circumstances. In spite of all their differences, they all end up in my office looking for help
with a common goal set. Two of the core components of that goal set are; 1. Growing their wealth and;
2.Paying less tax. While there is a broad range of creative solutions that we often help people
implement, there is also one very simple step that many are unaware of that can be taken to help with
both of these goals simultaneously.
The step involves the use of investment vehicles called “Corporate Class Mutual Funds”. Right off the
bat many people get defensive when someone says “mutual fund” and they stop looking at the vehicle
altogether. I’ve heard every reason to discount them as a viable option… “They’re too expensive”….
“They’re too risky”…. “I believe a portfolio built directly of stocks or bonds is better. Why pay a middle
man?”
What so many people overlook happens to be one of the best tax sensitive investments in Canada that is
available to the general public. Given that tax season is upon us, I felt this would be a good topic to
discuss in this article. Without getting too deep into the technicalities that make it work, a simple
analogy goes like this:
A group of families get together for a BBQ. They are all talking about their investment approaches and
they each have a different strategy. Some use GICs. Some use Canadian Stocks. Some use Government or
Corporate Bonds. Some use other things. They look at all their investments and realize that each approach
has different strengths and weaknesses, and that they are never all in favour at the same time. One of the
men present happens to be a wise accountant. While looking at the big picture he realizes that he can
help all of his friends pay less tax by simply allowing them to combine their portfolios into one big one and
then when one person’s strategy gains it can be offset by the strategy that loses and in turn, they can
avoid paying taxes that year. He opens a corporation, which is like a big basket, to put all these
investments into. Each family then gets a different class of share/stock in the corporation which reflects
their investment approach. Time goes by and each year some people make money while others lose
money, and neither the corporation nor the investors have to pay tax because overall they doesn’t show
any income because the gains and losses cancel each other out. Each year, the people using GIC’s and
Bonds also get a big break, because the costs of the stock investing strategies can be used as a deduction
inside the corporation to write down the interest income. Time goes on and all their money grows tax
sheltered and deferred, compounding faster, and then when the time comes to take money out, they only
have to pay tax on half of their profit instead of all of it due to the re-characterization of the investment
income from interest and dividends into capital gains.
The analogy may be an oversimplification of how these fantastic tax-planning tools work, but ultimately,
what is important to understand is that they enable people to invest into all different types of
investments, and through their structure, they work to optimize a person’s tax efficiency. Let’s consider
two real life examples of how corporate class mutual funds produce tax savings for a person or business.
The first example we’ll look at will be the true story of Katherine (not her real name). Katherine lived in a
nice town called Port Hope. She’d been retired for many years and was now a widow. We’d met
Katherine as the result of an estate planning referral. She just wanted a second set of eyes to look over
everything that her lawyer, broker, and her bank had done and make sure that things would work
smoothly for her four children when she passed away. Given that this is one of the areas that we
specialize in, she was referred to us to complete the process. When completing our initial discovery
process we found that Katherine was losing her Old Age Security (OAS) entirely and that the primary
cause of this was her portfolio at the brokerage. It was comprised entirely of dividend paying stocks (the
banks primarily) and GIC’s and Bonds. The dividend and interest income she was receiving each year was
causing her OAS to be clawed back entirely and was putting her into an effective tax rate higher than the
top marginal rate. When we asked her about it she had just accepted that it was part of life. We
recommended that she move her investments out of the stocks, bonds, and GIC’s she was holding and
invest them into a Corporate Class Mutual Fund portfolio with the same type of underlying holdings.
Because she took the advice, her OAS was fully restored and she significantly decreased her marginal tax
rate, while at the same time, increasing her actual rate of return. In effect she was making more money
and paying less tax on it. She was thrilled.
In 2012, her very defensive portfolio made 6.64% and the bulk of that return would normally have been
comprised of interest and dividend income based on her holdings. In this case, she only received a tax
slip for dividends amounting to a 0.57% return. The tax savings for Katherine in that year alone
amounted to $27,968 because she used Corporate Class Mutual Funds instead of the core holdings
directly.
The second example we’ll look at will be the true story of Pat and Simone (again not their real names)
and their numbered company 123456 Ontario Inc. They had run a very successful business and were
approaching retirement. All the way along, they had had their nest egg invested inside their holding
company in a wrap program of mutual funds and GICs. What is important to understand is that Holding
Companies pay tax at the top marginal tax rate on all investment income that isn’t paid out to the
shareholders. A portion of that tax is refundable when they do take income out but it sits on deposit
with CRA, in some cases for years, until the income is drawn.
Pat and Simone were already drawing as much as they reasonably could from their company and some
of their income was already landing in the top marginal tax rate, so there was nothing their accountant
identified could be done to improve the situation.
We were referred to them to help them develop their exit strategy from the business and to develop
long term plans for tax efficient extraction of their corporate assets. When we reviewed their corporate
financials, we identified the significant inefficiency that was resulting from their corporate investments.
As with Katherine’s situation above, we advised that they transfer their investments into Corporate
Class Mutual Funds to improve tax efficiency. They did so and the tax bill was dropped significantly.
In 2012, their corporate investment account which was invested very defensively made 6.70% but their
tax slip only showed dividends in an amount equal to a 0.53% rate of return. This again translated into
significant tax savings.
So what exactly is the bottom line? If you are a Canadian Resident that has more than $100,000 in nonregistered savings, Corporate Class Mutual Funds are an option that deserves careful consideration.
They may help you to preserve your OAS, reduce your marginal tax rate, and allow you and your tax
professionals to control when and how your investment income is realized. If you look in the right places
you will find that most respected investment providers are no more expensive than the other options
that are out there, and most offer options suitable for any type of investor risk tolerance.
Matthew Aston, CFP, CLU is an independent wealth management advisor and a partner in Lighthouse
Wealth Management Ltd and is an FPSC President’s List Award Recipient. He works with seniors and
business owners across Canada towards achieving financial freedom and maximization.
This article is intended for general information purposes only. Consult a qualified professional before
making changes to your wealth management strategy.