Uncertainty around changes to the capital gains inclusion rate is creating confusion for fund companies and taxpayers.BLAIR GABLE/Reuters
Asset managers that produce mutual funds and exchange-traded funds will have to file trust returns and issue tax slips to investors for their investment funds this tax season without being certain about how to report the capital gains those funds realized last year.
Investment funds that file returns and issue T3 slips under Ottawa’s proposed capital gains tax changes will likely have to refile and, in some cases, may have to issue amended T3 slips if the proposals don’t pass. This may also affect some returns for individual taxpayers with significant gains.
Most mutual funds and ETFs are established as trusts, which typically flow out their income, dividends and gains every year to unitholders. The funds then take a corresponding deduction. The income is thus taxed in the hands of the unitholders at their marginal tax rates and not in the trust, which is taxed at the highest marginal rate.
But this process is complicated this year because of changes proposed in the 2024 federal budget to increase the capital gains inclusion rate to 66.7 per cent from 50 per cent as of June 25, 2024, for corporations and trusts. The same increase applies to individuals but only on more than $250,000 in capital gains each year.
However, legislation to enact the measure never came to a vote in Parliament, which is now prorogued until March 24, clouding the outlook for the proposed changes.
Nevertheless, the Canada Revenue Agency (CRA) says it will administer the government’s changes as per its standard practice for proposed legislation. It also says it will issue the forms to allow taxpayers to file in accordance with the new capital gains rules by Jan. 31.
The CRA already issued the T3 slip for the 2024 taxation year – the Statement of Trust Income Allocations and Designations – in December. The slip includes guidance for the reporting of total gains and period one and period two gains: before and after June 25.
John Tobin, a tax lawyer and partner with Torys LLP in Toronto, says he thinks investment funds will report capital gains for the two periods, in addition to total gains, to align with the CRA forms even though the proposed changes haven’t passed into law.
“They’re [being] required to provide information that, right now, is not legally relevant,” Mr. Tobin says.
Josée Baillargeon, director of taxation policy with the Investment Funds Institute of Canada in Toronto, says asset managers were taking the CRA’s guidance that it would administer the proposed capital gains rules “under advisement.”
Ms. Baillargeon confirmed in a response sent via e-mail to questions Globe Advisor posed that it was possible asset management firms would have to reissue slips for some of their investment funds if they reported gains under the proposed rules and those rules don’t ultimately pass. Some firms have already posted information on inclusion rate changes for their unitholders, she said.
A spokesperson for CI Global Asset Management said the fund provider will be reporting capital gains under the proposed legislation, and IG Wealth Management also said it will report and issue tax slips for capital gains incurred in the two separate periods in 2024 when applicable.
Fund firms must file T3 returns and issue T3 slips to investors by March 31 for the 2024 taxation year.
However, funds are required to report their sources of income well before then – this year, by March 3 – to CDS Innovations, a data reporting service.
That means fund administrators must decide how to report capital gains over the next month.
Michael Friedman, a tax lawyer and partner with McMillan LLP in Toronto, says asset managers are “in a tough spot” in terms of deciding how to report.
Asset managers could decide to report based on the current rules, as the CRA’s audit guidelines say taxpayers can’t be compelled to file under proposed law, he says. However, firms wouldn’t be acting in alignment with the CRA’s administrative position, potentially leading to compliance difficulties for themselves and unitholders.
“Funds are trying to figure out what to do in a way that’s fair to investors, but that complies with their reporting obligations,” Mr. Friedman says. “I don’t think you’ll see a solely uniform approach.”
If funds file returns and report gains on T3 slips under the current rules, unitholders who choose to file under the proposed legislation would have difficulty doing so without information about gains the trust realized before and after the effective date.
A fund filing under the existing capital gains tax regime is “essentially making that decision for [their] unitholders as well,” says Rob Jeffery, a tax lawyer and partner with Deloitte LLP in Halifax, adding that it’s “a really tough situation for taxpayers.”
Mr. Jeffery says, in most cases, taxpayers could rely on the total gains reported on the T3 slip if the fund issued it based on the proposed legislation and the rules weren’t enacted.
However, in cases in which the fund had certain combinations of expenses or loss carryforwards, funds might have to amend a tax slip.
Peter Bowen, vice-president, tax and retirement research for Fidelity Investments Canada ULC, says the firm is also reporting under the proposed rules.
“That doesn’t mean investors have to pay taxes at the higher rate if they’re affected – it simply means we have split the gains reported into pre- and post-change periods,” he says.
That means investors can make their own decisions, he adds, and “very few investors” will be affected.
Individuals filing their T1 returns for 2024 will also have to decide whether to file based on the proposed or existing capital gains inclusion rate.
Investors who realized less than $250,000 of capital gains have little to worry about, tax experts say, as they should have the same tax result whether they file under the existing or proposed rules.
Taxpayers with capital gains above the threshold may be exposed to interest and penalties if they file under the existing legislation but the proposed rules are ultimately enacted. However, if they file under the proposed rules and those rules aren’t enacted, they could overpay on their taxes and may have to file an amended return to get a refund.
In November, the CRA announced it would provide arrears interest and penalty relief to trusts and corporations affected by the capital gains tax proposals with filing deadlines on or before March 3, 2025.
In response to a question from Globe Advisor about whether the CRA would expand the interest and penalty relief, spokesperson Sylvie Branch said the agency had “no further information to provide on this topic at this time.”