By Rob Cosman, Partner, Jones & Cosman Chartered Professional Accountants
The Canada Revenue Agency taxes mutual funds, and if you make this type of investment, it is important to understand your reporting and tax obligations. Here is an overview of the basics.
What Is a Mutual Fund?
A mutual fund is an investment vehicle consisting of a range of stocks, bonds, and similar assets. These funds allow investors to pool their resources together to spread their risk over multiple securities. Mutual funds are professionally managed, and in most cases, they have specific investment goals. For example, some mutual funds have aggressive earnings goals that can relate to large risks. In contrast, other mutual funds have conservative earnings goals, and by extension, may be stocked with less-risky investments with moderate earning potential.
What Is Income From a Mutual Fund?
When your mutual funds grow, that is considered income. For example, if you buy a mutual fund worth $100 and its value increases to $105, you have $5 of income. At the beginning of each year, the administrator of your mutual fund sends you a slip detailing your income from the previous tax year. Not all of your earnings are considered to be taxable income, but your slips advise you accordingly.
The T3 Slip, State of Trust Income Allocations and Designations, includes income on units from mutual fund trusts. The T5 Slip, Statement of Investment Income, shows income earned on shares from mutual fund corporations. If you cashed out any of your mutual funds, you receive an account statement or a T5008 Slip, Statement of Securities Transactions.
What Type of Income Comes From Mutual Funds?
Depending on the type of mutual fund you have, the income may fall into a range of different categories. The possibilities include capital gains, capital gains dividends, dividends, interest, and other income. If you have foreign mutual funds, the income is considered foreign. You may have mutual fund income in multiple categories, and you should consult the back of your slip to assess which type of income you have. Ultimately, that dictates where you report the income on your tax return. For example, if you have capital gains, you report them on line 127 of your federal return, but if you have dividends, you report them on line 121.
What Are Capital Gains From Mutual Funds?
When you cash out a mutual fund, you may experience a capital gain or loss. If you cash out the fund for more than you paid for it, you have a gain, and if you redeem the fund for less than you paid for it, you have a loss. However, you must also take into account fees you paid to acquire or sell the fund when calculating your gain or loss.
For example, imagine you purchased a mutual fund for $1,000. While owning the fund, you paid $100 in management fees, a $50 redemption fee, and $80 in commission. These expenses bring your total to $1,230. This number is your adjusted cost base. When you cash out the mutual fund, you receive $2,000. Subtract your ACB from the cash-out value, also referred to as the “proceeds of disposition,” to determine your capital gain of $770.
Conversely, if you spend $500 on a mutual fund and incur $100 in fees, you have an ACB of $600. If you redeem the mutual fund for only $400, you have a capital loss of $200, or $600 – $400.
How Are Capital Gains From Mutual Funds Taxed?
If you have a capital gain, 50% of it is considered taxable. Similarly, 50% of capital losses are considered allowable losses. For example, if you have a capital gain of $1,000, the taxable portion is $500. Alternatively, if you have a capital loss of $1,000, the allowable loss is $500.
To calculate your capital gains or losses, use Schedule 3, Capital Gains or Losses. This schedule includes places to report gains or losses from the redemption of mutual funds as well as other types of capital gains. If you have a capital gain, transfer the taxable portion of the gain to line 127 of your federal tax return. If you have a loss, attach Schedule 3 to your return to notify the CRA of your loss.
How Do Capital Losses Work?
If you have an allowable capital loss, you may claim it against other capital gains. The loss has to be claimed against the same type of gains. To explain, imagine you have a $100,000 taxable capital gain from selling a rental property, and you have an allowable loss of $10,000 from a mutual fund. In this case, you can use the loss to reduce your taxable capital gain to $90,000. If you do not have any capital gains in the year you incur the loss, you may carry the loss back three years or forward indefinitely.
About Rob Cosman
Rob Cosman, is a Chartered Professional Accountant who runs his own accounting and tax practice with his wife in Toronto, Ontario. Beginning in 2000, Rob’s career spanned over Halifax, Cayman Islands and Toronto. Rob held senior industry positions including CFO roles in public and private industries ranging from telecommunications, retail sales, and consumer packaged goods.
Rob has over 10 years of tax experience and is the author of numerous articles. He has the ability to take complex tax situations, explain them in common sense terms and guide clients to make the best decisions based on their individual situations.