How are segregated funds treated for Income Tax?
Tax treatment for segregated funds is similar in many ways to the taxation of mutual funds, however, there are a few differences including the following:
- Segregated funds allocate income and capital gains/losses to contract holders each year. This is different from mutual funds, which distribute or pay out income to investors in either the form of additional units or cash payments. This allocation of income does not change the number of units held nor a corresponding drop in price. The allocations will increase or decrease the investor’s adjusted cost base. Investors in segregated funds are allocated income, but do not actually receive a payment or distribution.
- A mutual fund cannot allocate capital losses to unit holders. Losses are subtracted from capital gains within the fund and only the fund’s net capital gains will be distributed to an investor and reported on their T3 Income Tax information slip. For a mutual fund, in a year where capital losses are greater than capital gains, the excess losses are carried forward to offset future capital gains.
- Segregated funds can flow through capital losses to contract holders. The capital losses are recorded on the investor’s T3 Income Tax information slip. This gives the segregated fund investor the advantage of taking the capital losses and applying them to other capital gains in the same year. The investor can also carry the segregate fund capital losses back three years and apply them to gains previously claimed and taxed.
- Segregated fund contracts allocate income and capital gains/losses on December 31st, regardless of the underlying fund’s distribution date. For example if the underlying mutual fund declares the distribution date as December 10th, the segregated contract will not distribute the income until December 31st.
- Purchasers of segregated funds in a taxable account might consider buying the fund at the beginning of the year to avoid receiving the income tax responsibility for segregated fund income, even thought they did not actually receive the income benefit.