Flaherty Budget hobbles several mutual funds

By Alain Thériault | June 18 2013 08:12PM

Mutual funds and exchange-traded bond and high income funds that redistribute their interest income in the form of capital gains or dividends through futures contracts were walloped by the Flaherty Budget. Many are refusing new sales. Manulife Mutual Funds is no longer accepting new or complementary purchases in its 11 funds and closed-end funds in its Corporate Classes. The funds affected are the six Manulife Corporate Class Funds and five Manulife Closed-end Funds, which notably use futures contracts to transform fully taxable income into capital gains. This decision comes in the wake of the federal budget that proposes to eliminate some tax benefits for the funds that use character conversion transactions.

“Manulife Mutual Funds continues to assess the budget proposal and its potential impact. At this time, it is believed to be in the best interest of existing investors in the funds and pools noted below to suspend further purchases until there is greater guidance from the Federal Government regarding this proposal. Once all of the details are known, Manulife Mutual Funds will determine the best long-term course of action for these funds and pools,” the firm announced.

Several mutual funds and exchange traded funds (ETF) in Canada use futures contracts to transform gains into income. Over 50 have stopped selling new units since the announcement of the budget measure. IA Clarington, Fidelity and Mackenzie, along with Horizons and iShares ETF, are among the suppliers that closed the most funds, largely bond and income funds.

AGF, Bissett Funds, Desjardins Funds, Franklin Templeton, Phillips, Hager & North, Quadrus Investment Services, RBC Global Asset Management, Sentry Investments and TD Asset Management took similar steps.

Pat Chiefalo, director, Derivatives & Structured Products, National Bank Financial, says that all suppliers will not necessarily choose to suspend sales of these funds.

“Those funds (with derivative forward agreements) are featuring five-year term contracts. We believe the funds can live until the contract matures. There only will be a tax impact when the fund matures, resets or changes. It’s all about how you interpret the rules,” Mr. Chiefalo explains. “Meanwhile, every player will wait for more clarity to come.”

Manulife Mutual Funds expects that the tax treatment of its funds that were using forward contracts prior to the budget announcement on March 21, 2013, will remain unchanged for at least 180 days from that date. During the transition period, existing investors should continue to receive the same tax treatment they received prior to the budget announcement.

“It is important to note that the fundamental benefits of corporate classes remain intact, including tax-deferred switching for investors, the ability of certain corporate classes to pay tax-efficient distributions of ordinary Canadian dividends and/or capital gains dividends, or the ability to potentially reduce or defer taxable distribution,” the insurer adds.