As I approached final exams for the last semester of my business administration degree, I had a close knit relationship with four or five pals, with whom I shared the burden of study and assignment grappling.
Our finance professor in that last semester was both brilliant and quirky. His hair was often unkempt and greasy, his clothing completely out of style. Corduroy pants which were two inches too short, and matted sweaters which looked like they had been pulled off the bedroom floor moments before class - probably because they had been.
He had previously been employed on Wall Street, in a very high-profile position, but was languishing in Vancouver while his wife tended to her ailing mother. It was our pleasure to sit at his feet and listen to his brilliant depictions of the world of finance. He had a gift for explaining things at our level, even if he was indistinguishable in appearance from some forlorn, confused, eternal student lost in the hallways of academia.
One of my study buddies was pressing for a grad school position, hoping that this professor would sponsor him. My friend, unrelenting in his pursuit of that dream, had won a listening ear in this kindly genius. He needed a sufficiently high letter grade in the course, which meant that the gruelling exam we had just written was stressing him out.
We knocked on the professor's door together to check on his mark and gauge his status with the friendly instructor.
"Oh it's you. Come on in boys." We sat down, the three of us in this tiny cement office on the hill, and looked over the exam results.
"Don't worry," he said. "I bumped you up to an A. You're in."
My friend was elated! His actual exam mark had being just a little shy of the required threshold, but the professor had decided he was worthy of sponsorship and had pushed him through.
The exam had been an extremely difficult one, and we had both scored a little lower than we were used to. I looked at the professor, hopeful, and he nodded. "I couldn't very well give him an A and not bump you up as well..." He paused, then casually announced: "It's a Gentleman's B," handing the exam back to me.
"A Gentleman's B." I had never heard of such a thing, but was not about to argue. It pays to be tied to the shirt tale of a smart guy.
In the investment world, there are products referred to as Market Linked Notes, Principal Protected Notes, and Non-Principle Protected Notes, which provide a return based on an outside asset. We will refer to them below all simply as "Linked Notes" to discuss how pending changes to the federal tax regime will impact them.
Linked notes
A linked note is a debt obligation (the investor is the lender) where the return on the note is linked to the performance of one or more separate assets or indices.
Therefore, the return is variable and can usually only be determined, shortly before maturity.
Historically investors could sell these notes just prior to maturity and realize a capital gain (or loss) on the change in value. As a result, the investor would have reported 50 per cent of the return as taxable income rather than 100 per cent of the return. This was a better tax treatment than if the notes had accrued interest, which is taxed as regular income.
The budget proposes to change this, treating any gain realized on the sale of a linked note as if it were regular interest. If the note is denominated in a foreign currency, foreign currency fluctuations will be ignored for the purposes of calculating the gain. Where a portion of the return on the linked note is based on a fixed rate of interest, any portion of the gain that is reasonably attributable to market interest rate fluctuations will also be excluded.
This measure will apply to dispositions of linked notes that occur after September 2016, so the old advantage will still be available for a few months.
Switch fund shares
Canadian mutual funds can be either in the legal form of a trust or a corporation. Many mutual fund corporations are organized as "switch funds" or "corporate class." Investors in these funds are presently able to exchange shares of one class of the mutual fund corporation for shares of another class in order to switch their economic exposure without triggering taxable events. This deferral benefit is available to investors of switch funds but not available to taxpayers who invest in mutual fund trusts or directly in securities.
The budget proposes to eliminate this advantage. Investors switching between corporate class funds will trigger taxable gains, if any, by initiating the switch. The measure will not apply to switches where the shares received in exchange differ only in respect of management fees or expenses to be borne by investors and otherwise derive their value from the same portfolio or fund within the mutual fund corporation (e.g., the switch is between different series of shares within the same class).
This new measure will also apply to dispositions of shares that occur after September 2016.
This article is not meant as individualized tax or legal advice. Readers should consult their own tax professionals before proceeding with a strategy.
Mark Ryan is an advisor with RBC Wealth Management, Dominion Securities (member CIPF) and can be reached at [email protected], or 250-960-4927.
