Mutual Fund Trust Vs Corporation
Mutual fund trust vs corporation is important to understand to determine tax responsibility and legal rights of the different fund types.3 min read
Similarities Between a Mutual Fund Trust and a Corporation
A mutual fund trust and corporation are actually very similar. Both are considered to be an investment portfolio and are often managed by more than one investor. Some mutual fund companies are even offering the same deal as both a mutual fund trust and a corporation. On paper, they look very similar. However, it is also important to consider the differences.
These are some of the biggest differences between mutual fund trusts and corporations:
- Corporations are structured as a typical corporation whereas a mutual fund trust is designed as a trust.
- Corporate funds can have more than one tax entity. Mutual trust funds, however, usually only have one fund.
- Corporations can take advantage of tax-free switching and rebalancing of funds for compounding power. Mutual funds do not have this same option.
- Corporations allow for profits and losses to be distributed across all funds. Mutual funds do not.
- Corporations usually have a higher price tag than mutual funds.
There are also additional differences in the terms used to describe the components of each type:
- Terms used to describe investors: Mutual funds use the term unitholders. Corporate funds use the term shareholders.
- Terms used to describe the type of investment: Mutual funds are referred to as mutual fund units. Corporate funds are referred to as classes or shares.
- Governance terms: Mutual funds are regulated by a trust which includes the trustee, settlers, and any beneficiaries. Corporate funds are required to follow the federal and provincial corporation's act which includes a board of directors and party. Both have a responsibility to the corporate shareholders.
- Amount of available funds: In a mutual fund, each fund is a single trust. In a corporation fund, a single corporation can have multiple funds available.
- Tax requirements: Every trust is taxed separately in a mutual fund. With corporate shares, each share is taxed separately. The corporation pays all taxes.
- Tax distributions: All taxable income in a mutual fund is split between unitholders. Corporate funds do not pay taxable gains. If profits are paid, they are paid as dividends payments.
- Flow-through income requirements: All types of income are paid to unitholders without taxation in a mutual fund. In corporation funds, these are only paid to Canadian dividends or the business capital gains.
- Investment mandate requirements: All funds are available in mutual funds. All mandates are possible with corporate funds.
- Annual fees: Annual fees vary among each fund in a mutual fund. Corporate funds fees also vary but tend to be higher than mutual funds annual fees.
- Tax effectiveness: Mutual funds have lower turnover funds and are able to utilize tax sheltering methods. Corporate funds are also able to utilize tax sheltering but through the use of claiming fees and reducing gains.
- Selling funds: Mutual funds are subject to taxes when selling. Corporate funds defer taxes when selling. However, selling out of the corporate structure may require taxes.
Understanding Capital Gains
In order to better understand the difference between mutual funds and corporate funds, it is important to understand what capital gains are. Capital gains are profits made from an investment. They are often subject to taxes.
Avoiding Capital Gains Tax
Classifying the sale of capital gains as dividend payments can reduce tax liability. Additionally, switching between capital gain types can help to avoid additional taxes. Switching funds actually means you are changing out one type of share for another type. By deferring taxes, you can increase your long-term profits.
Taxes can be avoided on capital gains by classifying the type of share when they are first given. Issuing shares, for example, categorizes them as corporate funds. Although each share remains separate with its own value, the entire corporation is taxed. This can save individual shareholders a good amount of money.
Fortunately, there is an easy way to determine how an investment is set up. You can look at the name. If the word “class” is in the name, it is a mutual fund. If it is not, it is likely a corporate fund.
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