Mutual Fund Trust vs Corporation: Key Differences

Key Takeaways

• A mutual fund trust and a corporation share similarities but differ significantly in structure, taxation, and governance.
• Trusts are governed by a trustee for the benefit of unitholders; corporations are governed by a board of directors for shareholders.
• Corporate funds allow tax-free switching and consolidated tax reporting; trust funds flow income directly to investors.
• Corporate structures often offer more flexibility for diversification, while trusts can offer simpler tax treatment for investors.
• Understanding capital gains treatment is key to optimizing investment returns.
• Mutual fund corporations can offer greater deferral of taxes compared to trusts.

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.

Factors to Consider When Choosing Between a Mutual Fund Trust and Corporation

When evaluating mutual fund trust vs corporation, investors should weigh several key factors:

• Investment Goals: Trusts often suit investors seeking direct income distribution, while corporations are better for those aiming to defer taxes and grow wealth over time.
• Tax Planning Needs: Mutual fund corporations can allow for tax-free switching between different funds within the corporation, enabling greater tax efficiency.
• Flexibility: Corporations offer greater flexibility by allowing investors to hold various asset classes under one legal structure through different share classes.
• Costs: Corporations often have higher administrative and compliance costs due to the additional legal and accounting work required compared to trusts.
• Residency: Mutual fund corporations typically offer better advantages for Canadian residents, particularly in the treatment of dividends and capital gains ​.
• Liquidity: Trust units can sometimes be easier to liquidate than corporate shares, depending on market conditions and fund policies.

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.

Taxation Differences Between Mutual Fund Trusts and Corporations

Understanding the tax differences between a mutual fund trust vs corporation is essential:

• Mutual Fund Trusts:
  • Must distribute all net taxable income annually to unitholders, who then report this income personally.
  • Income types retain their character (interest, dividends, capital gains) when distributed to unitholders.
  • No tax is paid at the trust level if all income is distributed .
• Mutual Fund Corporations:
  • Income is taxed at the corporate level, but capital gains can be deferred until shares are sold.
  • Profits are often paid to shareholders as dividends, which may be eligible for dividend tax credits (in Canada).
  • Switches between classes within the corporation can generally occur without immediate tax consequences, unlike in a trust.

In short, trusts pass income directly to investors annually, while corporations offer greater opportunities for tax deferral and planning

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.

Advantages and Disadvantages of Mutual Fund Trusts and Corporations

Here’s a quick comparison of the pros and cons of each structure:

Mutual Fund Trusts:

• Advantages:
  • Simpler taxation for investors.
  • Immediate flow-through of income can be beneficial for investors needing current income.
  • Generally lower management and legal costs.
• Disadvantages:
  • No tax deferral — all income must be distributed and taxed annually.
  • Switching between funds often triggers immediate taxable events.

Mutual Fund Corporations:

• Advantages:
  • Ability to switch between different funds (classes) tax-free within the corporation.
  • Capital gains can be deferred until redemption of shares.
  • Potential dividend tax credits when dividends are distributed.
• Disadvantages:
  • Higher administrative and legal costs.
  • More complex governance structure with a board of directors

Frequently Asked Questions

1. What is the primary difference between a mutual fund trust and a corporation?
   The main difference lies in structure and taxation: trusts distribute income directly to investors annually, while corporations allow deferral of taxes and can reinvest earnings internally.
2. Is switching funds tax-free in a mutual fund corporation?
   Yes, investors can often switch between different classes within a mutual fund corporation without triggering a taxable event, unlike in a mutual fund trust.
3. Which structure is better for long-term tax deferral?
   A mutual fund corporation generally offers better long-term tax deferral opportunities through class switching and retained earnings.
4. Do mutual fund corporations have higher costs than trusts?
   Yes, due to more complex governance, regulatory requirements, and tax reporting, corporations tend to have higher administrative and legal costs compared to trusts.
5. How does capital gains treatment differ between trusts and corporations?
   In a trust, capital gains are passed through and taxed annually. In a corporation, capital gains can be deferred until the investor redeems shares, allowing for potential tax efficiency.

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