This section describes the distribution process and tax features of mutual funds.

For a detailed explanation of how to report distributions on your income tax return, please see Section II.

1. What types of income will I get from my mutual fund?

Mutual funds invest in a variety of stocks, bonds and other securities that generate various types of income for the fund. Also, when the fund sells an investment, it receives a capital gain or capital loss on the transaction.

Canadian dividends and capital gains are taxed more favourably than other sources of income. This is because dividend income is eligible for the dividend tax credit and only 75% of a capital gain is taxed. Interest, on the other hand, is fully-taxed, the same as your salary.
 

The type of income that your fund distributes to you will vary depending on whether the fund is structured as a mutual fund "trust" or a mutual fund "corporation". For a more detailed description of the income distributions of mutual fund trusts vs mutual fund corporations, please see question 10 of this section.

2. Why do some funds issue T3s and others T5s?

Mutual fund trusts issue a T3 supplementary tax slip and mutual fund corporations issue a T5 supplementary tax slip to provide you with investment income information for tax reporting purposes.

3. Why do funds make distributions?

Funds make distributions so that, overall, less tax is paid to the government. Here's how:

Income earned by a mutual fund is subject to tax. If the income remains in the fund, the fund will pay the tax. However, if the income is distributed to investors, they pay the tax.

Since mutual funds always pay tax at the highest tax rate for each category of income, and since many investors are taxed at a lower rate, the fund pays out the income so that it is taxed at a lower rate in the investor's hands rather than at the higher rate in the fund. Therefore, all investors are better off by having the fund pay a distribution.

Also, many mutual fund investments are held inside registered plans (RRSP, RRIF, RESP, LIF, LIRA, LRIF, DPSP). Distributions paid into a registered plan are not taxable. However, if the income is left in the fund, the fund will have to pay tax on it.

4. Is my year-end distribution prorated if I invest in, say, November or December?

If you have investments in a fund when it pays a distribution, you will receive the full amount of the distribution, regardless of how long you have owned the fund. The distribution received by each investor is determined by the number of units owned by that investor on the "record day" for the distribution multiplied by the declared distribution per unit.

Investing in non-registered accounts late in the year may have tax considerations (for mutual fund trusts only, not corporations). For more information please consult your financial advisor.

5. I didn't receive any cash. Why did I still get a tax slip?

You may be wondering why you get these tax slips when you have not received, in cash, any of the income that's reported. You will not receive cash if you opted to have Mackenzie automatically reinvest your distributions as many clients have.

Automatic reinvestment of distributions is an administrative convenience for your benefit. It does not provide any tax benefit. The tax treatment is the same as if you actually received cash distributions and immediately purchased more units in the fund.

However, when distributions are automatically invested, you profit from the compounding growth of your investment.

6. What is "return of capital"? Do I pay tax on this?

Dstributions from some funds include a  return of capital (or return of principal) .  This is an amount above and beyond the taxable income of the fund for the year.

You do not pay tax on this amount and you do not include it in your taxable income for the year.

The "return of capital" is included in the detailed breakdown of distributions on the back of the tax slip so that you can calculate the Adjusted Cost Base of your investment (see "Adjusted Cost Base Calculation" in Section V).

For the benefit of investors who want a regular cash flow, Industrial Dividend Growth Fund and Industrial Income Fund, Class A and Class B each pay fixed distributions during the year. In these funds, the distributions will often be more than the taxable income of the fund resulting in a portion of the distribution being a return of capital for tax purposes.  At times, other funds may also have a return of capital to take advantage of tax opportunities.

7. How do I report income from my U.S. dollar account?

For Canadian income tax purposes, all transactions must be reported in Canadian dollars. Your T3 and T5 tax slips have been issued in Canadian dollars.

Distributions paid to your U.S. dollar account have been converted to Canadian dollars at the exchange rate in effect at the time of the distribution.

Distributions for the Universal U.S. Money Market Fund have been converted using an average daily exchange rate for the year.

8. When I received a distribution, why did the price of my mutual fund drop?

When a fund makes a distribution, its unit price drops by the same amount of the distribution per unit, but the value of your investment is unchanged. Here's why:

If your distributions are automatically reinvested, they are used to purchase more units of the fund. As a result, you will own more units. When you multiply the higher number of units by the new, lower price, you will find that the value of your holdings is unchanged.

If your distributions are paid out in cash, the remaining value of your investments plus the cash in hand will equal the value of your holdings before the distribution.

The following example shows how this works: 

9. What if my fund didn't declare a distribution?

If your fund did not declare a distribution, it does not mean that your fund is performing poorly.

Distributions are not an indicator of fund performance. There is no link between the amount of the distribution made by a fund in any year, and the fund's performance for that year.

To understand this, let's look at the components of fund performance:
 

Unless a fund has a fixed distribution (such as the Industrial Dividend Growth Fund or either class of  Industrial Income Fund), a distribution is only paid to ensure that the fund does not have to pay tax. 

Many equity funds, in particular growth-oriented funds, appreciate in value due to increases in the value of the underlying investments. Any increase in value is not included in the taxable income of the fund until an investment is sold. (This is the same as if you owned the stocks and bonds yourself you would not report the profit unless you sold the investment.) In this way, the increase in value of the mutual fund's investments can compound tax free until they are sold and new investments are acquired.

10. Do corporations and trusts pay out distributions in the same manner?

No, trusts and corporations pay out differently. 

When income is distributed from a mutual fund trust, the type of income retains its "identity" or "flows through" to the investor so that the trust can distribute the full range of income shown in the chart above in part 1. 

The trust may also flow through the dividend tax credit that is related to Canadian dividends and a foreign non-business tax credit that arises when the fund has tax withheld by foreign governments on interest and dividends earned in foreign countries. 

Mutual fund corporations can only flow through Canadian dividends, capital gains dividends and the dividend tax credit.

As of  January 1, 1998 Industrial Dividend Growth Fund and Universal Canadian Growth Fund were converted to trusts to take advantage of tax efficiencies available to mutual fund trusts.  Industrial Equity Fund Limited and Mackenzie Sentinel Canada Equity Fund Limited remain corporations.  It is our intention to propose the conversion of these funds to trusts when the circumstances are favourable.