Flaherty cracks down on Income Conversion and LSIFs
On March 20, Finance Minister Jim Flaherty delivered the 2013 Federal budget. By most accounts, it is described as a “modest budget” in that it contains very little in the way of new spending initiatives and keeps the government on track to eliminate the $26 billion deficit over the next two years.
For investors, there were a few changes that will have an impact on their portfolios. Perhaps the biggest is the plan to eliminate a fund’s ability to convert interest income into capital gains. Many companies including Mackenzie, Franklin Templeton, CIBC, and IA Clarington offered these types of funds with great success. With interest being taxed at an individual’s marginal rate while only half of capital gains are taxable, it is not hard to understand their appeal. After all, who doesn’t want to save 50% on their tax bill? Well, obviously, the Federal government is not too fond of the plan, and took action to collect more in taxes from investors.
In the coming weeks, the industry will continue to consult with their legal counsel to determine the best way to move forward. In the interim, many companies are not allowing new purchases into the affected funds. Regardless of the outcome, these types of arrangements are done, meaning that investors in non registered accounts will be hit with higher taxes in the years ahead.
In our conversations with a number of industry participants, there was some concern that corporate class funds may be next on the government’s hit list. Given their desire to close as many tax loopholes as possible, that certainly makes sense. Corporate class funds can help reduce the total tax paid by non registered investors through their ability to lower the likelihood of an interest distribution and the ability to switch between funds, without incurring a taxable event.
Another change in the budget is that the Federal government will be phasing out the tax credit on Labour Sponsored Investment Funds, much like the Ontario government did in 2008. For 2013 and 2014, the Federal Tax Credit for LSIFs will remain 15%, falling by 5% in 2015 and 2016, after which the credit is eliminated. When this happened in Ontario, many LSIFs were hit with a run on redemptions and a resulting liquidity crisis. Because of that, many funds have suspended redemptions, leaving investors holding the bag.
We expect that this move will have a similar effect on LSIFs right across the country. This is likely the death knell for the program. Worse things could happen. We have never been a fan of LSIFs. They were expensive and in the end, just didn’t live up to the promise. For most investors and advisors, they were a tax solution, not an investment solution. As a result, some poor choices were made, and many have lost money even when the tax credit is considered. They will not be missed.