Mutual Fund & ETF Tax Guide

Types of Fund Distributions

Canadian Dividends

• Eligible and non-eligible dividends
• Dividend tax credit applies
• Reported on T3 slip
• Gross-up and credit treatment

Capital Gains

• Fund sells securities at a profit
• Passed through to unitholders
• 50% inclusion rate
• Taxable even if reinvested

Interest and Foreign Income

• 100% taxable
• From bonds, foreign dividends
• No special credits

Return of Capital (ROC)

• Not immediately taxable
• Reduces your ACB
• Results in larger capital gain when sold
• Common with certain funds

Understanding Your T3 Slip

Key boxes on the T3:

Adjusted Cost Base (ACB) Tracking

Why ACB Matters

• Determines your capital gain/loss when selling
• Changes with each purchase, sale, and ROC
• Must track yourself for non-registered accounts

ACB Calculation

• Purchases: Add cost to ACB
• Reinvested distributions: Add to ACB
• Return of capital: Subtract from ACB
• Sales: Reduce ACB proportionally

Example

• Buy 100 units at $10 = $1,000 ACB
• Reinvest $50 distribution (5 units at $10)
• New ACB: $1,050 for 105 units
• ACB per unit: $10
• Receive $30 ROC
• New ACB: $1,020
• ACB per unit: $9.71

ETFs vs Mutual Funds

Tax Efficiency

• ETFs generally more tax-efficient
• In-kind creation/redemption reduces gains
• Less portfolio turnover
• Fewer surprise capital gains distributions

Mutual Fund Issues

• Can distribute large capital gains
• Especially if other investors redeem
• You pay tax on gains you didn't benefit from
• More common at year-end

Selling Fund Units

Capital Gain/Loss Calculation

• Proceeds minus ACB = capital gain/loss
• 50% inclusion rate
• Report on Schedule 3

Selling Part of Your Holdings

• Use average cost method
• Total ACB ÷ Total units = ACB per unit
• Reduce ACB by cost of units sold

Reinvested Distributions

How They Work

• Distribution used to buy more units
• Still taxable in year received
• New units have ACB = distribution amount

Record Keeping

• Track each reinvestment
• Keep all T3/T5 slips
• Use spreadsheet or software
• Broker statements help but aren't complete

Phantom Distributions

You may owe tax without receiving cash:

• Capital gains distributed but reinvested
• Must have cash to pay tax
• Common surprise for new investors
• Check fund's distribution history

Year-End Planning

Before Buying

• Check fund's distribution schedule
• Avoid buying just before large distribution
• December distributions common for mutual funds
• You'd pay tax on gains you didn't participate in

Tax-Loss Harvesting

• Sell losing positions to offset gains
• Wait 30 days to repurchase (superficial loss rule)
• Can buy similar but not identical fund

Funds in Different Accounts

Non-Registered

• All distributions taxable
• Must track ACB
• Prefer tax-efficient funds (ETFs, low turnover)

TFSA

• No tax on distributions or gains
• No need to track ACB for tax
• US dividend withholding still applies

RRSP

• No current tax on distributions
• All withdrawals taxed as income
• Good for interest-generating funds
• US dividends exempt from withholding

Asset Location Strategy

Optimize fund placement across accounts:

• TFSA: High-growth potential
• RRSP: Bonds, US dividends
• Non-registered: Canadian dividends, tax-efficient ETFs

Foreign Content in Funds

US-Listed ETFs

• 15% withholding on distributions
• May not be recovered in TFSA
• Exempt in RRSP
• Claim foreign tax credit in non-registered

Canadian-Listed Funds Holding Foreign Securities

• Foreign withholding may be embedded
• Some funds claim treaty benefits
• Check fund documentation

Common Mistakes

• Not tracking reinvested distributions: Overpay tax
• Ignoring return of capital: Wrong ACB
• Buying before distribution: Unnecessary tax
• Using broker's cost basis: May be wrong
• Not reporting T3 slips: CRA has copies