Investment Commentary – December 2012

A Distribution is Not the Same Thing as a Dividend

It’s that time of year again.  And, the month of December is rife with dates of significance, including multiple holidays, the first day of winter and for anyone who owns a commingled investment vehicle, in other words a pooled or mutual fund, year-end distributions.  But, what exactly is a distribution and why are they necessary?
 
Many investors erroneously believe that a distribution is made to share investment profits; however, this is simply not true. Somehow, investors have gotten distributions confused with dividends, but they are two very different things.  There is absolutely no connection between the amount of a distribution and the performance of the fund paying that distribution.  In other words, a fund that generated strong returns might not pay any distribution while another that has languished might actually pay out a distribution. The ability to carry forward losses would be a factor in the former situation while investments that generate income would be of importance in the latter scenario.
 
The key point is that commingled vehicles or funds are taxable entities that are subject to the highest marginal tax rate.  The rationale behind paying a distribution is to shift the tax liability from the highest-taxed entity to a potentially lesser-taxed entity, in the form of individual investors.  If the income isn’t distributed then it will be subject to taxation at the rate that prevails for the fund, which would leave less for unitholders.  All interest and dividend income that is received from the underlying investments of a fund is taxable, as are any capital gains realized by the fund (i.e. when shares that were in a gain position have been sold).  The end result is to ensure that the fund does not have to pay any tax.
 
Distributions can be automatically reinvested, which is the most common practice; however, they can also be paid out in cash.  In either case, investors are required to report any distributions received from holdings outside of tax-sheltered accounts (e.g. RRSPs, RRIFs and TFSAs).  The fund companies will send investors a tax slip that shows the distribution amount that must be reported to the Canada Revenue Agency, and, for Quebec residents, to Revenu Quebec.
 
It’s important to note that distributions are not pro-rated, but rather are all or nothing.  Therefore, investors need to be careful about investing close to year end outside of tax-sheltered accounts, if you don’t want to bear the brunt of a tax liability mere days or weeks after investing.  If you own the fund on what is referred to as the record date then you will receive the same distribution as everyone else, regardless of the date of purchase.  Check with the fund provider to find out the key distribution dates and try to avoid making your investment until afterwards.  That being said, if the planned distribution is relatively small then you may not need to wait, but this is a discussion you should have with your financial advisor.  T.E. clients are invited to contact their consultant or investment counsellor should they have any additional questions or require further clarification regarding fund distributions.
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These articles are for general informational purposes only. Please obtain professional advice before taking any action based on this information. No endorsement or approval of any third parties or their advice, information, products or services should be implied by any references to third parties contained in any article. Trademarks cited in these articles are the respective properties of their owners.

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