Tax efficiency with Natixis Class Funds

Innovative class structure has patent pending

They say in life, there are two sure things: death and taxes. If there is one thing that Canadian governments are particularly astute at, it is raising taxes. This holds true whether you are talking about employment income or investment income. In recent years, the federal government has taken many steps to reduce the ability of investors to reduce their taxes by making changes to corporate class mutual funds. But some fund companies are still fighting the good tax fight, including global investment manager Natixis Investment Management which has an innovative structure to help lower taxes for Canadian investors.

Changes to the class structure of mutual funds in 2018 included eliminating the ability to use derivative or other instruments to change the tax characteristics of investment income, and the elimination of the ability to switch on a tax-deferred basis within mutual funds in the same corporate structure. The result was the same, meaning higher taxes for investors.

Natixis Investment Management, a global investment manager, with offices in more than 30 offices around the world and nearly a trillion dollars in assets under management, offers tax-weary investors some help with its unique process. The process was created by the late Jim Hunter, the highly regarded mutual fund pioneer known for many innovations in the Canadian mutual fund business, including the creation of “clone funds,” and was behind the first income-conversion fund.

In 2005, Mr. Hunter left his position as chairman of Mackenzie Investments to launch NexGen Funds, which was acquired by Natixis in 2014. At NexGen, Mr. Hunter created a structure that allowed investors to choose the type of investment income they would like to receive, with the choices being regular income, dividends, capital gain, or return of capital. Within the corporate structure at Natixis, there are four different tax classes: Registered; Return of Capital; Compound Growth; and Dividend.

All income earned by all the funds in the structure are pooled and then separated by tax treatment. The income that is taxed at the highest level is directed towards the Registered class. Examples include interest income and foreign income. Because the Registered class is designed to be held in a tax-deferred plan, the type of income and its tax rate is irrelevant, as investors do not pay any tax on income earned until it is removed from the plan upon withdrawal.

Dividend income is funneled to the Dividend class of units, and investors receive a fixed monthly distribution that is designed to be treated as eligible Canadian dividends.

The Compound Growth class is not expected to receive any distributions, and all gains will be treated as capital gains when sold.

The Return of Capital class will pay out a regular monthly distribution that will be treated as return of capital. A return of capital distribution is not taxed in the year it is received. Instead, it reduces the adjusted cost base of the investment, and any difference between the sale price and adjusted cost base will be treated as a capital gain when the investment is sold.

The difference in tax rates is not unimportant. For example, in 2018 the highest marginal tax rate for investment income in Ontario was 53.53% compared with 26.77% for capital gains. Clearly, for an investor, it is more beneficial to have more income in the form of capital gains than from regular income. The table below highlights the combined tax rates for various types of income from a few provinces in Canada.

It really is an innovative approach, and so far, it has not been copied by any of its competitors. The main reason is that the firm has applied for a patent, which has not yet been approved. However, while the patent is pending, no one can copy the process. Whether or not the patent will be approved is still up for debate, and it is expected that if it is not awarded, competitors will step in to copy the structure. Until then, Natixis can try to benefit from its first-mover advantage

Before Natixis took over NexGen, I really wasn’t really a fan of the funds, to be honest. The main reason was that in my opinion, the relatively poor investment quality of most of the NexGen funds did not make up for the better tax treatment. However, since the takeover, many new managers have been brought into the program, and the investment quality has improved substantially.

Under Natixis, high-quality managers like J. Zechner Associates, Ziegler Capital, Loomis Sayles, and JP Morgan Asset Management are now available in this more favourable tax structure. This means that you don’t necessarily have to sacrifice investment quality for a more favourable tax treatment.

For investors looking to reduce their tax burden, it may be worth taking a look at the Natixis Class Funds.

Dave Paterson, CFA, is the Director of Research, Investment Funds for D.A. Paterson & Associates Inc., a consulting firm specializing in providing research and due diligence on a variety of investment products.

Notes and Disclaimer

Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. This article is for information purposes only and is not intended as personalized investment advice.