On December 11, Ontario’s Ministry of Finance issued a comfort letter to address the unintended effects of the new provincial surtax which have caused a mismatch of a mutual fund trust’s capital gains refund and the Ontario surtax payable on capital gains retained in the trust.

Mutual fund trusts retaining dividends have historically taken advantage of a dividend tax credit and capital gains tax refund to reduce both the basic personal tax payable by individual investors as well as the surtax for a trust on retained taxable dividends and realized capital gains. Under the relevant changes to Ontario’s Taxation Act, 2007 (the “Ontario Act”), however, the dividend tax credit would not have applied to the new surtax, resulting in mutual fund trusts having to pay the surtax on retained dividends.

In order to avoid the surtax, trusts would have been forced to distribute the income to unitholders. While such income would have been taxed at a lower rate than if retained by the trust, overall, the income would have imposed a higher tax burden on investors.

Fortunately, and prior to year-end deadlines, the Ministry of Finance has issued the comfort letter to allow mutual fund trusts to be entitled to an Ontario capital gains refund of surtax for a taxation year ending in 2014, equal to the amount of the trust’s surtax for the year under the following circumstances:

  1. The tax payable by the trust for the year is equal to, or less than, the product of the trust’s taxed capital gains for the year multiplied by the highest tax rate for the year; and
  2. The trust’s Ontario capital gains refund of basic tax for the year under subsection 105(1) of the Ontario Act is equal to the lesser of the amounts in respect of the year calculated under paragraphs (a) and (b) in formula item F in subsection (4) (that is, the amount from line 7 of the trust’s form T184 for the year is equal to the amount from line 1).

The Ministry of Finance is also recommending amendments to the Ontario Act to permanently address the issue and provide greater certainty going forward.