New mutual fund performance reports and tax reporting cautions
Early in 2017, a new report will be mailed to mutual fund investors (likely for the period ending December 31, 2016). It will tell investors how well their investments have performed in dollar and percentage terms over different time periods. In addition to this new report, investment gain/losses may be detailed on investor statements as well.
I asked Dan Hallett, Principal of Oakville-based HighView Financial Group and frequent contributor to the Globe and Mail and many other business publications, what investors could expect to see in the new reporting. In this discussion, we will concentrate on two of the calculations that Dan mentioned specifically:
- Cumulative Total ($) Gain/Loss: Market Value – Book Cost = Gain/Loss
- Percentage return calculation will be IRR (dollar-weighted internal rate of return) using beginning market value, ending market value, and interim cash in/out flows. The result is an annualized percentage return averaged over the entire measurement period.
According to Morningstar Canada, book values and gain/loss calculations will show on investors’ statements.
As mentioned, the brand new Investor Performance Report will be mailed to investors starting in 2017. The report will include percentage return calculations, changes in market values and other performance numbers specific to each investor. Here is a sample Investment Performance Report.
Rudy Luukko, award-winning editor of Morningstar Canada, wrote an article titled, “CRM2 won't solve tax-reporting headaches”. He cautions investors to be careful about using the new gain/loss information for income tax reporting purposes.
He says, “Under new disclosure rules for client statements -- as part of the second phase of the client-relationship model (CRM2) -- it will be mandatory for brokers and dealers to show whether a holding is making or losing money for you”.
However, Mr. Luukko appears to raise a red flag about some of these numbers:
“If you rely on the CRM2-mandated disclosure, you may be overstating or understating your capital gain from the sale of a holding in a non-registered account. You could end up either paying too much tax or you could risk getting in trouble with the Canada Revenue Agency for not paying all the tax you owe.”
Although Mr. Luukko gives a couple of specific examples as to why the numbers should not be used for tax purposes, both he and Dan Hallett point out that the book values listed on your dealer statement may not be the same as the ACB (adjusted cost base) that accountants rely on to calculate the actual gain or loss that must be reported to the Canada Revenue Agency for income tax purposes.
I also asked Dan Hallett about the new Investor Performance Report which will show total percentage rates of return over various time periods including the performance since the account was opened (at the current Dealer) or performance reports starting from a specific date (e.g. January 1, 2016). He emphasized that book values (incorporating original costs) will not be used in any of these calculations. Only market values will be used in the new Investment Performance Report.
Dan and I discussed whether the industry would be better off by using a universal inception date that all dealers would be subjected to. He noted that using a universal inception date starting say, in July 2015 (the CRM2 implementation date), is too short and would not generate any meaningful data for several years. The second best thing he said was to use the dealer account opening date. However, in our discussion, we debated that if the dealer account opening date is used instead of a universal start date for rate of return calculations, it could create unfair rate of return comparisons between advisers. Equally, the regulators have similar concerns about choosing an inappropriate start date like January 1, 20101 that would make rate of returns look unfairly (too good).
What is the big deal about start dates? In case I’ve managed to thoroughly confuse you about how important start dates are, how about a picture instead? Here is a chart of the widely followed S&P 500 Index2, the leading benchmark index of the U.S. stock market. Make sure you click on the link below.
Question: What is the rate of return of this S&P 500 chart?
Chart courtesy of dshort.com and Advisor Perspectives
Answer: There are tons of different returns! It depends on what start and end point you use. Note the -56.78% return from October 9, 2007 to March 9, 2009 (peak to trough) and the +215% return from March 9, 2009 to May 21, 2015 (trough to peak). Also note how dramatically different the returns can be especially if you start measuring from a high point versus starting from a low point.
If you have made mutual fund purchases prior to the Dealer account opening date, the new Investment Performance Report only measures how your investments performed since the Dealer account opening date, not what your rate of return was since inception3 – a very important and key difference.
[Editor’s note: Dealers can choose either a calendar start date or the client’s account opening date.]
Investors should also be aware that the Canadian Securities Administration is mandating a different way of calculating rates of return – it’s called the money-weighted rate of return. This is different from the time-weighted rate of return calculation that a mutual fund’s portfolio manager would use. There are important differences between the two and you should check out our info graphic for a more in-depth explanation.
To sum up, unless you know for sure that your particular Book Value is equal to the ACB (Adjusted Cost Base), book values should not be used for tax calculation purposes. If you have moved between investment firms, changed advisers, or made mutual fund purchases before the inception date listed on the new Investor Performance Report, some rates of return on the new report could be very different from your own records or the mutual fund companies' statements. The new reports though, have the ability to neatly consolidate the returns of several mutual funds and boil it down to one rate of return.
Although I believe that better reporting standards will allow investors to make better-informed decisions about their investments, it is always best to contact and consult with your financial adviser, especially if any of the above situations apply to you. Don’t forget to bring your new Investment Performance Report with you!
Need help in interpreting the new reports? Have a question about ACBs, book values, capital gain/loss calculations or rates of return? Contact me at firstname.lastname@example.org.
1 Stock market indices (post U.S. Financial Crisis) were at a very low level on January 1, 2010 and some indices have more than doubled in value since then. The regulator mentioned the use of this date specifically, as highly inappropriate. Since you are measuring from a low point, the returns (at current record high levels) would measure out to be very good indeed.
2 S&P 500 Index – used for illustrative purposes only.
3 Since inception: For mutual fund companies; refers to the date the investment was first made.
Book value: Original cost + reinvested distributions – return of capital
ACB (Adjusted Cost Base) = The cost of your units or shares, plus any expenses you incurred to acquire them, such as commissions.
CRM2: Client Relationship Model – Stage 2
Dealer: The adviser’s head office
IRR: Internal Rate of Return expressed in percent (dollar/money weighted)
Morningstar Canada, Rudy Luukko – “CRM2 won't solve tax-reporting headaches”