Canadian investors in mutual funds that allowed them to pay taxes at lower rates may lose the benefit, based on a recent announcement by the Canadian government. As a result, Toronto Dominion Asset Management has stopped taking investments in three Canadian mutual funds until the matter is clarified.

The Canadian Finance Ministry is eliminating “certain tax benefits derived by using forward contracts to convert ordinary income to capital gains,” according to a statement released by Toronto Dominion Asset Management CA, on April 3. Funds affected by the change include TDAM's Corporate Bond Capital Yield, Fixed Income Capital Yield Pool Class and Global Yield Capital Class funds.

Canada's Economic Action Plan 2013: Improving the Integrity of the Tax System contains nine points. The fifth one ensures that “derivative transactions cannot be used to convert fully taxable ordinary income into capital gains taxes at a lower rate.” In the U.S., the practice is already illegal.
Paul Nikolai, a director and principal with wealth manager Aspiriant, said he doesn't have any clients in the TD funds and doubted they are available to American investors. Nikolai manages the Cincinnati, Ohio office of the firm, which has more than $7 billion under management.
TDAM Canada declined to confirm whether any American-based investors were holding shares in the fund. TDAM USA did not return requests for comment.

On the whole, the prohibition against forward contracts for the express purpose of reducing investor tax obligations “is a very, very good move for a government,” says Michael Greenberger, a professor at the University of Maryland School of Law and former top aide to Brooksley Born (one of the first government officials to sound the alarm on derivatives). He describes the strategy as bearing no economic benefit to anyone and a detriment to tax revenues.