Ideal units for self-directed plans

For several years starting in the 1980s, Mutual Fund Limited Partnerships (MFLPs) were a popular and effective tax-shelter investment in Canada. These special investment vehicles were pioneered by the Mackenzie Group of Funds in 1987 to finance sales commissions on their regular mutual funds. Investors were invited to subscribe for units in a special limited partnership organized by a related mutual fund management company. The partnership used the money received to pay sales commissions to brokers and agents on regular mutual fund products. In return, the partnership was entitled to receive two kinds of revenues: (a) a share of the management fees charged by the mutual fund company on the regular mutual fund units for which the partnership had financed the sales commissions and, (b) cancellation fees charged to the regular mutual fund investors if they redeemed their units within a few years of ownership.

Initially, tax laws allowed these partnerships to deduct their commission outlays as a current expense when they were paid, and allocate the resulting loss to the investors for tax purposes. Investors could usually deduct their full investment in the year they made it. The taauthorities subsequently decided this was too beneficial and changed the law to require such limited partnerships to capitalize the cost of their sales commissions and amortize them over three years. Now, the tax laws have been toughened — the cost of mutual fund sales commissions now must be deferred and matched with the related revenues. The result? New investment in financing mutual fund sales commissions is no longer an effective tax-shelter investment, and there are no longer any new issues.

Before the changes in the tax rules put these special partnerships out of business, several other mutual fund companies — including Fidelity, Templeton, AGF and Global Strategy — picked up the idea and organized a number of partnerships. So now there are quite a number of MFLPs on the market that have long since used up their tax deductions but will continue to make fairly good cash distributions. And, because their investment in commissions has already been fully deducted for tax purposes, future income allocations to investors for tax purposes will be much higher than cash distributions.

This tax situation makes MFLP’s unattractive to taxable investors but ideal for self-directed RRSPs and RRIFs which are not taxable on current income and therefore immune from the excessive tax on future income allocations. Often the original tax-shelter investors have taken all the tax deductions and resold their units to others uninterested in tax savings.

The units of several of these MFLPs have now been listed on the T.S.E. and their current unit prices and income yields appear in the “Partnership” section near the end of the daily stock quotations in newspapers. Look for them there and observe the stated annual yields of many of these partnerships are in the 30 per cent to 40 per cent range. With some MFLPs these stated yields are payouts that include both true income and a return of capital because the partnerships have a fixed life over which the initial investment must be recovered. Some other partnerships are structured to renew or replace their contractual income and carry on indefinitely.

The assets and income underlying these partnerships are based on related mutual funds and their assets. If the mutual funds grow in value and the original purchases continue to hold them after early termination penalty provisions expire, usually six or seven years after their original purchase, they will be good investments. MFLPs are usually entitled to share a management fee calculated as a percentage of the mutual fund values from time to time, so if the fund values increase, the income from MFLPs will rise accordingly. But because of tax treatment and heavy future tax liability for regular investors, unit prices have declined and current yields have risen to quite high levels.

For more information about investment in MFLPs for your RRSP or RRIF, consult a broker or investment advisor familiar with them. Tim Morton of Midland Walwyn is a specialist. For more printed information and copies of financial statements and other financial analysis of some MFLPs on an obligation-free and no follow-up basis, please send $5 to cover copying, handling and mailing costs to: Donald I. Beach & Associates Inc., 2555 Highway 7, Greenwood, Ont. L0H 1H0.