Box 42 on T3 slips is “Return of Capital”. From my understanding this only really comes into play when determining the ACB when the fund is sold so there is no tax impact on a T2 (or, I suppose, any other return).
Are there any accounting entries for the return of capital though? I wondered if I should be adding something to the book cost of the investment but then I have no idea what the offset credit would be.
Remember that T slips are prepared on a calendar year basis, and most T2 clients do not have a Dec 31 year-end. So, the T-slips are not the best thing to go by.
Best to examine all the investment documentation. If the T2 client has an investment manager (i.e. RBC Dominion, Scotia McLeod, etc) they should provide a “tax package” as of the fiscal year-end date, with appropriate details re: dividends, interest, capital gains/losses, return of capital etc. The portfolio managers and mutual fund managers may be buying/selling securities which need to be recognized as “replacement property” or tracked due to the stop-loss rules, etc. As the “year-end accountant”, you could spend days or weeks sifting through all the required transactions to ensure you capture the tax effects correctly.
I take the approach (as I was taught at MNP when I started) that it is the investment manager’s job to track those details and provide his/her clients with appropriate information - both for accounting as well as tax reporting. I tell my clients they should demand such info and summaries from their investment manager. If they don’t want to do that, and they want to pay me an extra $10,000 per year to analyze their investment portfolio…ok, I’ll do it. Otherwise, I tell them, “I’ll use whatever summary info you give me, but I won’t verify it is correct.” They sign the representation letter attesting to that.
Yep - good summary.
Clients can also request that materials, in addition to being provided on a calendar year basis be provided on a fiscal year basis. If the account is big enough (or is related to one that is!), the investment advisor will generally arrange that. Makes life a lot simpler.
Thanks for the reply. The client I’m working on does have a Dec 31 year end so that’s not my issue. I have plenty of other issues with their ETFs and trying to sort out their income - like fund managers don’t even have the information available half the time until April and their taxes are due March 31, so I typically estimate their income and post a reversing entry on Dec 31 based on the investment activity and then true it up when I get the actual from the funds.
However, I still don’t know what to do with the box 42 info “return of capital”. I’ve never gotten any accounting information from the investment manager, I’m not even sure the client uses one. I think they just manage their investment portfolio themselves in about 5 ETFs.
Is the amount material?
It’s quite common. The fund manager decides to call the distribution a return of capital (rather than dividends or interest or capital gains) so that the tax effect is deferred. You have to reduce the ACB of the investment. In future, when that investment is sold, or position is closed, there will be a larger capital gain.
Yes, there amount is material.
I’ve scoured the planet and it looks like there is no need to do any accounting entries for the return of capital.
Thanks all!
Yes there is. That will take place when your record the cash distributions from the fund, which will include the ROC.
OK…so back to my first question then, if I’m debiting the investment GL account for the ROC, what am I crediting? Not cash, no cash is received. Not revenue, there is no revenue. So, what GL account is the credit?
Accounting 101
ROC would have been part of an income distribution received. We normally do an adjustment once a year for ROC to reduce income & adjust the investment ACB (Dr. Investment Income / Cr. Investment).
When the distribution is made I normally record it as
DR Bank
CR Investment income
Then when the T3 shows up
DR Investment Income
CR Investments - At Cost.
@Laura
ROC = Return of capital:
CAVEAT
I track ROC for individuals for ACB continuity in Excel.
I do not have any bookkeeping clients who hold investments with ROC so I have never had to deal with situation.
Bottom line, this in an education guess. However I do have a trick that I use for fixed asset tracking by class. I run a top line called the asset class. I run to sub lines called cost and proceeds. The balance is the net of the two. When a class is empty there is either a terminal loss of a gain which I enter as an adjusting journal entry (AJE). This helps me hugely in reconciling the bookkeeping entries and balances to the tax return forms and passing personal tax and GST reviews and desk audits.
Something similar may work in the case of Return of Capital. Run a top line of each investment by units. Run sub lines with costs and proceeds. Use an AJE to enter the ROC. Not sure if this valuable or necessary. It is just a suggestion.
Also, not sure if I am missing something or over complicating things. This situation using bookkeeping is new to me. I rarely find new bookkeeping problems so I am interested to learn common and best practices.
REFERENCES
AdjustedCostBase.ca
TD Bank
" ROC is a portion of an investor’s original investment amount, or capital, being returned to them by a mutual fund. It typically occurs when the amount distributed by a fund exceeds the total net income and net capital gains earned by the fund."
“Unlike other types of distributions such as interest income or dividends and because it’s your own money coming back to you, ROC is not taxable when received.”
Royal Bank of Canada
https://ca.rbcwealthmanagement.com/delegate/services/file/456782/content
The Balance Money
How does return of capital work.
Refer to ACB calcs.
CPI Capital
Return on Capital vs Return of Capital
Wikipedia
Seeking Alpha
https://seekingalpha.com/article/4493480-return-of-capital-for-dummies?
Return of capital - Wikipedia
OK thanks for the info.
I think my confusion is that the client does not actually receive cash for his distributions, they stay in the fund and are reinvested. So the monthly distributions are actually nothing, and the only change to the investment’s balance is by the actual income at year end.
Right… the Return of Capital is distributed by the fund along with other income which never actually hit’s the investor’s pocket. Instead it is all plowed back into the fund to purchase more units.
The Return of Capital reduces the ACB of the mutual fund but when that money is used to purchase more shares of the same fund it increases the ACB of the fund by that same amount because nothing was actually returned to the unit holder.
If there is no cash distribution, but distribution is reinvested, I normally record it as:
DR Investments - At Cost.
CR Investment income
Then when the T3 shows up I record it as show on the T3. - for example Canadian Dividends, Capital Gain, Regular Interest etc.
If all of the distributions are ROC, the ROC is recorded as:
DR Investment Income
CR Investments - At Cost.
So you end up with no increase in income and no increase in the cost of the investment [even though there are more shares because of the invested distribution]. When the shares are sold the capital gain is larger, or capital loss is less because there are more shares.
Or to put it in other words: The increase of the reinvested distribution is offset by the Return of Capital.