ETFs
More tax problems for former Emerge ETF unitholders
The CIBC letter warned that the Emerge ARK ETFs were ineligible investments and offered several options to correct the problem. The letter also informed investors that they must pay tax penalties to the Canada Revenue Agency (CRA) for holding non-qualifying investments in a registered account.
ETFs appear in investors’ accounts because “ETFs still have proceeds owed to unitholders,” a CIBC spokesperson said in an email.
These revenues are the debt of 4.7 million dollars owed by Emerge Canada Inc. to five of the six Emerge ARK ETFs. Emerging Canada announced on January 5 that former unitholders are now unsecured creditors of the company.
This situation is “like a kick in the pants after a slap,” said Dan Hallett, vice president of research and principal at HighView Asset Management Ltd. in Oakville, Ontario. “ETFs have not performed well; they were delisted while over their peaks; they [liquidated] before the recovery, it’s the perfect storm of everything that could go wrong.
Last April, the Ontario Securities Commission (OSC) placed Emerge Canada’s 11 ETFs under a an unprecedented cease-trade order, which lasted until the ETF delisting in October. Unitholders remained trapped in the ETFs until the funds ended in December.
One month after the trading ban, the OSC suspended registration of Emerge Canada for capital deficit. The OSC continues to oversee Emerge Canada and demand that its activities be monitored by a law firm, although it suspended Emerge Canada’s recordings on February 12. On Monday, the OSC confirmed that it continues to investigate Emerge.
What Investors Need to Know
Permitted investments in registered accounts, including TFSAs and Home Improvement Savings Accounts (FHSAs), include securities, such as ETFs, listed on a designated exchange. However, once a security is delisted, it becomes ineligible unless it qualifies for other reasons.
“The reasons for a delisting have no bearing on the determination of whether shares of the ETF remain a qualifying investment,” Nina Ioussoupova, a spokeswoman for the ARC, said in an emailed statement.
Holding non-qualified investments in a registered account can result in serious tax consequences: the plan pays a tax of 50% on the fair market value of the non-qualified investment at the time it was acquired or changed status, and the income of the investment is also taxable.
The taxpayer must remit the 50% tax as well as Form RC243 (for TFSAs) Or Form RC339 (for other registered plans)no later than June 30 “of the year following the year of acquisition or change to ineligible status,” the CIBC letter states.
Based strictly on the delisting criteria, Emerge ETFs would have become ineligible after the close of business on October 23, 2023. In this case, the deadline for forms would be June 30 of this year.
The penalty for late filing of the relevant form is 5% of the balance due plus 1% of the balance for each full month the declaration is late, up to a maximum of 12 months. The CRA will also charge interest on the balance, compounded daily, beginning July 1 of the year following the end of the calendar year after the tax arises.
The form requires the investor to report the fair market value of the investment as of the date it became ineligible. “The price at the close of business on the day of delisting provides the most sensible and reasonable basis for valuing the ETF,” Hallett said. (See bottom of article for Emerge ARK ETF prices on October 23.)
The 50% tax is refundable in certain circumstances. But Jason Rosen, managing partner at Rosen and Associates Tax Law in Toronto, recommends that investors be proactive and pay the tax even if they believe they are entitled to a refund. The ARC will charge 9% interest on late payments in the third quarter.
“To be eligible for the refund, the investment must be disposed of before the end of the calendar year following that in which the tax arose (or any later date authorized by the Minister of National Revenue),” said Yusoupova. “However, no reimbursement is available if it is reasonable to assume that the registered plan holder knew or should have known that the investment was or would become a non-qualified investment.
Based on the October 23, 2023 delisting date, investors would have until the last trading day of 2024 to dispose of the security and potentially receive relief, Hallett said, since the CRA considers the delisting date regulation is the date of entry into force.
December 30 is the last trading day for settlement in 2024. However, best practice is to avoid waiting until the last minute, as unexpected issues can delay the settlement process.
Another penalty for holding a non-qualified investment is that the investment income becomes taxable. These taxes would not be refundable. However, none of the Emerge ARK ETFs distributed any income after the delisting. According to 2023 Q3 filings for the six Emerge ARK ETFs (Canadian and US dollar versions), the funds allocated only one return of capital to their investors during the year.
Hallett cautioned, however, that if the debt is repaid in full with interest, the interest income could be taxable if paid into the registered plan.
To obtain a refund of the 50% tax penalty, you must complete Form RC4288, Rosen said. “Make sure you have the documentation to support your investment,” he said. He also suggested stating any extenuating circumstances, such as death or disaster, that prevented the investor from realizing their investment no longer qualified.
Rosen cautioned that relief requests can take several months to review and are not always granted.
“Get ahead of it,” he said. “That [might] include obtaining advice from an accountant, investment advisor or tax attorney – or all three. It’s never dangerous to have too much information.
How to have security
An investor could remove an ineligible investment from their account by selling or withdrawing it; they could also trade the position for cash from an unregistered account. However, these options are difficult, if not impossible, when a position has a zero balance and/or is no longer a tradable security, as in the case of Emerge ETFs.
One option CIBC offers its clients is to order the brokerage to delist the delisted security and transfer ownership to the brokerage. In doing so, the former unitholder also assigns all rights to the outstanding claim.
Hallett said former unitholders must weigh the 50% tax penalty against repayment of the debt, which varied between 0.55% and 5.6% of the net asset value of each ETF as of December 15..
“The lesser of evils is to get rid of security to avoid [50%] penalty, and the tradeoff is you give up the opportunity to receive that debt with interest,” Hallett said. “But I think the probability of receiving it is quite low.”
According to a May 14 judgment rendered by the Ontario Superior Court of Justice, which approved the abandonment of a proposed class action against Emerge Canadaa lawyer indicated in January that “Emerge is no longer a going concern and has no assets that could be used to satisfy any judgment that might be obtained against it.”
Emerge Canada said in a Jan. 5 news release that it “continues to work toward paying unitholders.”
An attorney for Emerge did not respond to a request for comment.
Hallett said it is the responsibility of investors and their financial advisors to monitor and understand their holdings.
He said any former unitholder who sees Emerge ETFs still showing up on their statement should call their broker to ask why. He also urged former unitholders to read and act on letters sent by their brokerages, such as CIBC.
Former unitholders may be affected even if they have not received a warning letter.
“Where the shares of the ETF are not disposed of by the registered plan, it is likely that the registered plan will be considered to continue to hold the shares of the ETF,” said Ioussoupova, noting that the fact that the shares are still held or possessed is “a question of fact and law.”
Lessons learned
The tax challenges faced by former Emerge unitholders are another consequence of a fund manager accumulating a large debt owed to its funds and failing to repay it before termination.
The practice is not common. In April 2023, Investment Executive reviewed the financial statements of 10 other small ETF families with similar assets under management to Emerge (less than $500 million). The analysis revealed most managers absorbed the operating expenses of their ETFs and paid the expenses directly each year. Only two of the ten ETF families had an “investment manager receivable” in FY2021, but both were canceled in FY2022.
Drawing on his nearly 30 years of industry experience, Hallett acknowledges that large claims are rare: “Every claim I’ve seen of this nature was proportionately much smaller, and in the next round of financial data, it has been reset to zero. »
Emerge’s practice was disclosed in its financial statements from 2019. “You have to look at the financial statements as part of due diligence, including the notes,” Hallett said.
“Usually it’s very simple vanilla stuff; there is nothing to see here. Until there is.
Unit prices of Emerge ETFs as of October 23, 2023
- EARK: $7.69
- EAGB: $8.80
- EAU: $13.36
- AET: $7.61
- EAAI: $9.08
Each ETF continues to have a receivable due at the time of publication.