Box 42 -- what are you? ROC explained

National Post

2007-05-12



During the tax season just passed, one of the most popular questions posed by
investors was what to do with amounts reported in Box 42 of the T3 slip. A T3
slip is used to report trust income such as distributions paid out by mutual
fund trusts. I like to call Box 42 the "mystery box."

If you've attempted to complete your tax return on your own this year, no
doubt Box 42 gave you some pause for concern.

Why? Because there was no place to enter the amount in Box 42 anywhere on the
tax form nor in the tax software.

The cryptic description on the back of the slip is of little help, describing
Box 42 as "Amount resulting in cost base adjustment." Further explanation
states: "this amount represents a distribution or return of capital from the
trust? Adjust the cost base of the property at the end of the tax year."

Return of capital? Adjust the cost base? What's going on here?

This new box was added in 2004 by the federal government because of concern
that investors were receiving large amounts of "non-taxable distributions" which
constituted a return of capital (ROC).

Indeed, under tax law, these amounts are not currently taxable and they do
reduce the investor's adjusted cost base (ACB) of the units held, generally
resulting in a deferred capital gain when the units are sold.

The Canada Revenue Agency was justifiably worried that investors would simply
"forget" to include this downward cost base adjustment when computing their
ultimate gains or losses when they sold their units, thus under-reporting their
capital gain and losses.

So, what is ROC and where does it come from? Think of good ROC as a return on
your own capital, and bad ROC as a return of your own capital.

There are two possible sources of good ROC. The first one is the distribution
of non-taxable amounts, such as depreciation, which are claimed by the income
trust and flow through to the investor. The second type is when a fund
distributes unrealized gains to investors at the end of the year.

Imagine a mutual fund that nets, after fees and expenses, $10 in dividends,
$20 in realized capital gains and pays out a $70 distribution-- the excess $40
being classified in Box 42 as ROC. If the fund's net asset value is at least $40
higher than it was at the beginning of the year, you've received good ROC.

On the other hand, if the fund's net asset value at the end of the year was
less than $40 higher, then a portion of the ROC you received was bad ROC,
consisting of nothing more than a return of your own money.

With tax season behind us, you may wish to dig a bit deeper to unveil the
true source of that number in the mystery box. -

Jamie Golombek, CA, CPA, CFP,
CLU, TEP is vice-president, taxation and estate planning, at AIM Trimark
Investments in Toronto.

jamie.golombek@aimtrimark.com.