• MIC Questions & Answers
• What to Look For in a MIC
• MIC History and Purpose
• Section 130.1 of Income Tax Act
• National Housing Act

MIC History and Purpose

Section 130.1 was enacted by Section 18 of the Residential Mortgage Financing Act (chapter 49 of the Statutes of 1973-74), the purpose of which is to stimulate the flow of private mortgage money for housing in Canada. That Act provides three steps for achieving the stated purpose:

1)		the creation of a Crown corporation (the “Federal Mortgage Exchange Corporation”) to buy and sell mortgages,
2)		the recognition of specialized Mortgage Investment Corporations (MICs) under the Loan Companies Act and the Income Tax Act, and
3)		the adoption of a “conduit” or “flow-through” tax treatment as to the income of the mortgage investment corporations.  It is with this last step that section 103.1 of the Income Tax Act is concerned. The income of a mortgage investment corporation is allowed to flow through to and be taxed in the hands of the shareholders as interest income.

The purpose of the Residential Mortgage Financing Act is further explained in the following excerpts from Hansard for June 12, 1973, at page 4686:

To help resolve these problems and to make residential mortgages competitive with other forms of investment and thereby attract private savings, the bill provides for a new form of Canadian financial institution, the Mortgage Investment Corporation (MIC), which is intended to make investment in residential mortgages and real estate more accessible to the small investor. It is extremely difficult at the present time for smaller investors to make this kind of investment. Unlike investment in securities, mortgage and real estate investments are legally and administratively cumbersome to split in such a way that investors can become owners of separate, divided interests.

Backed by expert management service and the security of a diversified portfolio, mortgage investment companies will provide opportunities for the smaller investor to participate in mortgage and real estate investments, and in this way attract new savings into residential mortgages and real estate investments.

The stated purpose of the Residential Mortgage Financing Act was “to enhance the marketability of mortgages issued on residential properties in Canada and improve the effectiveness of the contribution of the private sector to the financing of housing in Canada.” For this purpose special tax treatment was introduced that in effect treated the MIC as a conduit, flowing income earned on its investments through to its shareholders without the imposition of corporate tax.

Investment in a MIC becomes particularly attractive for the various deferred income vehicles provided for in the Income Tax Act. These include Registered Retirement Savings Plans (RRSPs), Deferred Profit Sharing Plans (DPSPs) and Registered Pension Plans (RPPs). Such plans are prohibited from borrowing funds and are thus restricted to earning income on funds contributed to the plans or upon reinvestment of earnings. Thanks to the MIC these plans can indirectly enhance their earning capabilities by leveraging their investment in residential mortgages and enjoying a spread between the rate of interest paid on borrowed funds and the rate charged on the MIC's residential mortgages. Since the income of the MIC can flow through to registered plans without intermediary tax and be reinvested by them, the MIC can retain the entire amount on a tax-free basis until distribution of funds from the plans to their beneficiaries.

NATURE OF THE CORPORATION

The corporation must be a Canadian corporation and must not do anything other than invest its funds. Specifically, it must not manage or develop any real property even though it may own the property as an investment.

INVESTMENT RESTRICTIONS AND LIMITATIONS

There are certain minimum and maximum investment criteria that a MIC must meet, and all are based on the cost of property acquired. At least 50% of the MIC’s property must be represented by mortgages on residential properties, as defined in the National Housing Act, together with cash on hand or deposits with a bank or other corporation whose deposits are insured by the Canada Deposit Insurance Corporation or the Quebec Deposit Insurance Board, or with a credit union. The cost of real property owned by the corporation must not exceed 25% of the cost of all of the MIC's property. An exception is provided for real property that may have been acquired by foreclosure on a mortgage.

1)		It is permitted to loan funds only on property located in Canada.
2)		It is not permitted to make loans to nonresidents of Canada unless such loans are made on the security of real property located in Canada.
3)		It is not permitted to acquire and hold shares of nonresident corporations.
4)		It is not permitted to own real property that is located outside Canada.

 

SHAREHOLDINGS

A MIC must have at least 20 shareholders, and no shareholder may own more than 25% of the issued shares of the company.

BORROWING

Although a MIC is permitted to borrow for purposes of investment, there are restrictions on the amount it can borrow. Provided at least 2/3rds of the cost of its property is represented by residential mortgages or cash on deposit, it is permitted to borrow up to 5/6ths of the cost of its assets. If less than 2/3rds of the cost is represented by residential mortgages and cash on deposit, its borrowings cannot exceed 3/4ths of the cost of its property.

In short, the MIC can borrow (leverage) up to 5 times the cost of its assets if 2/3rds of its assets are in residential mortgages and/or insured bank deposits.

DISTRIBUTION OF DIVIDENDS

Where a MIC has paid taxable dividends to its shareholders during its taxation year, it is permitted to deduct the total amount of the taxable dividends in computing its income for the year. Similarly, where a MIC has realized a capital gain, it may elect to distribute the gain as a capital gains dividend to its shareholders.

In short, dividends paid to MIC shareholders are treated as company expenses for tax purposes. Hence, a MIC is not taxed.

SHAREHOLDER TREATMENT

Dividends received by shareholders are deemed to have been received as interest for tax purposes.

LEVERAGE

A particular strength of the MIC arises through effective use of the leveraging that is permitted to a MIC and the spread that can be achieved between the cost of borrowing and the return that can be obtained on the MIC's mortgages. As a simple example, if we assume that the initial contributions to the MIC total $100,000, the corporation could borrow up to 5 times this amount provided more than 2/3rds of its investments are represented by residential mortgages or cash on deposit.

If it is assumed in this situation, for example, that the rate of return that can be obtained on the MIC's mortgages is 7% and the total amount invested is $600,000 (the maximum funding that could be obtained utilizing the 5 times cost leverage allowance), the interest earned would be $42,000. The cost of borrowing the permitted maximum of 5 times equity is assumed to be 5% for a cost of $25,000, leaving a net income of $17,000. It can be seen that the return on invested capital of $100,000 is 17%. These funds would then be paid as dividends to the Registered Plan and may in turn be reinvested in the MIC at no tax cost. It is apparent that if the net income of $17,000 is reinvested the MIC can borrow a further 5 times equity and in the second year the potential income could be $19,890 for a net return of 17%.

 

YEAR 1
Initial contribution		$100,000
Borrowings, maximum 5 x $100,000		$500,000
Available investment funds		$600,000
Interest income (assume 7% achieved on mortgages of $600,000)		$42,000
Leverage cost (assume 5% cost of borrowed funds)		$25,000
Net income distributed to shareholders		$17,000
Return to the MIC		17%
YEAR 2
Accumulated equity		$117,000
Borrowings, maximum 5 X $117,000		$585,000
Available investment funds		$702,000
Interest income		$49,140
Leverage cost		$29,250
Net income distributed to shareholders		$19,890
Return to the MIC		17%

Note that the figure of 17% is before MIC operating costs and expenses.

It can be seen that the potential accumulation of funds to Registered Plans using a compound rate of 17% is dramatic. There are MICs that have achieved this kind of return and greater depending on the mix of investments in the portfolio.

When the potential yield available to the Registered Pension or Registered Savings Plan through use of a MIC is compared with the normal compound return that has been traditionally experienced in Registered Plans it is apparent that the performance of MICs has proved to be significantly better than guaranteed income or equity funds.