Today we have another guest post from Ed Rempel.  He has graciously taken his time to write an article explaining and giving examples of tax-efficient mutual funds.  Could this be a better way of investing with the Smith Manoeuvre?

One of the 3 D’s of tax savings is Defer. Paying tax some time far in the future is much better than paying tax now. 

One of the most effective ways of getting huge, compound growth in your portfolio is to pay as little tax as possible along the way. This is why RRSP investments usually grow far faster than non-RRSP investments. 

For example, if you invest $100,000 for 30 years at 10% and then pay capital gains tax in 30 years, you will have $1,367,000. If you invest the same but pay tax each year, you will have only $926,000. This is a 48% larger nest egg just for paying the tax at the end instead of some tax each year! 

This is why tax efficiency is very important for any investments outside your RRSP, such as the Smith Manoeuvre. Tax efficiency is the percent of your profit you still have after tax. For example, if your fund makes 10% and is 90% tax efficient, then you get a T3 or T5 slip that costs you 1% for the year, leaving you with a net 9% gain for the year. 

A bond or GIC will be 50% tax-efficient. The average mutual fund is about 75% tax-efficient, but there are 585 funds that have been 100% tax-efficient for the last 5 years and 72 funds that have been 100% tax-efficient for the last 10 years

100% tax-efficient mutual funds usually come in 2 flavours – buy-and-hold funds and corporate class funds. In both cases, it is common to NOT pay distributions. 

How do they stay tax efficient? 

There are 4 main ways they manage to avoid paying any distributions: 

1. Buy and hold – Mutual funds pass on taxable income to their investors in the form of a T3 or T5 if they have taxable income within the fund. However, if a fund has a buy-and-hold philosophy and never sells any of its holdings, then there is no taxable income to pass on to the investors. 

Most mutual funds have a relatively high turnover rate. They sell 1/3 to ½ of their holdings each year. Therefore, much of their profit must be passed on to their investors each year. However, some funds keep their holdings for many years, so very little tax is ever passed on to the investors. 

Warren Buffett is known for buying great companies and holding them forever. Some fund managers follow this philosophy. Since trading more often almost always leads to lower returns, this philosophy usually creates higher returns – plus defers most or all tax. 

2. Turnover credit – Mutual funds get a credit for the capital gains of investors that sell the fund. This avoids double tax. 

For example, let's say you invest $1 million and are the only investor in a fund. The fund buys one stock that doubles to $2 million. You sell and claim the $1 million gain. The fund gets a credit for the $1 million gain you claim and therefore – the fund pays no tax. If it did, then the same $1 million gain would be taxed twice. 

3. MER is tax-deductible – The costs in the MER are tax deductible. The fund nets the taxable part of any taxable capital gains or dividends received against the MER. 

For example, if a fund has an MER of 2.5%, then the first 5% in capital gains (50% is taxable) each year is netted against the costs and not taxable. 

4. Corporate class – Many fund companies put large groups of funds into one corporation. This has 2 main advantages: 

First, losses in one fund can be netted against gains in a different fund. For example, the fund company can net the gain in your resource fund against the loss in someone else’s tech fund, so that you have no tax on the growth of your fund. 

Second, a switch from one fund in the corporate class to another is not a taxable event (it is considered a share exchange), so you can move your money around (even to money market) without triggering any tax. 


There are quite a few examples of 100% tax-efficient funds. For example, AIC tends to follow Warren Buffett’s buy-and-hold philosophy. Their flagship fund is the AIC advantage fund that was established in 1985 and has never paid a distribution. We have not been using this fund specifically, but it also does not have a large, pent-up gain, since many investors in the fund have sold it at a profit over the years. 

Most of the major fund companies have corporate class structures for many of their funds. Two good examples are the C.I. Corporate Class and the Mackenzie Capital Class funds. The C.I. corporate class was set up in 1987 and has only ever paid a distribution once – 1999, when profits were too high in too many funds. They are 94% tax-efficient for the last 15 years. Mackenzie’s capital class was set up in 2000 and has not paid any distributions since inception – so all have been 100% tax-efficient. 

If you are investing outside your RRSP, focus on tax-efficiency and you can end up with a 48% higher nest egg.


  1. The Financial Blogger on August 1, 2007 at 8:03 am

    Thank you for the tips Ed!
    Any idea where I can find the list of funds you were talking about?


  2. alice on August 1, 2007 at 9:09 am


    Thanks for the detail info. I’m wondering if you invest in 100% Tax-Efficient mutual fund for Smith Manoeuvre, is the interest still eligible for tax deduction every year since you don’t have any income for your investment?

  3. FourPillars on August 1, 2007 at 9:17 am

    I couldn’t agree more about effects of tax drag on your performance. I’m currently working a couple of spreadsheets to quantify the effects in a real life situation.

    I’ll have to look at that AIC fund, I’m amazed that an equity fund wouldn’t pay any dividends since most of the larger Canadian stocks pay dividends which get passed through to the unit holder. This would apply in corporate class funds as well.


  4. Fernando Montenegro on August 1, 2007 at 10:43 am


    Thanks for the article.

    I echo Alice’s question – if the fund as a strict “no distributions” policy, will the CRA allow interest expenses to invest in that fund? Isn’t this the same as investing in gold directly (the typical example of a no-no investment for Smith Manoeuvre)?

    Also, part of the SM is that distributions are used to prepay the mortgage. If there is no distribution, then this is (to me) a not very efficient SM investment.

    This is not to say that tax-efficiency isn’t important (quite the contrary!) but that tax-efficiency and SM may be mutually exclusive… Perhaps *after* one has done the SM and has a “SM-friendly” portfolio (and loan) one can use the extra cash to start a fully “tax-efficient” portfolio.

  5. FourPillars on August 1, 2007 at 11:05 am

    From what I’ve read you only need the “expectation” of future income for an investment to qualify for the interest to be tax deductible. I’m sure Ed or FT can reference this.

    I suspect that these funds do indeed pay dividend distributions which in my mind means they are not 100% tax efficient. However the gist of the article is still valid since it’s pretty hard to have a fund investing in large companies without getting dividends so there’s not much you can do about it. As Ed points out, there are large differences in the amount of capital gains declared between different funds so that’s where you can gain tax efficiency by holding funds that have low turnover. A corollary of this idea is that if you want to own a fund with high turnover, it would be better to hold that fund inside an rrsp.


  6. Canadian Capitalist on August 1, 2007 at 12:01 pm

    Or you could buy an index fund by making sure the underlying index is tax efficient.

  7. Bootsie on August 1, 2007 at 12:04 pm

    Could you expand on the index funds or give few examples?

    Very informative post btw.

  8. Stewardship Journey on August 1, 2007 at 12:30 pm

    This post leads into the big question I am facing. My wife and I have about $100K in RRSP room and we are implementing the Smith Manoeuvre with our Manulife One account. I have been hearing people yell that investing within the RRSP while implementing the SM is silly and yet others who still say that tax-efficient investing outside the RRSP with the SM is still not going to beat putting money into our RRSP. We are both under 30 and have a hefty $300K mortgage to convert. Thoughts??

  9. FourPillars on August 1, 2007 at 12:43 pm

    SJ – you’re opening a can of worms with that question!

    Comparing the SM vs RRSP is a bit of apples vs oranges. The rrsp account is not leveraged (normally) whereas the SM is a leveraged strategy, so regardless of the tax treatment, if the returns of the underlying investments are reasonably good then the leveraged strategy should win out quite easily. The downside of course is if the investment returns aren’t so hot, then the leveraged strategy will be a lot worse than the non-leveraged strategy.

    I’d suggest in your case you spend more time doing research and try to figure out for yourself what the best strategy is for you. Keep in mind that contributing to an rrsp and buying securities on leverage are not mutually exclusive (I do both).

    The question is not which one is better but rather how much risk are you willing to handle in order to get potentially better returns. Using leverage will always raise your risk profile, which is why it’s important to learn as much as you can about it so that you can determine how much leverage (if any) is appropriate for your situation.


  10. FrugalTrader on August 1, 2007 at 1:08 pm

    SJ – In my opinion, you don’t have to do one or the other. Do both. Contribute to your RRSP’s as you normally would but at the same time, do the SM. The SM will pay for itself while you pay down your mortgage and won’t affect any of your cash flow.

    Alice – Tax law states that the investment must have a “potential” to produce income in order for the investment loan to be tax deductible. In the end though, it’s at the discretion of CRA. Personally, I would rather purchase investments that pay distributions to be safe.

  11. nobleea on August 1, 2007 at 3:22 pm

    Do 100% tax efficient mutual funds have the same performance as a 75% tax efficient fund? Seems a little silly to focus on paying less tax if the consequence would be lower returns.

    RE: investment loan interest…Does the investment income have to exceed the interest claimed? What if your investments are geared primarily toward capital gains, but there are some income/dividend producing assets as well.

  12. Gates VP on August 1, 2007 at 5:01 pm

    So Ed, I love the “non-taxed” income is bigger example at the start… however I just had a stark realization while reading this piece (and in follow-up to our UL piece :)

    The RRSP fund may be bigger, but you still effectively have a lien (tax) on those funds. The 926k is all yours to do with as you please, but the 1,376k is not really yours yet. In fact, if you wanted to cash it all out and make it yours you’d probably only keep 60% or about 825k b/c it would be taxed as income not as capital gains.

    If you took it out in chunks, then you’d definitely be able to make the RRSP money last longer, but as a lump sum it’s actually worth less :(

    Sounds to me like there’s a point where one will actually want to invest outside the RRSP. i.e.: Once the money is no longer “retirement income” but has instead become “my current wealth”. And of course, this is where tax-efficiency comes in to play… Hey, hey Ed… it’s all starting to make sense :)

    So back to the point how tax-efficient are dividends? I mean we’re talking about holding funds long-term without crystallizing any gain, how about holding dividend funds?

    I recall reading about one investor who held some 350k in stock, but had actually invested it in low-volatility dividend stocks b/c he wanted the cash flow from the dividends and didn’t plan on cashing out the stock. I seem to recall that dividends are only taxed by 5% b/c they’re taxed elsewhere (but I don’t have the evidence to back that claim)

    As a guy who doesn’t really plan on “retiring” just “slowing down” and taking more time off, the concept of dividends as cash flow really struck me as smart. But it’s only good if dividends are taxed less.

    (PS: Thanks as always Ed for heeding my odd-ball inquiries)

  13. Cannon_fodder on August 2, 2007 at 2:58 pm

    Gates VP: I’m not sure if I understand your issue with the deferred tax vs. annual tax payment example Ed provided, but the $1,376k was after tax. Ed took $100k and grew it by 10% per year over 30 years. That grew to $1,745,000. He then subtracted the initial $100k to give him the capital gain. Only 50% of that was taxable. He then used (apparently) a 46% marginal tax rate to arrive at the final figure.

  14. Cannon_fodder on August 2, 2007 at 3:10 pm

    I believe Ed explained how a fund could receive income yet not distribute it. He spoke of how a fund could offset it with losses in other funds or the MER cost.

    Thus, it should be apparent that a fund that is 100% tax efficient could be constructed even though it held dividend paying equities.

    I also doubt that Ed would even suggest 100% tax efficient funds for the SM if they couldn’t stand a challenge from the CRA. Ed gave an example of a fund designed to be tax efficient being forced to declare a distribution.

    It is a good point that one doesn’t want to choose a fund solely on its tax efficiency considering you also want it to grow commensurately with the risk attached.

    And, I have never seen any expectation by the CRA that the income from an investment at least match the borrowing charges.

    Finally, it is not a requirement of the SM to have distributions of the underlying investment portfolio pay down the mortgage. That is an interesting accelerator. I’ve run various scenarios through my calculator and, unless you are starting with a situation like the Ed Rempel Maximum (which I think is similar to Turbo SM) the effect is not that significant.

    I’m actually considering implementing the SM with the Ed Rempel Maximum by crafting a portfolio that pays a distribution which covers the interest costs and tax liabilities.

  15. sam on August 3, 2007 at 1:12 am

    hi Ed,
    thanks for all your time & efforts you put into your posts…

    i have a few concerns.
    1) reg AIC Advantage funds..

    the MER ranges between 2.5% – 2.75% while for a index fund it would just be around 0.25%.

    while earlier discussing Universal Insurance..we saw on the link of Perry Kundert how large MER wipes out more than 50% gains in the long run…

    how could you..who spoke against big Fees while discussing Universal Insurance now even think of mutual funds with big MER….

    2) “Mutual funds get a credit for the capital gains of investors that sell the fund. This avoids double tax.”

    i am sorry..but i have never heard/read of them before..can you please elaborate…

    there are 2 different capital gains involved..

    a)when the mutual fund has a capital gain while it churns out it’s portfolio…almost in all cases the mutual fund passes the capital tax liability to unit holders through T3..the investor would then increase his ACB accordingly(even though the fund might not have passed any distrubution but only the tax liability on it’s capital gain..)

    b)when the individual sells/redeems his units..he might have capital gain…

    thanks again..

  16. Ed Rempel on August 5, 2007 at 7:52 pm

    Great questions!

    Alice and Fernando, the guys are right – all you need is a potential to pay dividends for the interest to be tax deductible. Most companies don’t pay dividends – especially young, growing companies. If Company A buys a growth company that ends up not paying a dividend, can it deduct the interest to buy the growth company? Of course it can.

    The same applies to buying mutual funds that buy equities, but never pay any dividends or distributions.

    About your quote, Fernando: “Also, part of the SM is that distributions are used to prepay the mortgage. If there is no distribution, then this is (to me) a not very efficient SM investment.”

    You obviously have not read the book. Paying distributins onto the mortgage is not part of the SM at all. What you are referring to is a different strategy called the Smith/Snyder which uses distributions paid onto the mortgage. There are significant tax issues with this, however. If the distributions are non-taxable and you pay them onto your mortgage, your original loan becomes non-deductible over time.

    I would recommend against paying any distributions onto your mortgage, unless you know what you are doing and how to do the “Snyder tax calculation” to figure out how much of your credit line interest is still deductible.

    For this reason, a 100% tax-efficient mutual fund is definitely more SM-friendly than any fund that pays out distributions.


  17. Ed Rempel on August 5, 2007 at 8:04 pm


    That is an excellent question that does not have a simple answer. It seems like a perfect topic for another article – Use extra cash for SM or RRSP?

    The short answer is that it will depend on the way you implement the SM, what you do with your tax refunds and where your taxable income is in relation to various tax brackets.

    Thanks for the well-worded question. I’ll have an article on it in a few days.


  18. Ed Rempel on August 5, 2007 at 8:14 pm

    Cannn Fodder,

    I’m curious – why you are considering implementing the Rempel Maximum with distributions enough to pay the interest on your loan and tax cost? Is there not enough principal payment with your mortgage payment to cover the interest? How are you figuring out how much leverage to do?

    The definition of the Rempel Maximum is that you use whatever principal payment you have and leverage the amount it will carry.


  19. Ed Rempel on August 5, 2007 at 9:30 pm


    The issue with fees and MER’s is to get value for your money – not just cheap. If you want to have the world’s best fund managers working for you, you can’t expect them to be cheap.

    If you want to find Tiger Woods, don’t look among the low-priced golfers!

    The difference with Universal Life insurance policies is that you are usually not getting anything for your extra fee. The higher cost is for insurance for life and is a waste of money unless you actually need insurance for life. And you can almost always get the same investment outside of your policy for less money.

    Have you looked at this AIC fund, Sam? It has beaten the TSX Composite by 2.3%/year compounded since inception 21 years ago. This is AFTER the 2.47% MER. And it has had zero distributions of any kind. I think this is good value for the MER.

    While we don’t use this particular fund, all the fund managers we use have similar profiles – they have normal to slightly high MER’s, but despite that, they have all beaten their index by a significant margin for a minimum of 15 years.


  20. Ed Rempel on August 5, 2007 at 9:31 pm

    Cannon Fodder is right that you should not buy a fund only because of tax-efficiency. The purpose of the article, however, is that it should be a consideration. We normally choose our investments based on risk and return – but we should also consider tax efficiency.

    We use some 100% tax-efficient funds, but also some that are less tax-efficient because of the risk/return and quality of manager.

    CC, by comparison, the equity index funds that have been around for 10 years are mostly between 85-95% tax efficient. Indexes normally have a turnover of 10-15% of their holdings each year. This is quite a bit lower than most funds, but many buy-and-hold funds can have far lower turnover. One of our fund managers has an average turnover of only 4%/year – less than 1/3 of the turnover of his index. Warren Buffett’s turnover is similarly low.


  21. Ed Rempel on August 5, 2007 at 9:56 pm


    “Do 100% tax efficient mutual funds have the same performance as a 75% tax efficient fund? Seems a little silly to focus on paying less tax if the consequence would be lower returns.”

    In general, more tax-efficient funds tend to have somewhat higher returns. This is an interesting point and possibly the topic of a future article.

    In comparing any 2 investing styles, almost always the one with lower turnover (fewer transactions) out-performs. This explians why:

    1. Every study shows that women are much better investors than men.
    2. Studies show market timing strategies reduce returns.
    3. Technical anaylsis (charting) usually does not work.
    4. Day traders usually lose money in the long run.
    5. The average mutual fund makes less than their index.
    6. The world’s top investors and fund managers are usually buy-and-hold investors.

    Any study I’ve ever seen comparing 2 investing styles almost always shows that the one with fewer transactions wins.

    This is not just because of trading costs or taxes. Most investing strategies still end up with buying and selling at the wrong times (buying high and selling low).

    One huge study done over 10 years of all transactions done in a number of discount brokerage firms showed that most of the time, the investment any investor sold out-performed the next one they bought. Think about that every time you are considering a transaction.

    This same reason means that tax-efficient funds in general have higher long term returns than less tax-efficient funds.


  22. DanB on August 6, 2007 at 12:51 am

    Ed, I would assume this does not include taxable stock dividends? i.e. stock dividends are used as additional income to implement the SM. I fail to see how this would affect the LOC interest deductibility?

    Ed, you said:
    >I would recommend against paying any distributions onto your >mortgage, unless you know what you are doing and how to do the >“Snyder tax calculation” to figure out how much of your credit line >interest is still deductible.

  23. FrugalTrader on August 6, 2007 at 8:39 am

    DanB, you are right, withdrawing stock dividends does not affect your tax deductibility.

  24. DanB on August 6, 2007 at 10:52 am

    What about capital gains?
    Could you sell an investment, then promptly buy another for the same original amount that you borrowed, except any capital gain would be put towards the mortgage (after paying taxes).

  25. FrugalTrader on August 6, 2007 at 10:57 am

    DanB, no, you cannot withdraw your profits without affecting your interest deductibility.

    If you get the chance, please read this article:
    Key Considerations to an Investment Loan

  26. DanB on August 6, 2007 at 11:29 am

    That is what I thought. Thanks for clarifying.

  27. Ed Rempel on August 6, 2007 at 7:58 pm

    Dan & FT,

    It is possible to withdraw capital gains without affecting your loan interest deductibility. If you sell an investment and pay the amount borrowed down on your credit line, then you can use the capital gain any way you want. Then reborrow the same amount and invest it again.

    It is all a matter of traceability. You can’t just withdraw the gain, but if you follow the procedure above, then you are fine.

    Mutual funds allow you to get around this by paying capital gains distributions. You can have them paid in cash without affecting your interest deductibility.

    The general rule is that any income paid to you that you pay tax on (dividends, capital gains distributions or interest), you can withdraw (or spend or pay down on your mortgage). Any amount paid to you tax-free (ROC distribution from a mutual fund or an income trust) reduces your loan deductibility on that amount.


  28. Cannon_fodder on August 6, 2007 at 8:13 pm


    You caught me – when I implement the SM I will actually take on more debt than I did with the original mortgage and will not be based on current investment streams or other calculations akin to “Rempel Maximum”.

    I’m comfortable with borrowing (when the time is right) for investing in solid companies keeping a long term (>15 years) view. I’m not looking to get rich quickly, just get more comfortable, more quickly.

    I will heed your advice in investigating any pitfalls to setting up a structure which would allow the investments to ‘self fund’, i.e. after tax cost of borrowing = after tax revenue in dividend income.

  29. FrugalTrader on August 6, 2007 at 8:55 pm

    Ed, are you absolutely sure about capital gains? I recall reading in Tim Cestnicks book that you cannot withdraw capital gains. Perhaps he neglected to explain “how” to withdraw them properly?

  30. Ed Rempel on August 14, 2007 at 1:02 am

    Hi FT,

    Yes, I’m sure. The difference comes down to procedure. Tim Cestnick is right that you can’t just withdraw capital gains. However, you can if you cash in everything and then reinvest.

    For example, let’s say you invest $100,000 and it grows to $200,000. If you withdraw the amount of gain – $100,000, then 1/2 of it is your principal and half is your growth. You cannot just withdraw the $100,000 gain. Any withdrawal is considered to be 1/2 your capital and 1/2 the growth.

    However, if you sell the entire investment, then you can withdraw the $100,000 gain and then immediately reinvest the original $100,000. This way, the entire $100,000 gain is taxable as a capital gain, but this allows you to withdraw the amount of the gain and then reinvest your capital again.


  31. […] Is 100% Tax Efficient Investing Possible? (30 comments) […]

  32. Julie on August 7, 2008 at 8:06 pm

    Hi FT,

    I have some questions to bring up.

    I am doing a sort of SM. I have two portions of investment loan invested through a financial advisor. I don’t think he is knowledgeable as Ed. Thanks Ed for sharing such important investment knowlege with us).

    One investment loan is borrowed from B2B and invested in two CI funds with monthly distribution. After checking T3 form, I know the distribution of one fund is consisted of ROC and interest . I also have another investment loan borrowed from LOC which also pays both loans interest. If I want to cash out ROC, can I return ROC to LOC loan to avoid of reducing loan tax deductibility? The reason is that B2B will not take back a small portion of return – monthly ROC, and I don’t want to reinvest the ROC which will go to back end of the fund.

    Thanks a lot!

  33. FrugalTrader on August 7, 2008 at 8:11 pm

    Julie, based on my limited understanding of tax law, you can, as you stated, take your ROC distributions and pay down your LOC to maintain tax deductibility. Ofcourse, you’ll want to double check with an accountant.

  34. Julie on August 8, 2008 at 8:25 pm

    Thanks FT!

    Could Ed confirm it? I don’t know any accountants.

    Have a nice weekend!


  35. Ed Rempel on August 9, 2008 at 3:36 pm

    Hi Julie,

    As long as 100% of the ROC distribution is paid down onto one of the investment loans and you can trace it, you should be able to deduct all the interest from both loans.

    The other option that is usually better is to just have all distributions reinvested.

    What are you trying to accomplish, though, Julie? It sounds like you are trying to get out of the leverage or invest differently – is that right? Why do you want to take money out of the invetments to pay down on the loan (as opposed to trying to maximizing the investment nest egg long term)?


  36. Julie on August 10, 2008 at 7:30 pm

    Hi Ed,

    Thanks for the confirmation.

    I am trying to learn how to invest efficiently via learning from you, FT and everyone here. My advisor is not interested in the SM and he doesn’t care about what we can achieve through the SM.

    Yes. I am thinking of reinvest LOC to ETF after it grows up. What is your suggestion?

    Thanks again,

  37. Chuck on August 10, 2008 at 10:52 pm

    Julie, I would suggest that if your advisor isnt interested in investing using the method of your choosing (ie Smith Maneuver) you may want to consider interviewing a couple of other investment advisors, or at least speak to the branch manager.

    You’re still the customer in the transaction and I could understand your advisor concerned with the risks involved in leveraged investing, but at the end of the day its your decision. My father did leveraged investing for 20 years with a full service broker – without issues.

    I’d guess he’s reluctant because your proposed move from mutual funds to ETFs means a potential reduction in commissions (or trailer fees) to the advisor.

  38. Ed Rempel on August 30, 2008 at 1:13 am

    Hi Julie,

    I just noticed your post. We are not really fans of ETF’s or other index products. We work with what we call “All-star fund managers” that have all beaten their indexes by wide margins (3-5%/year) over long periods of time (15-30 years). There are fund managers that know how to take advantage of systematic inefficiencies in markets. They are often less risky than indexes as well.

    With ETF’s, you still need to decide which ones to own, which means that your portfolio would still be an amateur portfolio. If you want professional advice with investing ETF’s, you would likely pay at least 1%, which would mean lower than index returns. We would prefer to have the best professionals manage our clients investments.

    We think amateur ETF investors will generally make less than amateur index investors, since ETF’s have a huge temptation to switch them and buy at the wrong times.

    Most ETF investors will buy whichever ETF is “doing well”, which means they will consistently buy high. Studies also show that 80-90% of all trades by all investors are stupid, so almost any strategy involving fewer trades beats almost any strategy with more trades. ETF investors tend to trade more often than index investors.

    In short, we are not fans of ETF’s either as an amateur portfolio or as part of a professional portfolio.


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