Tax harmonization not just “Ontario’s problem”

By Mark Noble | March 19, 2009 | Last updated on March 19, 2009
4 min read

If the government of Ontario implements a harmonized sales tax in its next budget, expect the costs of mutual funds, ETFs and — most dramatically — segregated funds to rise substantially across Canada.

Some in the industry have brushed off an added sales tax as an Ontario problem of little financial consequence to the end investor, who will absorb the cost. The Investment Funds Institute of Canada (IFIC) estimates that if an 8% sales tax is added to the management expense ratio of an Ontario investor with $20,000 in a mutual fund, the annual tax will be about $60. Not ideal given this economic climate, but some investors may be okay with that.

The huge hit for advisors and the mutual fund industry comes from the fact that a fund’s trust structure has to pay GST on its management and operating costs, according to Barbara Amsden, director of strategy and research for IFIC. As an entity, a mutual fund is independent of the firm that operates it and pays tax separately.

“While most people don’t know it, people who buy mutual funds and have non-government pension funds pay higher sales tax than people that purchase a GIC, term deposit, stock or bond directly,” she says. “That is because the GST applies on 100% of mutual fund services. In comparison, the GST applies only to materials and third party services bought to supply other financial services — that leads to a big difference when you consider that the biggest cost for financial services providers is salaries.”

Amsden says funds have to pay GST on all labour and operating costs to the firm running it. Adding an HST would potentially add another 8% to all these costs for any fund based in Ontario. That’s the vast majority of the industry.

To put this into perspective for investors, Stephen A. MacPhail, the president of CI Financial, explained to that the HST would effectively double the operating costs on its funds, which are operated out of Ontario. Investors from coast to coast would absorb that cost in higher MERs on the mutual fund, which in turn would go into the coffers of the Ontario government.

“The MER of a mutual fund has three components to it. The first is the management fee. The second is the operating expenses of the fund — that’s sending out statements and providing the custody etc. — and the third component is GST,” he says. “The GST is calculated based on the management fee and operating expenses; some of the operating expenses are exempt and some aren’t. The GST is 5%, so if you had a 2% management fee and 20 basis points of operating expenses, the GST is going to be approximately 11 basis points. The MER would then be published as 2.31%, of which 0.11% is the GST.”

Harmonization would add another 18 basis points into the MER, increasing the cost of the fund from 2.31% to 2.49%, MacPhail points out. The thing investors may not realize, though, is that 18 basis points is essentially equal to CI’s current fixed operating costs of 0.185%.

“That cost will be carried by the investors. It doesn’t cost CI anything other than the fact that our product is more expensive. It will look like all of a sudden we’re increasing our prices even more, whereas if you were to get rid of the GST our prices would drop by 11 basis points,” he says. “We’ve learned to live with the GST; the HST would add a material amount of additional costs. An incremental increase would be equal to our entire operating expenses that we charge to unitholders.”

This cost increase would be incurred by every fund provider in Canada that operates out of Ontario. This includes ETFs, quite possibly investment counsels that provide fee-for-service and most glaringly, insurance guarantees on mutual funds. Guaranteed segregated funds offered by Ontario-based distributors would most likely be taxed twice, MacPhail points out.

“I can’t speak on behalf all providers, but all I can tell you is we charge the client GST on the guarantees offered on our SunWise line of products (insured by Sun Life), which we’re the distributor of. It is our view that if it’s already subject to GST it would be subject to the harmonized sales tax,” MacPhail says. “For purchasers of segregated funds it becomes an even more onerous expense. That becomes really silly because now you’re paying a sales tax on guarantees to protect your investment. We fought the battle on the GST and lost. The idea to move the tax on those from a 5% to a 13% charge would be pretty scary. Almost every advisor that’s insurance licensed has sold their clients segregated funds.”

IFIC hopes an exemption would be made for the investment industry, Amsden says.

“If the government decides to move ahead with harmonization — and as mentioned, this could be a big stimulus for manufacturing and many businesses — IFIC wants to work with the province to identify ways to minimize penalizing investors,” she says.

If the HST is a direct port of the GST, fund firms may have to pick up and move elsewhere. Funds based in provinces such as Alberta, which don’t have a sales tax, would have a national advantage by being able to offer cheaper funds than those that originate from Ontario.

“The interesting thing is you basically have a fiduciary obligation to look at reducing expenses where you can. If the unitholder could save the entire amount of PST by relocating operations to Alberta, you have to look at that,” MacPhail says. “Even though it would be expensive to move things, it’s not completely out of the realm of feasibility. Maybe it was a couple of years ago when employment in Alberta was so tight, but today the employment situation has changed considerably.”


Mark Noble