Fund industry mulls national solution to HST

De Laurentiis pointed out that some sort of national HST exclusion for mutual funds would signify virtually no changes for the industry and investors. Investors would continue to pay a 5% GST charge on their funds.

“We’re also talking to both provincial and federal governments to make them aware of the policy changes that need to be made. Fundamentally, this is a change that needs to be made to the Excise Act because that’s where the framework that drives the GST works. Harmonization with the national sales tax is what compels provinces to align taxation to the GST, so if you fixed things at the [national] level, then it flows quite elegantly,” she says.

The HST is a hot topic for the fund industry right now, given the substantial increases in price it will cost investors, who will see the tax they pay on mutual fund management expense ratios (MERs) rise from 5% to 13% in Ontario and 12% in B.C.

Unlike stocks or GICs, investment funds are subject to goods and sales tax (GST)because they have to be held in trust apart from the firm that distributes them. As a result, the firm has to pay the fund a management fee.

That management fee is considered a taxable service subject to GST, so the fund firm has to pay GST on the fees it pays to the fund.

For example, on a fund with an MER of 2.20%, the HST would add about 18 basis points of tax expenditures.

In proportion to the principal investment, the additional tax an investor pays is small but over time, it compounds as drag on performance. Investors pay more tax on their funds each year and lose out on the potential compound gains from those amounts.

Already in dollar terms, Canadians pay an estimated $450 million more in GST on their mutual funds than they would have if they had invested in non-fund financial products.

For this reason, De Laurentiis argued that the HST is a detrimental tax on retirement savings — something governments usually try to support with tax credits or incentives.

“Our issue is not that mutual funds are taxed, it’s that they are disproportionately taxed a higher level than non-investment fund products,” she says. “Sixty-two percent of fund holders earn less than $100,000 a year, and more than 70% of the funds we sell are owned in retirement savings vehicles. Fundamentally, the impact of the harmonized tax is on the retirement savings — not Canadians. It’s an outcome that’s pretty undesirable, given that we have a public policy concern about whether we’re saving enough for retirement.”

Adding the HST will only increase the cost to Canadian investors and their fund providers who will have a number of new administrative challenges to overcome, which may include having to create a new series of funds for each individual province’s tax treatment.

“With a national single tax exemption, there is no reason to create multiple fund series’ for different provinces, which would be quite an administrative nightmare, because you would probably need to create a different series of funds for each province,” De Laurentiis says.

According to a study conducted by KPMG, Canada would be an outlier in the world in applying value-added taxes such as the GST and HST to financial savings vehicles.

“We asked KPMG to look at key leading jurisdictions similar in demographics to Canada, because they are useful comparisons,” she says. “The European Union provides broad exemptions for management services, and the U.K. broadened its exemption last year. New Zealand exempts 90% of unit fees for unit trusts — what we call investment funds. Australia has a narrower definition of financial services, so that more services are taxable; however, financial service providers are eligible for a special credit equal to 75% of eligible expenses.”

(10/08/09)