Mutual fund investors pay higher sales taxes on their portfolio holdings than direct stock and bond investors or owners of guaranteed investment certificates (GICs), which effectively hampers retirement savings, argues a new report from the Montreal Economic Institute (MEI).
According to new research from the non-partisan think tank, the share of sales taxes (GST and/or provincial sales taxes) on the management fees paid by mutual fund unitholders is more than 8%. By comparison, GIC owners pay between 1% and 3%, the report says, and investors pay nothing in taxes when they purchase stocks and bonds directly. These taxes effectively inflate mutual fund management fees, and reduce returns, the paper says.
Moreover, mutual fund unitholders in the Western provinces, which have lower sales taxes, end up subsidizing the higher tax rates that are charged in Ontario, Quebec and the Atlantic provinces, the MEI report notes: “Investors from the west and the north end up paying provincial taxes to the Atlantic provinces, Quebec and Ontario through their mutual funds.”
As most mutual funds are organized as trusts, all of their operating and management expenses are subject to the GST and to provincial taxes in provinces with harmonized sales taxes, the report says. Furthermore, mutual funds are eligible for sales tax rebates, as other businesses generally are, the paper adds. Although this wasn’t a big deal when the GST was introduced and the fund industry was comparatively small, it has become a much bigger issue as the mutual fund industry has grown significantly over the past 25 years, the paper says.
“Mutual funds, of course, remain an attractive form of investment. For one thing, they are a way to delegate the management of your portfolio to an expert. For another, they allow you to pool your investments with those of many other investors and thereby to enjoy the benefits associated with a large portfolio,” the paper says.
“However, successive reforms of Canadian sales taxes have created a particular situation that imposes a much heavier tax burden on mutual funds than on other investment vehicles, which has the effect of slowing down Canadians’ retirement preparations,” the report adds
Policy-makers could address the inequality by exempting mutual funds from sales taxes or by applying the rules that are applied to pension funds, which reimburses a third of the sales tax, the MEI paper says.
“With rising life expectancy, saving for retirement is becoming increasingly important,” says Michel Kelly-Gagnon, president and CEO of the MEI. “Programs like RRSPs and TFSAs encourage Canadians to save by allowing them to shelter certain portions of their incomes from taxation, but governments undermine this objective by excessively inflating mutual fund management fees.”