Managers of mutual funds and other pooled products, as well as fee-based financial advisors who charge clients a management fee for their services, will be affected dramatically if the harmonized sales tax proposed for Ontario and British Columbia comes into effect next year. These financial services professionals will be forced to impose additional taxes on their clients if the harmonization is implemented as proposed.

The GST is levied on money management because it is considered a taxable service.

In Ontario, the new harmonized sales tax will add 8% (the provincial sales tax portion of the HST), based on the value of money-management fees, to the 5% federal GST already being charged; harmonization will add 7% in B.C. The result will be a hefty tax on Canadian savings, putting mutual funds and other managed products at a disadvantage compared with deposit products, such as GICs, which are not subject to the same tax.

“It’s bad enough with the GST,” says Stephen MacPhail, president of Toronto-based CI Financial Corp. “But if the HST is applied to the same items, it will be unfairly onerous to all providers of portfolio-management services, including [providers of] segregated funds, investment counsellors and fee-based advisors. We feel the HST will be terrible for our customers, and in turn for the providers of the product. This is the biggest issue facing our industry today.”

The HST is the combination of the federal GST and provincial retail sales tax lumped into a single levy and administered by the federal government on the majority of goods and services purchased by consumers. Generally, the goal of the HST is to save the government costs and create efficiencies related to compliance and collection. For the past several years, Nova Scotia, Newfoundland and Labrador, and New Brunswick have been charging an HST. Ontario and B.C. are proposing to harmonize their provincial sales taxes with the federal GST effective July 1, 2010.

Last year, Canadians paid $450 million more in taxes on their mutual funds, due to the GST alone, than they would have paid on non-taxed financial products, according to the Investment Funds Institute of Canada. Since the GST’s inception in 1991, consumers have paid $5 billion in aggregate sales taxes on mutual fund products. If Ontario and B.C. harmonize their taxes as planned, sales tax rates will grow by 160% in Ontario and by 140% in B.C.

Research by Toronto-based Mac-kenzie Financial Corp. estimates an individual investor with a $100,000 portfolio would pay almost $2,500 in additional taxes during a 10-year period if the HST is implemented. That assumes a pre-tax MER of 2.28% and a compounded annual growth rate of 8%, with the fees expanding as the asset base grows.

MacPhail says the HST will produce more than $1 billion in annual government revenue when applied to the investment-management industry; the $568-billion mutual fund industry represents the largest component of that industry. The HST will also apply to management fees charged by exchange-traded funds, hedge funds, charitable trusts and any other large institutional pools that pay a fee to managers. These managed pools can be found in many RRSPs, RRIFs, locked-in retirement accounts and defined-benefit pension plans.

Joanne De Laurentiis, president of IFIC, calls the tax “discriminatory” because mutual funds and other managed pools will be taxed at four to five times the rate of GICs, equities, term deposits and other non-fund investment vehicles. Deposit savings vehicles do not pay GST on the labour component of their costs, which amounts to 75% to 80% of the product expense, she explains. The uneven playing field came into being when the GST was introduced and will be made worse by the HST unless some kind of exemption or rebate is made available, she adds. The “unintended consequence” of the HST is that investment fund products will become more expensive for Canadians, even though they are considered a viable alternative to investing in deposits or individual stocks. Therefore, De Laurentiis says, the HST contradicts principles of fairness.

“We didn’t have the policy debate when the GST came in, because the industry was not as big,” says De Laurentiis. “We are hopeful that it is not too late to change the situation, and are having constructive meetings with officials in the Ontario and B.C. governments. They recognize the problem, and we are hoping for resolution.”

@page_break@Outside the financial services industry, Canadian consumers might benefit from lower prices on manufactured goods under an HST regime. These benefits come through offsetting credits for manufacturers for taxes paid on inputs used in the making of their products. There is no similar offset proposed for investment managers.

Because mutual funds are a popular retirement-planning vehicle, the new HST will essentially be a tax on retirement savings that will erode returns and could encourage clients to turn to other types of products. According to IFIC research, Canadians hold more mutual funds than any other single type of financial asset, on a per-capita basis. Almost half of mutual funds are held by Canadians approaching retirement or already retired. And about 70% of holdings in RRSPs are mutual funds.

“Harmonization could slow or reduce Canadian savings if the heavier sales taxation of funds causes investors to turn to lower-risk/return deposit vehicles,” De Laurentiis says. “Alternatively, some could choose to invest in individual stocks and may expose themselves to more risk because they do not have enough capital to diversify effectively.”

Most Canadians are unaware of the level of GST they are currently paying on their managed funds because it is imbedded in the management fee, and many will be unaware of the damage being done by the HST as well. MacPhail says the HST will be hidden from investors because of an Ontario Securities Commission requirement for fund managers to report a single MER that covers all costs, including taxes. No other business is required to hide the tax in this way, he says. With the GST originally intended to be a tax on consumption, not savings, he adds, it should never have been introduced on managed financial products in the first place. Ultimately, investors pay income tax on the growth, dividends and interest that their managed investments provide, he says, and the HST is an extra layer of taxation.

“Few investors will even know they are paying the tax. And for the government, the beauty of it is that it is hidden,” he says. “I’m not against a consumption tax; I’m against a tax on savings. The government is taking away from investment returns, and reducing the incentive for Canadians to invest in products that will help them grow their retirement savings.”

Most of the Canadian investment fund industry is based in Ontario, but investors who buy products from Ontario or B.C. fund-management companies will be paying the extra tax no matter what province they live in. The pooled structure of funds would create an administrative nightmare in charging different fees to investors in different provinces. It would be further complicated by investors moving from one province to another or making various deposits and withdrawals to funds.

“The complexity of trying to pull the tax apart is daunting,” says De Laurentiis. “Our goal is to arrive at a fair level of taxation relative to other financial products.”

Another solution, she says, would be a credit or refund system for investors.

Charlie Sims, president of Mackenzie Financial and head of IFIC’s working group on the HST/GST, says any solution would have to deal with inequities among provinces and products, and work uniformly across the country.

“We want to encourage Cana-dians to save for retirement, and the government would seem to be aligned with that goal,” he says. “Clearly, the tax is a drawdown on returns, and the effects compound over time.” IE