HST: The gloves come off!

I received a phone call the other day from talk show host Dale Goldhawk. Some listeners had complained to him about the Ontario government imposing a tax of 0.25 per cent on the assets in their RRSPs and RRIFs and wanted him to take some action.

He had never heard of such a tax so he gave me a call. We came to the conclusion that the complaints had been prompted by an article that appeared in The Globe and Mail that morning about the impact of the proposed harmonized sales tax (HST) on mutual fund fees. The story included this quote from Stephen MacPhail, president of CI Financial, one of the country’s largest mutual fund companies:

“If the Ontario government announced they were skimming one-quarter of a percentage point a year out of everyone’s savings, chequing, and GIC accounts, the outcry would be unbelievable. But because it can be hidden within mutual funds, the government appears to believe no one will notice.”

Of course, no government is proposing a direct tax on your savings. Mr. MacPhail was only using an analogy to emphasize his point. But the immediate reaction from some of Mr. Goldhawk’s listeners shows how sensitive this issue has become and how it has the potential to blow up in the faces of the Liberal governments in Ontario and British Columbia, both of which plan to move to the HST next year. In Ontario, the combined tax will be 13 per cent while in B.C. it will be 12 per cent.

All sorts of goods and services that do not attract provincial sales tax at present will be hit by the HST and lobby groups for the sectors most affected have been responding aggressively. The mutual funds industry is one of them. The Investment Funds Institute of Canada (IFIC) has been trying to obtain some relief from the HST for several months, so far without success. Barbara Amsden, IFIC’s director of research and strategy, told me after a meeting on the issue with officials of the federal Department of Finance a few weeks ago that they “did not seem impressed” with the industry’s arguments.

Currently, the 5 per cent GST is levied against mutual fund fees. So if a fund has an MER (management expense ratio) of 2 per cent, the GST increases it to 2.1 per cent. If the HST goes ahead as planned, that management fee will increase to 2.26 per cent for Ontario-based funds and 2.24 per cent for those based in B.C. The higher a fund’s MER (and some exceed 3 per cent) the greater the impact will be.

There’s a lot of money involved — more than $400 million annually by my estimate which would be a terrific windfall for deficit-strapped governments. Of course, that cash has to come from somewhere and a report released recently by TD Bank makes clear where that somewhere is: your pocket.

Some companies are already musing openly about creating special funds for investors in Alberta, where there is no provincial sales tax and hence no possibility of an HST in the future. But that’s an awkward and expensive option. The industry would prefer to see no tax on management fees or at least a level playing field with other types of investment products.

However, it appears governments are in no mood to be conciliatory on this issue. In fact, Ontario seems ready to take the gloves off and engage in a public slanging match with the fund companies. On September 17, The Globe and Mail reported that the provincial Finance Department is “prepared to issue a document on the negative impact of mutual fund fees for investors if executives continue to complain in public”.

If true, it would be a huge mistake. Mutual funds are one of the cornerstones of the wealth management sector in this country. For a government to attack them overtly would be highly destructive.

Yes, it is true that mutual fund fees in this country are higher than in the U.S. But Som Seif, CEO of Claymore Investments Inc., says the difference in management fees is not significant and that the main disparity is in the trailer fees paid to financial advisors.

Mr. Seif’s company is in the business of exchange-traded funds (ETFs) which would appear at first glance to be potential beneficiaries of a move to HST. That’s because the management fees on ETFs are much lower than for mutual funds so the tax bite will not be as great. Nonetheless, he is not happy with the situation, calling it “unfortunate” during a phone conversation we had while he was in Chicago last week. As for the Ontario government’s reported hints of retaliation by attacking high MERs, he describes it as “childish”, saying it is “unacceptable to threaten an industry like this”.

Although the HST would make Claymore’s products, which are traded on the Toronto Stock Exchange, more attractive in terms of their MERs when compared to mutual funds, Mr. Seif says there is a bigger issue that governments have lost sight of.

“Mutual funds are sold only in Canada,” he points out. “We have to compete with ETFs in the United States and they are not subject to any tax on their management fees. Just a few basis points of extra cost can put us at a competitive disadvantage. We could see more money lost in the Canadian marketplace.”

He has a point. Canadians can buy American ETFs just as easily as those based here. A significant difference in management costs will show up directly on the bottom line. Investors will react accordingly.

It’s time for Ontario to stop blustering and to think this through. A scorched earth policy will benefit no one, least of all investors.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, click here.

Photo ©iStockphoto.com/ james steidl


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