Wealth Manager-Mutual fund investors face Ontario tax bite

* New harmonized tax could increase cost of mutual funds

* Fund industry group lobbying government for solution

* Ontario budget deficit estimated at C$24.7 billion

By John McCrank

TORONTO, Oct 27 (Reuters) - Ontario's mutual fund industry is fighting for changes in a new tax regime that it says unfairly targets its products, but government officials say the province's economic malaise leaves them with little room for compromise.

Ontario, where the bulk of Canada's C$650 billion ($608 billion) mutual fund industry is based, is set to roll out its harmonized sales tax next July. The HST combines the 5 percent federal goods and services tax with Ontario's 8 percent provincial sales tax, for a combined 13 percent hit across a broader range of services and products.

Management fees and most operating expenses attached to mutual funds, known as management expense ratios, or MERs, are currently subject to Ottawa's GST, but not the PST. That's because mutual funds are held in trust apart from the firm that manages them. The firm pays the fund a management fee, which is considered a service and is subject to the federal sales tax.

Under the new regime, the HST will apply to everything that the GST applied to, so the tax on MERs will jump from 5 percent to 13 percent.

Non-fund products, like guaranteed investment certificates, equities, bonds, and term deposits, don't have the same management fees, so the tax burden on them is lower.

So, in its current form, the HST would apply a rate five times higher to managed money than the rate applied to other financial vehicles, said Barbara Amsden, director of research and strategy at the Investment Funds Institute of Canada.

"There is an inequity," she said. "One would assume that in a competitive marketplace that it's going to have a negative effect on the number of players in the market and the amount of choice that would be available to Canadian investors."

IFIC says the higher tax rate on MERs means that an Ontarian putting C$5,000 a year for 35 years into mutual funds will lose about C$42,000, or about eight years of savings, due to the compounding of small HST amounts each year. Under the current regime, with just the GST, the investor's return goes down by about C$17,000 over the same period.

IFIC is trying to convince the federal and Ontario governments to create a single tax rate for all financial products, or to possibly exempt mutual funds from the HST. Amsden said she thinks both levels of government "understand that there is an inequity."

ONTARIO'S BIG DEFICIT

But that understanding may not count for much, as the tax on funds represents a potential windfall for the province, which is staring down a record budget deficit.

Ontario's top tax man has not yet said how the HST will ultimately apply to mutual funds, but he has argued the new regime will end up benefiting consumers overall, as personal tax rates will be lowered for the majority of consumers.