* 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.”
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.
“In addition to tax cuts, the proposed HST already has a number of exemptions for consumers — beyond that I won’t speculate on any further exemptions — except to caution that we are in fiscally difficult times and any exemption must be looked at through that lens,” John Wilkinson, Ontario’s minister of revenue, told Reuters.
Ontario’s fall fiscal update showed the province is facing a C$24.7 billion deficit this fiscal year as it battles to pull its manufacturing and export-oriented economy out of recession.
When Canada first implemented the GST in 1991, mutual funds were not a common form of investment. But over the years, they have exploded in popularity, especially among retirement-bound baby-boomers looking to diversify risk and get higher returns than savings accounts offer.
“What used to be the caviar of the financial services products is now kind of macaroni and cheese,” said Amsden.
Since 1991, IFIC said, the GST on mutual funds has added C$3.8 billion to the coffers of the federal government.
Wilkinson, who said provincial officials continue to meet with investment fund industry representatives on the matter, pointed to corporate tax measures in Ontario’s 2009 budget that he said would benefit the investment industry.
“As a result, mutual fund managers and dealers would have the opportunity to pass on these tax savings to mutual funds and their investors,” he said.
But those in the mutual fund industry say the burden of the HST will be too high for them to fully absorb.
“The impact on the mutual fund industry is probably about C$700 million annually,” said Stephen MacPhail, president of CI Financial Corp (CIX.TO), who added that number would climb as asset levels rise with the markets.
A similar HST will also come into effect in July in the province of British Columbia, which has a 7 percent provincial sales tax.
Harmonized sales taxes have existed in Quebec, Nova Scotia, New Brunswick, and Newfoundland and Labrador for years. But Quebec does not apply its HST to its financial industry and the Atlantic provinces have provided an HST rebate to fund companies.
$1=$1.07 Canadian Reporting by John McCrank; Editing by Frank McGurty and Rob Wilson