As you may know, Ontario and B.C. are introducing a new tax on mutual funds in July of 2010. Their plans to harmonize their respective provincial sales taxes with the federal GST will hurt Canadians saving for their retirement. Other provinces are being pressured to harmonize as well.
At present, Canadian investors pay the 5% GST on the management fee and almost all operating expenses of investment funds (e.g., mutual funds and segregated funds). Under the HST, that tax will balloon by as much as 160% to up to a combined rate of up to 13% in Ontario.
The Popularity of Mutual Funds
Canadians overwhelmingly choose mutual funds to help them reach their savings goals and save for retirement. Mutual fund usage is particularly high for Canadian families across the middle-income brackets. 47% of those who own mutual funds have incomes of between $50,000 and $100,000.
Mutual fund usage increases significantly as Canadians approach retirement. An estimated 51% of mutual fund owners are near-retirees (45-64) and another 22% are retirees (65+).
Canadians use mutual funds because they know that they provide an affordable way to obtain the benefits of capital market investment with fewer risks and lower costs than owning securities directly.
Discriminatory level of tax levied on funds
Under the HST, a fund’s management fee will be taxed with the 13% rate (Ontario) whereas guaranteed investment certificates (GICs), equities, bonds, term deposits and other non-fund financial vehicles are exempt from charging investors the tax.
Who will be affected by the HST?
Ontario and B.C. investors that own mutual funds and segregated funds will be negatively affected. An Ontarian saving $5,000 each year will lose $42,000 over a 35-year period due to the 5% GST plus 8% HST. This compounding of small GST/HST amounts each year adds up to eight years of savings.
Additionally, harmonization could slow or reduce savings accumulation even further if the heavier sales taxation of funds turns investors to choose lower-risk-and-return GICs, which may not allow them to save enough for the retirement they want. Or some may choose to invest in individual stocks and may expose themselves to more risk because they do not have enough capital to diversify effectively.
What actions are the mutual fund companies taking?
Mutual fund and insurance companies are very concerned about the approaching HST for obvious reasons. Some of the companies have been asked if their respective fund company will absorb the HST and the answer, so far, has been no.
To make matters worse, Canadians outside Ontario and B.C. may become subject to Ontario and B.C. sales tax because of the pooled structure of funds, which makes it difficult if not impossible to charge the tax to the individual end investor.
If this topic is of interest to you, you may consider having a discussion with your fund company wholesaler for more details.
What actions can you take?
Seek out funds with lower MERs
With over 5,000 mutual fund options in Canada, you can shop around on your clients behalf to find a respectable and proven money manager with a reasonable fee structure. If your dealer/MGA has a wide and diversified product shelf, you shouldn't have a problem finding many cost effective options.
Consider using a Fee for Service Account
If you have access to a fee for service account that can allow you to add mutual funds with lower management fees such as F Class funds, you can save your clients a substantial amount of money. A good fee for service account should give you pricing flexibility to allow you to set a fee based on your clients needs and account size.
Continue to express and prove your value proposition to your clients
Clients usually place a lower emphasis on fees when they clearly see, feel and understand the value proposition that you deliver as a financial advisor. Continue to promote your benefits and the value that you've brought to the relationship to-date.
Don't panic
Mutual funds won't be the first or last product and service that is subjected to the HST. Canadians will be upset with the new tax as it's consumers that will pay the tax. However, Canadians have proven to be resilient and patient when it comes to taxes. Only time will tell if financial advisors, and mutual fund companies, will need to take more action. In the meantime, keep your lines of communication open with your clients and listen actively.
How will you manage your client base with the new HST tax?
I'd love to hear any constructive ideas that readers may have on this topic.
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