Clients to carry cost of harmonized tax

Ontario’s harmonized sales tax proposal seems to have created a disconnect between advisors and their investment fund providers. Ontario-based fund firms see their operating costs skyrocketing. Many advisors, however, get a tax break. But it’s the investors who’ll end up paying more.

The mutual fund industry has been very vocal about adding the provincial sales tax to investment fund products — which were previously exempt. In a nutshell, mutual funds are taxed separately than the firms that operate them. Therefore mutual funds have to pay tax for the management and operating services the fund firm provides.

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On a fund with a management expense ratio of 2%, a mutual fund company will have to tack on roughly 16 basis points to cover their tax expenses, in addition to the 10 basis points of GST it must pay. When you consider the operating costs of most major mutual funds are less than 20 basis points, this is a rather large proportional addition to the cost base.

“Having more media coverage relating to tax issues in mutual funds is important. It’s a material cost to the end investor. It’s very transparent in the prospectus and in all our materials,” says Peter Intraligi, president of Invesco Trimark.

Intraligi says few investors are reading through the entire prospectus; they primarily rely on advisors to explain the costs associated with the product. In many ways it’s up to the advisor to educate the end investors about the cost they are paying on funds.

“Advisors are playing a key role, taking their clients through what goes into the MER. There’s definitely support on that front. I think in today’s environment, there will be a lot more emphasis and focus on it. If you’ve got your investment portfolio and you’re down 30%, you’re going to be asking a lot of questions, you’re going to be taking a closer look at your finances,” he says.

While some advisors have expressed concern about the overall cost to their business, the increased cost to the investor doesn’t seem to have elicited the same outrage as it has from industry groups that represent product providers. Nominally, 16 basis points are viewed as a small increase in fees. For independent business owners, of which there is a strong advisor contingent, the HST benefits can outweigh the costs (to investors) on the services they provide.

“It would have been good to see the government provide exemption for the servicing costs of investment funds. The full harmonization will reduce investor returns during a time when investors are really trying to regain what’s happened to their portfolios,” says Peter Tzanetakis, senior director of regulatory affairs for Advocis, Canada’s largest advisor advocacy organization.

Tzanetakis says the efficiencies created by the tax proposal for advisor businesses are welcome.

“From an operating perspective, business purchases that attract provincial retail sales tax will now be subject to the new harmonized sales tax. Businesses are able to claim tax returns on the combined 13%; not just the 5% current GST. For example, advisors or planners leasing an automobile would be able to claim tax back on the combined tax rate where they are permitted to do so,” he says.

Tzanetakis says this creates cost savings opportunities on the business the advisor runs. For advisors who build their business on commissions, the HST may end up being a net-win situation.

John Novachis, executive vice-president of Investment Planning Counsel, says to his knowledge none of IPC’s affiliated advisors have complained about the HST. He doesn’t foresee any increase to the operational costs at the dealership.

Novachis suspects fee-for-service advisors may, however, have some challenges.

“From all indications — and to be fair, I haven’t dug deep into this — I would suspect advisors who are in the fee-for-service would be impacted by the harmonized tax,” he says.

Fee-for-service advisors tend to sell their services based on a lower fee for advice-only investment or planning advice. A typical charge is 1% annual fee on all managed assets. The HST will force these advisors to add eight basis points of tax to the services they provide.

While this may not seem like much, but consider that high-net-worth investors are particularly attracted to flat management fees. Eight basis points on a $1 million account amounts to $800. What’s $800 to a millionaire? Maybe not a lot — then again see it against a backdrop of 30% losses in their portfolio. This is a challenge advisors will have to address.

And then there’s insurance. Right now, the industry is trying to figure out whether the HST proposal is good or bad. From the look of it, it will likely have more of a negative impact. In particular, an Ontario-based segregated fund will now have to pay an additional 8% sales tax on the insurance protection it provides. Investors will end up paying double sales tax on these products.

Ron Sanderson, director of policy holder taxation and pensions for the Canadian Life and Health Insurance Association (CLHIA), says life insurance companies straddle so many sectors and products, it’s difficult to determine how the tax will impact pricing and costs.

“The extent of the HST impact is something we are still examining, says Sanderson. “For example, group insurance products may already be subject to provincial sales taxes in Ontario and Quebec. The question is: Does a combined harmonized sales tax create a more [efficient] tax situation?”

Sanderson notes the HST is not going to affect all products in the same way. It may not even impact all companies the same way, since they are all based out of different provinces.

“Unfortunately, our business is more complicated than other financial institutions,” he says.

(04/03/09)