Ontario budget gets mixed reviews

Ontario’s financial services industry seems to be welcoming yesterday’s budget by the Ontario government — albeit with caution. In particular, the unknown impact that the harmonized sales tax (HST) will have on fund investments remains a concern.

The reduction in corporate tax rates that comes along with the harmonized sales tax is definitely a positive move, according to the Toronto Financial Services Alliance.

“We are particularly pleased with the reduction in corporate income tax rates and its commitment to a value-added tax,” said Janet Ecker, president of the TFSA. “While there are still issues to be resolved regarding the application of a harmonized sales tax to services provided by our members in the financial services sector, the move toward tax harmonization will undoubtedly contribute to the province’s longer-term competitiveness, as will lower rates.”

Ecker questions how effective the measure will be in diminishing the impact of a global recession that is having a much more pronounced impact in Ontario than in other provinces. Ecker notes that the tax changes do not come into effect until 2010, which means they will not have any immediate stimulative effect on the economy.

Advocis, the largest financial advisor association in Canada, gave the thumbs up to the “Open for Business” initiative, which will attempt to reduce the regulatory burden by 25% over the next two years, including work to develop a single national securities regulator and promote the further development of Toronto as a global financial centre.

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“The Open for Business initiative, which commits to reducing red tape by 25% over the next two years, is a positive move,” says Greg Pollock, president and CEO of Advocis. “However, it would have been better to see some specific reference to the financial services sector. When advisors and planners are not crushed by increasing compliance costs, they are able to afford to stay in business in this province, and consumers will continue to have a wide choice in where and how they receive financial advice.”

A point of contention is the impact the HST will have on Canada’s fund industry and the advisors who sell them. Advisors across Canada can expect to pay an additional 8% on the management expense ratios of most of the funds they sell — simply because most of those funds are domiciled in Ontario.

“Harmonization will add another tax to disadvantaged mutual fund investors during a global economic downturn that has already eroded their savings,” said Randy Ambrosie, president, AGF Funds Inc. “The addition of this tax comes at a time when Ontarians are worried about their jobs, their homes and their retirements.”

Both mutual fund and ETF trust structures are taxed as entities apart from the firms that operate them. They were exempt from provincial sales tax but will now have to pay the new 8% sales tax on the management expense and most of the operating costs they incur. Proportionally, this charge is huge when you consider that the operating costs for a fund are a relatively small part of the MER.

John Parker, vice president and chief financial officer of IFIC, says his organization will try to persuade the Ontario government to change the budget bill.

“I think there is still an opportunity to make this relatively acceptable for investors,” he says. “We’ll try to move on this as quickly as possible so we can minimize the impact this will have on savings.”

One of the suggestions IFIC may put forward would be that Ontario follow the Quebec model for taxing financial services.

“Quebec offers a zero rating with a compensatory tax,” he says. “You’re still paying a little bit of tax, but you’re zero-rated, so the province is not losing any money from the sector that it would have gained under the old system, but it’s not charging the full harmonized rate.”

Parker cautioned that it is still too early for fund companies to be talking about moving out of Ontario, because they still don’t know what parameters will trigger taxation.

“The odds are it will be based upon where the trustee is physically residing, but I’m speculating on what we think it will be. We do need to wait for those details,” he says. “Taxation could end up being based on where a company’s head-office is, or also could be based on where investors reside. [The latter] would be an administrative nightmare, but it would be more palatable for investors.”

In an interview with Advisor.ca last week, Stephen A. MacPhail, president of CI Financial, highlighted that on many of its mutual funds, the taxes paid will be almost equal to its fixed operating cost of 18.5 basis points. For example, on a fund with an MER of 2.20%, the HST would add about 18 basis points of tax expenditures. Tax in total would be about 30 basis points — almost double the operating expenses of most mutual funds.

“Taxes will be 160% of what it cost us to operate the whole fund and provide all the other services. The tax would end up being more than the entire payroll of our entire company,” MacPhail said.

This type of increase in expense &$151; which will create double taxation on segregated funds because the guarantee is taxed — will be borne by investors. This concerns Advocis.

“At a time when consumers’ investments have taken a huge hit, consumers don’t need any additional cost burdens,” Pollock says. “Given the present circumstances in the markets, investment funds should have been exempt from an Ontario HST.”

Som Seif, president of Claymore Investments, points out that even on ETFs the MERs will be increased &#151 although by a much smaller amount than on mutual funds, since they have much smaller fees. Seif says the failure to exempt investment products doesn’t make sense, when the Ontario government has pointed out that protecting savings is one of its key initiatives.

“The MERs will go up with the HST. We haven’t done our analysis on it, but I would assume it’s going to affect us,” he says. “It’s 8% of our fees, which are lower than mutual funds. The government has effectively squeezed through a tax that will cost investors a significant amount of money. They are trying to promote saving and then they go and tax it all. It’s a terrible idea. This is a travesty for Ontarians and even Canadians.”

CI has openly mused about moving its fund operations to another province. Seif says for fund providers to do so would be taking a big risk, because there is a strong likelihood that other provinces will follow suit in harmonizing their sales tax.

“Moving is something we’re looking at. The problem is, we anticipate other provinces will follow suit. We could end up going through the work of domiciling the trusts in other provinces only to have those provinces offer the same type of [tax harmonization],” he says.

One group of fund providers, though, is giving the budget an overwhelming thumbs up. The Retail Venture Funds Association (RVFA) is pleased with the Ontario government’s proposed investment of $715 million to support innovation.

“This past year has been tough on Ontario workers, but it’s also been tough on venture capital investors and the start-up firms that rely on them,” said RVFA board member John Varghese, managing partner of VentureLink Funds. “The result has been that many early-stage technology companies have not been able to gain access to capital pools at a critical time in their development. The budget measures will help instill confidence in our tech sector and motivate venture capital investors to start investing in innovative Ontario companies again.”

(03/27/09)