The recent arrival of the harmonized sales tax in British Columbia and Ontario has created a challenge for investment fund management firms struggling to find a fair way to levy the HST, implemented on July 1, on their management fees, given a national client base and differing tax regimes across the country.

Although a handful of innovators, including Brandes Investment Partners & Co., EdgePoint Wealth Management Inc. and DundeeWealth Inc. ’s Dynamic Funds division, all based in Toronto, are introducing non-HST funds for provinces that don’t pay the HST, the majority of fund companies are taking a blended approach that applies a standard tax increase to all, whether unitholders live in a province that charges the HST or in a non-participating province that charges only the 5% goods and services tax.

“We do not feel it’s right to ask consumers in the non-HST provinces to pay the tax of the harmonized provinces,” says Jordy Chilcott, executive vice president of DundeeWealth and head of Dynamic Funds. “We have introduced a series of non-HST funds because we clearly believe it’s a benefit to unitholders.”

In Ontario, the HST adds an extra 8% to the imbedded money-management fees; in B.C., it adds an extra 7% — in addition to the 5% GST already being charged federally. This brings Ontario’s harmonized tax to 13% and B.C.’s to 12% — about four or five times the level of taxation on deposit products such as guaranteed investment certificates. Deposit products do not pay GST on the labour component of their costs, which amounts to almost 80% of a product’s expense.

When Ontario and B.C. introduced the HST in July, they joined Nova Scotia, New Brunswick, and Newfoundland and Labrador. However, a large population of investors in the Prairie provinces and in other parts of Canada are still not required to pay the HST — except on nationally distributed mutual funds that apply the HST, a cost that is imbedded in the management expense ratio paid by all unitholders. This means mutual fund unitholders in non-harmonized provinces are effectively subsidizing unitholders in HST provinces, the latter of whom are actually paying a little less than they should when their tax obligations are spread among unitholders across the country.

Dynamic Funds is launching a new series of non-HST versions of 44 of its mutual funds — spanning Canadian equity, foreign equity, equity income, balanced, fixed-income and specialty funds, as well as several fund-of-fund portfolios — which are expected to be available in early November. Chilcott says the launch of the new series is a “huge undertaking,” and will mean a non-HST version is available on more than 80% of the firm’s assets under management.

The eligible funds were chosen based on the size of their AUM, to ensure that the new versions would not incur management expenses that would exceed the cost savings passed to unitholders by eliminating the HST. Fund companies benefit from economies of scale, and expenses decline proportionately as AUM increases.

Chilcott describes the feedback from unitholders in Alberta, Manitoba and Saskatchewan as “overwhelmingly positive” and says there has been a “groundswell of support” for the non-HST series.

Brandes’ non-HST series is available only on the firm’s four largest funds: Brandes Global Equity, Brandes International Equity, Brandes Sionna Canadian Equity and Brandes Sionna Canadian Balanced.@page_break@EdgePoint is introducing an non-HST series on all four of its existing funds, but expenses are kept in check by having a minimum investment requirement of $15,000 on all funds — resulting in larger unitholder accounts and a lower administrative burden.

“If we were to introduce a non-HST series with the smaller funds, it would have a bigger impact on costs,” says Oliver Murray, president and CEO of Brandes. “On the smaller funds, we have decided to absorb the HST temporarily until we see how things shake out.”

Mark Kent, president of Calgary-based fund dealer Portfolio Strategies Corp. , says many of his firm’s clients are irate about paying the new blended tax, and some are moving their assets either to non-HST funds or to locally based money managers and investment counsellors who manage assets for high net-worth investors.

“Our more sophisticated clients are aware of the HST being imposed on some products and are quite upset,” says Kent. “We are being careful to avoid any solution that is more tax-friendly yet higher-cost, but have been taking some assets from some of the Ontario-based firms and placing it with Alberta-based firms. The blended rate option is terrific for Ontario residents whose tax bill is now being subsidized by someone on the Prairies but unfair to Canadians in non-HST provinces.”

The increase in fund taxes due to harmonization is significant and discriminatory, says Joanne de Laurentiis, president of the Toronto-based Investments Funds Institute of Canada, putting mutual funds and other types of managed money at a disadvantage relative to products such as GICs and individual stocks and bonds.

“We want the federal Finance Department to review the policy,” says de Laurentiis. “If funds are treated the same way as other financial products and services, the tax would be considerably lower. And that would be a huge relief for taxpayers. Statistics show that mutual funds are primarily used for retirement savings, which means the HST is hurting Canadians’ ability to save for retirement at a time when governments are concerned they’re not saving enough.”

IFIC is continuing to talk with the feds to arrive at a fairer taxation arrangement, she adds, and the talks are on “positive footing.”

The majority of fund companies have settled on a blended rate for the time being, but some are still considering other options, including tax rebates. Hartford Investments Canada Corp. of Toronto, for example, has decided to temporarily absorb the HST while studying which solution will work best.

Toronto-based Mackenzie Financial Corp., Invesco Trimark Ltd. and Royal Bank Asset Manage-ment Inc. , among others, have decided a blended rate is the fairest, most cost-effective and administratively feasible way to administer the HST, considering their huge selection of funds and their legions of small unitholders.

CI Financial Corp. of Toronto is also applying a blended rate for now, but executive chairman Bill Holland is unhappy about the upward pressure the HST puts on management fees. He says the HST is the biggest part of the MER — exceeding even payroll costs. “We probably will introduce non-HST funds,” he says. “People in the non-HST provinces don’t want to pay a sales tax for the rest of the country.” IE