The implementation of the harmonized sales tax in British Columbia and Ontario on July 1 has created some disharmony in the Canadian mutual funds industry.

Fund companies are dealing with the thorny problem of how to implement the new HST on their management fees, given that the tax rules vary from province to province — and the fact that mutual funds pool the investments of Canadians across the country.

Although most fund companies are taking a “blended” approach, which will apply the same tax increase to all investors, whether they live in a province with HST or not, a few trailblazers are launching separate series of funds for non-HST provinces. One firm says it will temporarily absorb the HST as it seeks a fair way to implement it.

B.C., Ontario, New Brunswick, Nova Scotia, and Newfoundland and Labrador all levy HST. The non-HST provinces include Alberta, Saskatchewan, Manitoba, Prince Edward Island and Quebec.

Goodman & Co. Investment Counsel Ltd. ’s Dynamic Funds divi-sion, Brandes Investment Partners & Co. and
EdgePoint Wealth Man-agement Inc. , all of Toronto, are the only fund firms so far to announce a separate series of funds for non-HST provinces. But there could be more such announcements as other companies gauge investor reaction to the higher tax and competitive pressures.

“With the blended rate, [clients in] some provinces will pay less GST than they should and [those in] the non-HST provinces will pay more — and that’s subsidization,” says Patrick Farmer, EdgePoint’s CEO. “Investors in non-HST provinces shouldn’t be paying a portion of the tax liability of those inves-tors in HST provinces. The people who elected the governments that are imposing the tax should be paying it.”

Hartford Investments Canada Corp. of Toronto will temporarily absorb the added cost of the HST; it is looking for a fair and administratively feasible way to implement the tax as it expands and introduces new funds. Hartford may cover the HST until the end of this year to avoid making a hasty decision.

“Ironically, it’s the smaller companies that are taking a fairer approach,” says Dan Hallett, director of asset management with HighView Financial Management Inc. of Oakville, Ont. “I would have expected the larger, more profitable companies to have created the separate series of funds.”

In Ontario, the new HST adds on an extra 8% to the value of money-management fees, in addition to the 5% federal GST already being charged; in B.C., the HST adds on an extra 7%. That adds up to a hefty tax on Canadian savings and puts mutual funds and other managed products at a disadvantage to deposit products, such as guaranteed investment certificates, which are not subject to either GST or the new HST in any province.

The blended approach in implementing the HST requires fund companies to make a weighted average calculation for the total taxes payable by fund unitholders in each specific fund series, based on the location of each investor’s assets under management.

For example, if half of a fund’s AUM is held by Ontario residents, the combined taxes on the management expense for this portion of assets is 13%. If the other half of AUM is held by Alberta residents, who pay only GST, taxes would be 5%. Fund unitholders in both provinces would pay the average — 9%.

Another possible solution is the provision of HST rebates to inves-tors in non-HST provinces. But this could be an administrative nightmare and may create tax implications for the rebate amounts.
@page_break@“Mutual funds are a national product, and our members must collect the tax according to the value of assets held in the harmonized provinces,” says Joanne De Laurentiis, president and CEO of the Investment Funds Institute of Canada. “The most administratively simple solution is the blended approach, in which everybody pays the same tax — and this is the solution most companies are using now. Where they will land longer term, we don’t know. Firms will be looking at the options as they gain more experience with the tax and things settle down.”

Even with a separate series of funds for non-HST and HST provinces, fund companies will still be doing some blending because the tax rate is slightly different among the provinces that charge HST. Thus, another challenge is the ad-ditional bookkeeping required when fund unitholders move from province to province and HST status changes.

“With the HST, we’re are moving with the pack and going with the blended rate,” says John Kearns, CEO of Toronto-based Northwest & Ethical Investments LP. “Some organizations are developing different classes of products, and that’s something we could potentially look at. The HST raises a lot of questions, and the blended solution could raise the ire of investors in non-HST provinces.”

Although the HST is buried in the management fee and not blatantly obvious, financial advisors may face challenges in explaining to their clients in non-HST provinces why those clients are subsidizing their counterparts in HST provinces.

“We have not yet received customer complaints, but the reaction has yet to be determined,” says Doug Coulter, president of RBC Global Asset Management, which uses the blended rate on its $100 billion of AUM, including those managed by RBC Phillips Hager & North Investment Counsel Inc. of Vancouver.

Introducing a separate category of funds in non-HST provinces could mean increased administrative and regulatory costs, Coulter adds, to the point at which there could be upward pressure on costs even without the HST.

Investors will need to compare MERs of competing fund companies and products carefully, Coulter says: “If the client is paying a higher fee for a non-HST fund, that negates the reason for the special series. Investors must decide if a fund is appropriate, based on its investment strategy and taking all costs into consideration.”

In RBC’s case, Coulter believes, the management fee will be competitive — even with the HST.

Brandes, for its part, has launched a series of funds for Class A and F investors in Brandes Global Equity, Brandes International Equity, Brandes Sionna Canadian Equity and Brandes Sionna Cana-dian Balanced funds. These will be subject only to the 5% GST and are for investors in non-HST provinces.

EdgePoint is planning to launch non-HST equivalents of Series A, B and F for each of its funds — Canadian Equity, Canadian Growth & Income, Global Equity, and Global Growth & Income — this month.

Farmer says EdgePoint’s relatively high minimum initial investment of $15,000 means its average account is bigger than at most fund companies, which eases the administrative burden in managing an additional fund series. EdgePoint’s tight lineup of only four funds reduces the number of transactions, which reduces costs.

Based on province of residence, eligible EdgePoint clients will be switched automatically and without tax consequences into the new class of funds. If they move to an HST province, they will be switched back to funds that charge the full tax.

“Advisors and investors in non-HST provinces are thrilled,” says Farmer. “Our competitors offering the blended rate will have a few tough questions to answer.”

IE