Every Canadian who owns mutual funds, needs to pay attention to Ontario’s provincial budget and its proposed harmonized sales tax (HST).
Ontario Premier Dalton McGuinty has announced that his government intends to harmonize the Ontario PST with the federal GST. Normally, this would only be of interest to Ontario residents but harmonization may mean that certain services that previously were not subject to Ontario’s PST will now be subject to the new HST. Most notably, certain financial service fees charged to mutual funds.
A mutual fund is a basket of stocks and/or bonds owned by a group of investors. The mutual fund company manages the money and the investment returns are passed along to the unit holders like you and I. The mutual fund companies charge a “management fee” which is currently subject to the federal GST but currently not PST in Ontario.
Higher Tax = Higher MER
If the new Ontario HST passes and financial services are subject to this new HST any mutual fund company resident in Ontario would need to increase the sales tax charged on its management fee from 5% to 13%. This means that the mutual funds management expense ratios or MERs will increase.
The MER charged to the mutual fund actually reduces the overall return of the fund which is why it’s important to pay attention to MERs on mutual funds. So when MERs increase the net investment return to investors goes down.
Here is an example. A particular mutual fund has an MER of 2% which includes the current 5% GST and has a gross investment return of 9%. The return on the investment the investor will see is 7%. If the HST is applied, the MER increases to 2.15% and the net return to the investor goes down to 6.85%.
Quantifying The Impact
So the MER went up, what does this mean in real dollar terms? If you invested $5,000 per year in this mutual fund inside a registered account (RRSP, RRIF, TFSA etc.), after 10 years your investments would be worth $625 less. After 25 years $8,000 less and after 35 years, $25,000.
Beware that this is proposed legislation and we won’t know all of the details until tomorrow. I’m keeping my fingers crossed that Ontario’s government will exclude mutual fund MERs from their HST.
Stay tuned as I follow this story.
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