I have been writing about how HST would have an adverse impact on the average mutual fund investor. Clearly the imposition of a new tax on the management expense ratio (MER) charged by mutual funds reduces the rate of return for investors. But what about the federal GST?
The GST has been charged on mutual fund management fees since it was introduced in 1991. Like HST, GST also impacts the returns investors realize on their mutual funds but since it has been around for so long, it hasn’t really been an issue for many Canadians. We have held our noses and accepted this additional tax on our investments.
If Mutual Fund MERs Are Exempt From GST
What happens to government revenue if mutual fund MERs are exempt from the GST?
Logic dictates that when the GST is eliminated, the return on the mutual fund goes up. Since the return goes up, the capital gain also increases. The question becomes: Will governments benefit from exempting MERs from the GST?
The Math Suggests Not
The government receives tax revenue from the GST and capital gains. The following chart assumes a $100,000 investment in a mutual fund with GST and with out. If the mutual funds are held outside of a retirement account, the government looses tax revenue from exempting MERs.
With the above scenario, the government forgoes $110 in tax revenue.
The Economic Effect
If the return on mutual funds is too low due to the sales tax burden, then investors will ultimately seek other investments such as direct investments in stocks, bonds or ETFs that do not have (or have a substantially lower) sales tax attached.
This economic shift, which is already underway with the popularity of ETFs, will ultimately erode the revenue from GST.
Exempt MERs From GST (And HST)
The government will ultimately lose their tax base from mutual fund MERs as investors shift from high cost investments and they should therefore exempt MERs from both the GST and HST.