Note to reader: I have an axe to grind. I own and operate a low-cost mutual fund company - and I'm hopping mad about the HST.
The impact of Ontario and British Columbia's harmonized sales tax will be negative for investors. No matter who you want to blame - the government or the investment industry - there is no getting around the fact that resulting higher all-in fees, compounded over a long investment horizon, add up to real dollars. For a long-term investor, it will be the difference between an Audi and a Taurus, or golfing in Florida versus watching the Battle of the Blades on CBC.
There are compelling arguments and precedent for not further taxing Canadian's retirement capital, but unfortunately they've fallen on deaf ears because of bad timing and the wrong messenger.
The timing relates to budget deficits. From what the insiders have told me, bureaucrats have been sympathetic to the investment issues around HST, but the response from a higher authority has been clear and consistent: "This is going to happen because we need the money. Focus on implementation and we'll talk about the inequities later." Recessions are a bad time for rational arguments and good policy.
As for the messenger, Joanne De Laurentiis and her team at the Investment Funds Institute of Canada (IFIC) have done a good job of laying out the arguments why the HST is bad for Canadian investors. But IFIC is an organization whose membership is made up of too many firms that charge world-leading fees, and have been reluctant to share the benefits of their scale with clients. IFIC's association with Bay Street's fat cats has hurt its credibility when arguing against HST.
The banks, which represent tens of millions of investors, have been surprisingly mute on the issue. They have huge mutual fund operations that attract HST, but most of their other investment and savings products are tax exempt. Their silence may be the result of their conflicted position, but it may also be because the impact of the HST is hard to figure out. As is often the case with tax policy, the legislation will significantly change the wealth management landscape, and not for the better.
Canada's regulatory patchwork, cut up by geography, product type and ancient history, has already inadvertently shaped how investment products are designed and sold. Structured products, for example, fall between the regulatory cracks and have been given freer rein to make marketing claims and obscure their fees and risks. A whole industry has been built around this regulatory arbitrage (playing one off against the other).
The HST will distort the industry more broadly, however, because some financial services are HST-able, while others are not (Note: The tax experts I consulted with are cringing at the simplification). The relative competitiveness of every product on the shelf will be affected, some good, some bad. The inequity lies in situations where there are products that are indistinguishable as to their objectives, risks and underlying investments that sit on opposite sides of the HST line.
Let me give you the early betting line on how it will play out, for both providers and clients.
Short-term vehicles like GICs and high-interest savings accounts will continue to be tax exempt. Money market and short-term bond funds on the other hand are taxable. Their attractiveness relative to banking products has always ebbed and flowed, depending on interest rates and the banks' funding requirements. But the tax will tilt the balance toward the deposit-taking institutions. Because investors have options when it comes to their savings needs, they will not be hurt in this case.
Facilitating a transaction is exempt from tax, so any form of service that charges a commission, as opposed to a management fee, will fare better. Hiring an adviser to select and buy individual securities won't incur tax, but getting professional help in another form - by buying a mutual fund - will.
The unfortunate consequence of different tax treatment for commissions versus fees is the likely reversal of a trend that has seen clients shifting to fee-based accounts. These accounts, which charge fees based on assets as opposed to transaction activity, better align the interests of advisers and clients. To be clear, the adviser is being paid for advice in both cases, whether it be a taxable fee or tax-exempt commission.
Structured products are not subject to HST. Compared to mutual and pooled funds, they will become more competitive. Again, for the client, any shift in this direction will be a step backwards. Structured "anything" is more expensive, complex and poorly understood. Firms selling exchange-traded funds (ETFs) have argued against HST on behalf of their clients, but from a competitive standpoint, they are huge winners in the HST realignment. Taxes on ETFs will go up, but due to their low fees, it won't be much. The fee gap between ETFs and conventional funds will widen.
I'm mad because this additional tax on Canadians' retirement goes against one of our country's, and dare I say our government's, highest priorities - getting Canadians to invest more for retirement. It hammers individuals who are investing on their own, and puts them at a bigger disadvantage compared with members of company pension plans. And its urgent and sloppy implementation negates years of efforts by the industry and regulators to improve how financial services are delivered.