Governments seek answers as to why fund fees are higher in Canada. Taxes are part of the problem.
On September 28, Finance Minister Jim Flaherty announced that he plans to ask a Senate national finance committee to investigate why it is that Canadians pay higher mutual fund fees than Americans. With all due respect to Mr. Flaherty, I don’t think that we need a Senate committee to investigate this issue. There are a few key reasons why fees are higher here than in theU.S.
The first is that inCanadamutual funds carry embedded compensation on most of the funds that are sold. This is often referred to as a “trailer fee” and is paid to a mutual fund advisor who sold the fund to an investor. This fee will typically add between 0.50% and 1.00% to the cost of a mutual fund. With a number ofU.S.based mutual funds, these fees are not included in the total cost of the fund. The second reason that mutual funds tend to be more expensive inCanadais that there is a patchwork of regulatory bodies that companies need to deal with here. When a mutual fund company wants to launch a new fund, it has to file a prospectus with 10 provincial securities regulators and three territorial securities regulators. This also adds to the cost.
A third reason that mutual funds cost more here is taxation. The management fees that mutual funds charge are subject to the HST. This can add up to 13% to the total cost of owning a mutual fund. Prior to July 2010, mutual funds were only subject to the GST, which is only 5%. The impact could be significant. The table below looks at the costs of a typical mutual fund inCanada.
|
Mutual Funds with no taxes on Management Fees |
Canadian Mutual Funds before July 1, 2010 |
Canadian Mutual Funds after July 1, 2010 |
|
| Management Fee |
1.00% |
1.00% |
1.00% |
| Trailer Fee |
1.00% |
1.00% |
1.00% |
| Fund Operating Expenses |
0.20% |
0.20% |
0.20% |
| Total Costs Pre Tax |
2.20% |
2.20% |
2.20% |
| GST/HST |
0.00% |
0.11% |
0.29% |
| Total Management Expense Ratio |
2.20% |
2.31% |
2.49% |
As you can see, the impact of the taxes can be significant. When only the 5% GST is charged, there will be an additional cost to investors of 0.11%. However, when the full 13% HST is charged, the additional cost to investors adds 0.29%. After the switch from the GST to the HST, the additional cost to investors amounted to 0.18%. Putting that in perspective, the total MER on the iShares S&P/TSX 60 Index ETF is only 0.17%.
A number of fund companies including Dynamic Mutual Funds, EdgePoint and Brandes have launched a different series of mutual funds for investors who live in provinces where there is no HST. These funds, typically referred to as G series funds, will only charge the GST on the embedded management fees for investors. This can be a big cost savings for investors who live in the non HST provinces.
Other fund companies are not charging the full 13% HST on their funds. Rather, they are charging what is known as the “Blended Rate”. The Blended Rate is a weighted average of the tax rates charged by the various provinces which is based on the location of the investors in the fund. To calculate the blended rate, the fund company would look at each fund and determine where all of their investors live. They would then calculate the blended rate based on this geographic breakdown.
For example:
| Province / Territory of Residence |
HST / GST Rate |
Investor Residency Breakdown |
| Alberta |
5% |
10.9% |
| British Columbia |
12% |
13.2% |
| Manitoba |
5% |
3.6% |
| New Brunswick |
13% |
2.2% |
| Newfoundland |
13% |
1.5% |
| Nova Scotia |
15% |
2.8% |
| NWT |
5% |
0.1% |
| Nunavut |
5% |
0.1% |
| Ontario |
13% |
38.7% |
| PEI |
5% |
0.4% |
| Quebec |
5% |
23.2% |
| Saskatchewan |
5% |
3.1% |
| Yukon |
5% |
0.1% |
| Weighted Average by Province |
9.60% |
While this scenario will still result in an increased cost to investors, it will have a lower impact than if the full 13% HST were to be charged. In our example above, the blended tax rate would amount to 9.6%, which would translate to an MER of 2.41%, which is 0.10% higher than the MER if just the GST were to be charged.
So while Mr. Flaherty and the Senate look for reasons why the costs of mutual funds are higher inCanadathan in theUS, the first place they may want to look is with the level of taxes that are paid on the management fees of mutual funds. Removing or reducing such taxes won’t close the cost differential betweenCanadaand theU.S., but it will certainly help to reduce it.