It’s Time to Reduce Taxes on Mutual Funds

Laws and regulations follow each other in such quick succession that we rarely take the time to think about the inequitable and unfair situations that can result from their accumulation.

As one of my colleagues recently pointed out, the taxation of mutual funds is a case in point.

Two decades after the introduction of the GST, and after several modifications of provincial sales taxes, the burden of mutual fund sales taxes has gradually become heavier, reaching a point today that is completely out of proportion compared to other investment vehicles.

This situation is the result of a particular feature of mutual funds. Since they are trust companies, they do not hire any staff directly, which means that all hours of labour devoted to them are subject to sales taxes. This places these funds in a situation that is different from practically all other investment products. And since these funds do not sell anything that is taxable, they cannot be reimbursed for these sales taxes using tax credits.

This leads to a situation that is patently unfair. The average portion of sales taxes embedded in mutual fund management fees, and which is therefore entirely paid for by investors, is estimated at 8.2 per cent, versus around 2.6 per cent for guaranteed investment certificates. As for buying stocks and bonds directly, the rate is 0 per cent since the companies issuing such securities are reimbursed for sales taxes.

This unfavourable treatment of mutual funds means that the government is inflating mutual fund management fees. It therefore hampers Canadians' retirement preparations, and works against policies aimed at encouraging saving through RRSPs and TFSAs. For an investment goal that would have taken 25 years to reach, these taxes delay the achievement of this objective by five months. Workers therefore either have to delay retirement, make do with less, or contribute more each month.

And the cost of this injustice has increased over the years. When the GST was introduced in 1991, the mutual funds industry represented less than $25 billion, whereas today it has grown to $855 billion. During the same period, provincial taxes appeared, and with harmonization were also applied to mutual funds, leading in the end to the current situation, without paying any heed to the effects of these new taxes.

Moreover, the sales tax levied on mutual funds does not reflect the rates in effect in each province, but rather an average of the sales taxes applied in the different provinces, weighted according to the proportions of a fund's shareholders in each province. Concretely, this means that through their mutual funds, shareholders in the four Western provinces and the three territories–where provincial sales taxes are not applied — end up paying provincial taxes to the Atlantic provinces, Quebec, and Ontario.

There are solutions that would address this situation. In order to reduce the tax burden of investors who choose to purchase mutual funds, we could for example take a page from pension funds, which are entitled to tax credits equal to 33 per cent of the sales taxes they pay. Alternatively, mutual funds could simply be exempted from all provincial sales taxes.

With rising life expectancy, saving for retirement is becoming increasingly important, and programs like RRSPs and TFSAs encourage Canadians to save by allowing them to shelter certain portions of their incomes from taxation. But governments undermine this objective by excessively inflating mutual fund management fees with sales taxes, thereby slowing down Canadians' retirement preparations.

Michel Kelly-Gagnon is President and CEO of the Montreal Economic Institute. The views reflected in this column are his own.

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