More news on HST

Message sent on behalf of Nick Pszeniczny, Executive Vice-President, Distribution, and Rick Rausch, Senior Vice-President, Individual Retirement Investment Services.

Copies have been sent to regional directors, operation managers, Investment Managers and Consultants, Investments Administrative Coordinators, field management and administration personnel and staff associated with Individual Retirement and Investment Services.

Important information regarding the Goods and Services Tax and Harmonized Sales Tax – Impact on mutual funds and segregated funds

Effective July 1, 2010, expenses charged to investment funds and all investment management and advisory fees will be subject to the Harmonized Sales Tax (HST) in Ontario, British Columbia, Nova Scotia, New Brunswick and Newfoundland and Labrador.

The HST, a federally-administered tax, combines the Goods and Services Tax (GST) and the provincial retail sales tax (PST) into a single sales tax. The HST is new in Ontario and B.C., while new rules now make the tax in the existing HST provinces applicable to all funds.

What are the tax rates?

Province(s)/Territories HST rate     
British Columbia        12% (5% federal and 7% provincial component) 
Ontario, New Brunswick, , Newfoundland and Labrador     13% (5% federal and 8% provincial component) 
Nova Scotia    

15% (5% federal and 10%

  provincial component)

(as of July 1, 2010)

     
Alberta, Manitoba, Prince    Edward Island, Quebec, Saskatchewan, Territories   5% federal GST only    

What’s taxable?

The HST will apply to GST-taxable services that are charged to investment funds as well as to any investment management or advisory fees that are paid outside of the fund. These services are currently subject to five per cent GST. The HST will also apply to other services already subject to GST, for example annual trustee fees for RRSPs, RRIFs and RESPs.

The HST will not apply to expenses or fees that currently are not subject to GST such as insurance premiums (including premiums paid for benefit riders on segregated fund policies).

You may have seen media coverage of a proposed change in the definition of a financial service for GST purposes that would have the effect of introducing GST on commissions related to the sale and service of investment funds. Industry associations have opposed the nature and timing of this change in policy. 

Federal Finance Minister Jim Flaherty has recently stated that no change in existing policy was intended, but rather just a clarification that all services previously taxed would continue to be taxed. This clarification was required following some 2009 court decisions against the Canada Revenue Agency (CRA) in this regard. We await confirmation from the CRA of the minister’s position.

What does this mean for investors?
The HST means a higher tax rate will apply to investment funds effective July 1, 2010. This will increase the costs incurred by the fund, where such costs are paid at the fund level, and for investors directly, where such costs are paid by the investor. Only half of the increase will be felt in 2010 due to the timing of the change.

How will the tax apply?
The specifics of how the HST will apply are not yet fully known. New rules defining what rates apply have been released for some sectors and discussed with industry representatives for others. We have been working with the federal, Ontario and B.C. governments for many months to try to address the challenges of applying various tax rates to a pooled product like investment funds. Industry associations continue to express concerns regarding the effects of this tax on Canadians’ ability to save and invest for retirement and other purposes.

We will provide further detail once the government publishes the final regulations.

HST on Insurance and Investments

I just received an email from Advocis, the insurance and financial services association I'm a member of. The topic was on GST/HST Notice No. 250

CRA has indicated that trailer commissions, front-end
load commissions, deferred sales charges, commissions on various
insurance products and redemption fees paid by investors do not constitute a
supply of a financial service and will be subject to GST. It is not clear at this
point in time whether financial advisors will be required to register for GST
purposes and remit GST.

Currently the insurance and investment products are exempt from PST/GST/HST. Its been this way for years. In this latest notice CRA has indicated that they have decided to remove this exemption from certain policies. That means any new insurance or investment policies will now be GST-able or in BC HST-able. That means we have gone from no sales tax to 12% overnight. There is nothing in the notice which indicates who gets to deal with this change. Do the insurance companies take over the administration of remitting the tax? Does every advisor now need to register for GST/PST/HST? Unlike some products where the CRA says HST will actually lower prices because there will be a "flow-through" of PST that will not be the case with this change. There has never been GST or PST anywhere in the supply chain so we cannot pass along any savings. Furthermore, as well as the tax, there is going to be added cost in administration of these policies so base costs will be going up as well. 

I think this is a terrible idea, why would the CRA want to discourage people from investing and purchasing insurance? Last time I checked CRA makes buckets off taxes on investments.

CRA has provided some handy dandy examples of when the service would be deemed non-exempt. according to the example below. CRA doesn't clarify exactly how this will apply to real world commissions, does it impact the commissions paid to the MGA? what about overrides or bonuses?

Example 2
In the course of providing services to investors, an investment dealer arranges to purchase units of a mutual fund for an investor. A commission is paid to the investment dealer at the time the units are purchased. In addition, the investment dealer will receive a fee referred to as a "trailer commission or fee" from the fund manager. The prospectus describes these fees as being paid in recognition of the investment advice and ongoing administrative services rendered by the investment dealer to the investors. The “trailer commission or fee” is paid annually subsequent to the arrangement for the purchase of the units. The services provided by the investment dealer, including advice, arranging for the purchase of the units and on-going administrative services for which the investment dealer is paid the commission and subsequent fees would not be a supply of a financial service.

For example, If I were to invest $100,000 of your money in an RRSP, I would be paid a commission of approximately 3% or $3000 (for a back end load policy), however, the MGA I placed the business through would also get paid 2%, for a total of 5%. Now is the 3% taxable or the 5%? We are talking CRA here, so lets assume they are going to be greedy and they tax the 5% commission paid to the MGA and the advisor. In BC the HST will be 12% so we are looking at 12% HST on $5000 of total commission. That is $600 in new taxes you will have to pay. This new tax just cost you 60 base points of return.

Furthermore, CRA is proposing that these changes be effective Dec 14, 2009. a full three and a half months in the past!

Coming into force
These proposed amendments would apply to investment management services rendered under an agreement for a supply if any consideration for the supply becomes due or is paid without becoming due after December 14, 2009. They would also apply to an investment management service rendered under an agreement for a supply if all the consideration for the supply became due or was paid on or before December 14, 2009, unless the supplier did not, on or before that day, charge, collect or remit any amount as or on account of tax in respect of the supply or in respect of any other supply that includes an investment management service and that is made under the agreement.

This means every advisor or insurance company has to go back into their records, and somehow collect GST on past sales? lunacy!

More as this unfolds.

Trading liquidity for certainty with an annuity

Great article in the Globe and Mail on the Insured Annuity concept.

Tim Cestnick

Published on Thursday, Jan. 14, 2010 12:00AM EST
Globe and Mail

Tim Cestnick is managing director at WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians. 
 
Perhaps you've heard the story of the elderly gentleman? The story, which varies a little depending on where you first heard it, goes like this: A reporter was sent to interview a man as he turned 100 and find out if there were a formula to his longevity. "Sir, do you have any secrets you can share that have allowed you to maintain such good health for so long?" "Well, I go to bed early, get up at six in the morning, eat lots of vegetables, I don't smoke or drink, and I go for a brisk walk every day," the man replied. "There must be more to it," said the reporter. "I had an uncle who lived the same way and he died at age 60. I'm not sure how to explain that." "That's easy," the man said. "He didn't keep it up long enough."

Everyone is searching for the secret to longevity. The question is: Will you run out of income before running out of retirement? Today, I want to share a retirement income idea that can provide an increase in your after-tax cash flow in retirement, preserve your capital, boost your returns after tax and other costs, and remove interest rate risk from your portfolio. I'm talking about an insured annuity.

The idea
The insured annuity concept involves doing two things: First, purchasing an annuity to provide you with cash flow in retirement, and purchasing life insurance at the same time. Why life insurance? Simple. When you carve out some capital to purchase the annuity, those are dollars that your heirs will never receive. Once you're gone, the annuity payments cease, and whatever capital might have been invested in that annuity is also gone - nothing will generally be given to your heirs (you can purchase a guarantee so that, if you die young, your heirs are guaranteed to receive some minimum amount, but this is not generally done due to the added cost).
The insured annuity idea works well provided that you or your spouse are insurable at standard rates (if you're high risk and the insurance is more costly, the idea may not make sense).

The example
Here's an example that comes courtesy of John Jordan, CFP. Consider Mike and Shannon. Both are 70 years of age and are in good health. They're concerned that their retirement income has been eroded by low interest rates and poor investment returns. The couple has a portfolio that includes $400,000 in GICs and T-Bills, earning an average of 4.5 per cent annually. Mike and Shannon would like to keep $150,000 fairly liquid for emergency purposes, but would like to increase their after-tax returns on the other $250,000.

Currently, the couple will earn $11,250 annually (4.5 per cent on $250,000) on the GICs and T-Bills. At a marginal tax rate of 43.41 per cent (the second highest marginal tax rate in Ontario), the couple will pay taxes of $4,884, and will be left with $6,366 after taxes annually.

Mike and Shannon have chosen to implement an insured annuity strategy. Here's what they did: They used $250,000 to purchase an annuity. The annuity will pay them $20,286 annually. Just $5,042 of the annuity payments are taxable. Why? Because each annuity payment is partly a tax-free return of their original capital, and partly interest income. The tax owing annually on the annuity payments will be just $2,189, and they will recoup some Old Age Security benefits in this case as well ($527 annually) since their taxable income won't be as high, leaving $18,624 after taxes annually in their hands.

Now, Mike and Shannon will use some of this annuity income to pay for a $250,000 life insurance policy that will pay out on the second spouse's death. This will replace the $250,000 that was used to buy the annuity. Their heirs will get this cash upon the second death. The life insurance premium annually is $6,252 in this case. So, the amount left in their hands annually until the second spouse dies (after taxes and insurance costs) is $12,372. This is much higher than the $6,366 with the GICs and T-Bills. In fact, the couple is better off by $6,006 annually.

Keep in mind that you'll be giving up some liquidity with this idea; you can't pull money out of the annuity except by way of your set monthly payments. So don't invest all of your cash in this strategy. Finally, be sure to apply for the life insurance first; if you're not insurable, you may choose not to buy the annuity.

This is a great strategy if you are in good health, or if you already have a permanent life insurance policy in force. This strategy was very popular in years gone by, but with the stock market vastly outperforming GIC's and Term Deposits over the last decade;save the last 18 months, keeping liquid in a RRIF was more popular. Now that growth and income is down the tubes, the insured annuity strategy is paying the highest return in town.

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Edit: Nerding out a little, I ran real quotes for the life insurance and annuity.

Best life insurance rate for a couple age 70 in good health is $5,047.50/y from Industrial Alliance Pacific

A non-reducing Annuity, (payments stay the same after the first death) will currently pay $17,917.47/y from Canada Life. Taxable portion $4964.10

A reducing Annuity, which drops to 70% after the first death is currently paying $19,773.15/y also from Canada Life. Taxable portion $4803.09

A reducing Annuity, which drops to 50% after the first death will pay $21,229.32 from, you guessed it, Canada Life. Taxable portion $4450.80

You also can't get 4.5% from a GIC right now, highest I see is 3.55% for 5 years from Empire Life, but lets assume they have some older GICs that are paying 4.5%

Going the GIC route the couple will be left with $6,366 after taxes annually.

Non-reducing Annuity $10,715.05 after taxes and insurance.

70% reducing Annuity $12,640.63 after taxes and insurance, until the first death then, $10,479.04  after taxes. There is no insurance cost as the policy is paid up on the first death.

50% reducing Annuity $14,249.73 after taxes and insurance, until the first death then, $9,648.61 after taxes. There is no insurance cost as the policy is paid up on the first death.

So which would you prefer?
One point that needs to be made, is that using a prescribed annuity, which uses return of capital to keep taxes down, starts to result in higher taxes in later years. As the original capital is paid out the the annuity more and more of the payments come from interest earned. Eventually the taxable portion will grow to the entire annuity payment. In later years the benefit from the strategy starts to reduce.

Taxation of Critical Illness and Disability Insurance Cheat Sheet

Great West Life, one of the companies I do a fair amount of Living Benefits business with has a great cheat sheet for the taxation of Critical Illness and Disability Insurance. I'll let the sheet do the rest.

Edit: Yay for JPEG compression, better quality here Link to PDF

Edit 2: Replaced images with better quality PNG