Foreign content confusion

The sudden abandonment of the foreign content rule that was announced in the February budget is still causing confusion among both investors and money managers. But some mutual fund companies are starting to take steps to remove the financial disadvantage imposed on clients who have invested in “clone” funds, which were originally created to get around the 30 per cent foreign cap within registered plans.

On March 9, HSBC Investment Funds announced that it has reduced the management fees on two of its clones, retroactive to Feb. 28. They are the HSBC Global Equity RSP Fund and the HSBC US Equity RSP Fund. In the latter case, the difference is significant. Prior to the roll-back, the fund had a management expense ratio (MER) of 2.57 per cent compared to 2.23 per cent for the parent HSBC US Equity Fund. That differential of 34 basis points is on the high side for clones and investors paid the price in lower returns. Over the six months to Feb. 28, the parent fund gained 1.94 per cent while the clone was ahead only 1.4 per cent. Eliminating the MER differential will bring the two into closer alignment until they are eventually merged.

The next day, Fidelity joined thparade by announcing that the MERs on all its clones will be reduced to the level of their parent fund. By my count, Fidelity has 17 clone funds with total assets approaching $1 billion so the loss in fees to the company is significant. Fidelity said the move is effective immediately.

There was a paragraph in the announcement that caught my eye. It read: “This decision is in anticipation of the eventual elimination of RSP funds. Fidelity will proceed to eliminate the funds as soon as the Government’s proposed policy change comes into force. This, however, is expected to take several more months. In the meantime, Fidelity expects to continue managing the RSP funds without any significant changes to their structure or tax eligibility.”

This is an example of the utter confusion gripping the industry. Fidelity says it will act “when the policy change comes into force”. Actually, it is already in force. Historically, the practice has always been that when a Finance Minister makes an announcement of a tax change that is to take effect immediately, the Canada Revenue Agency (CRA) treats it as if the legislation were already approved. That’s why a tax increase can be implemented at midnight on the same day it is announced. The details are tidied up later.

I have asked the CRA whether the policy applies in this case and have been assured that it does. No penalties are to be levied on registered plans that exceed the 30 per cent limit going forward.

Plan administrators not on board
However, you’re likely to find that your plan administrator isn’t co-operating. I’ve received several complaints from people who have been told they are not allowed to go over the old 30 per cent limit or have been assessed the 1 per cent monthly penalty if they do.

The reason is that it will cost a lot of money to reprogram the software that monitors foreign content. Registered plan administrators don’t want to commit to that expense until the enabling legislation has been passed by Parliament. The bill was tabled in March but will probably take at least a couple of months to go through.

Plan administrators and fund companies are worried because this is a minority government. They fear the Liberals might be defeated and an election called before the amendments to the Income Tax Act are passed. It would then be up to the new government whether or not to proceed. So they are protecting their backsides.

Any penalties assessed in the interim will have to be refunded, but that will take time. So you may want to hold off a while before increasing your foreign content, even though the government says its all right to do so.