INCOME TRUST TRUTHS #3

Flaherty’s Folly: In Bungling Bureaucrats We Trust

“You have to leave it [unwanted trust conversions] alone, or fix it.” -- Finance Minister Jim Flaherty, quoted in the Globe & Mail.

And what a fix Canada’s tiny perfect Finance Minister put the nation’s retirees in on Halloween Eve 2006, not to mention Canada’s energy industry, and the nation's future tax base. It was nothing short of what one retired civil servant typified as “the usual Finance bureaucracy f--k up.”

Metaphorically speaking, it’s what would happen if a plumber came to your home and fixed your leaking toilet the way Finance Minister Flaherty fixed the rush by corporate CEOs to convert to income trusts. Your entire toilet would be gone, your house would be completely flooded, and you would have to resort to, um, well let's not go there, when you felt nature’s call.

Talk about throwing the baby out with the bath water, along with the rest of your family and most of your life savings.

Vanity, Thy Name Is Flaherty

But the most amazing thing is that Minister Flaherty was so badly briefed on this issue, and knows so little about income trusts, that the poor fool still doesn’t realize the damage he’s wrought. Nor does he have any idea of the further damage his proposed initiative will have on Canada’s home-grown energy industry, or Canada’s future tax base.

Instead, Canada’s little financial Napoleon still struts proudly in front of the TV cameras and boasts proudly how the Conservative government saved Canada from financial disaster. And on that point, he’s proudly joined by the Canada’s Boss of Bosses, Stephen “Hit Man” Harper.

Yes, that’s correct. Both Tory fiscal masters of disaster are still willing to tell all and sundry what savvy and brave guys they were to break a popular election promise, without prior consultation, and to cumulatively relieve millions of Canadian investors of 20 billion dollars in savings -- not to mention making cat food the dinner of choice for many retired seniors.

And is anyone in the Conservative Party courageous enough to bring the two deluded amigos back to reality by pointing out all the damage they are about to wreak in Western Canada’s previously prosperous oil patch? Or inform them of the irony that this onerous tax initiative will likely result in less tax revenues for future governments? Not likely.

Panic In The Ministerial Corridors

Okay, so what were the events preceding Halloween eve that so panicked Canada’s ruling Conservative government that they approved a draconian legislative measure that even Paul Martin’s stumbling Liberal government had refused to sign onto one year previously?

Why did the Conservative political gang that can’t shoot straight (just look at their attempts to clean up the environment) eagerly sign onto yet another lame initiative from the gang in Finance that can’t calculate straight?

According to the Finance oligarchy’s media ally, The Globe & Mail, there was only one reason -- panic whipped up by, er, the Globe & Mail, regarding a perceived catastrophic loss of government tax revenues, resulting from Telus, BCE and other publicly-traded Canadian corporations converting into income trusts.

But wait a minute, how could the government lose further tax revenues from the conversion of Telus, for example, into an income trust in the autumn of 2006? As far as we know, Telus -- as a public corporation -- hadn’t paid a cent of corporate taxes to the government of Canada since the year 2000.

That’s correct, zilch. Nothing. Nada. Not a cent of corporate taxes from Telus in the five years before the company decided to convert into an income trust.

But under the pre-Halloween tax rules, once Telus became an income trust, investors in the new Telus trust would have had to pay personal income tax on the income they received from the Telus trust.

Not only that, but since the posted pre-Halloween corporate taxation rate was well under 33%, and the highest personal tax rate maxed out at around 47%, government coffers would have been filled with more tax revenues if Telus had converted to a trust -- even if Telus had been paying the maximum corporate tax rate.

What About BCE?

But what about the calamitous conversion of BCE into an income trust, you say? Surely, in this case, the barbarians were at the gates, taxwise.

After all, you might argue, where would the federal Arts Council otherwise get the money to fund that enlightening public art exhibit by Montreal artist Cesar Saez, in which a giant-sized yellow banana-shaped dirigible circles around the skies of Texas to make a symbolic statement about…er, uh, um…well, about something very important to Ottawa’s ruling elites…damned if we know what?

But actually, there’s something that the bureaucrats forget to tell our tiny perfect Finance Minister and his dour boss about corporations like BCE and Telus. The immediate tax haul, in terms of capital gains (“deemed dispositions”) collected from investors in the Telus and BCE common stock conversions (the “paper” gains Telus and BCE investors would have made at the point these stocks converted into income trusts), would have poured hundreds of millions of dollars of new tax revenue into government coffers.

And here’s another discomforting factoid that makes one wonder what Jim Flaherty and friends were smoking on Halloween eve. Now that the government has clamped down on income trust conversions, and prevented BCE from turning itself into a trust, we now learn that BCE still expects to be come up with enough tax dodges, as a common stock again, to pay minimum federal corporate tax until 2010.

How do we know? Well, BCE’s CEO Michael Sabia -- evidently now a close pal of Canada’s Finance Minister -- has proudly told us so: BCE, as a common stock, will face "no significant federal cash taxes through 2010."

Not to mention that Telus, as a common stock, is confident that its lawyers and accountants will be able to find sufficient tax loopholes in the coming years to continue to pay NO corporate taxes to the federal government.

In Harm’s Way: Harper’s Way, Or The Highway

Ooops! Did someone just mention alarming tax leakage -- and from publicly-traded corporations, not from income trusts?

By golly, is this how Jim Flaherty and Stephen Harper saved Canada from financial ruin? Just like Rona and Stephen saved Canada from environmental disaster?

Hmmm. Just how up-to-speed on this issue were the tiny perfect one and his brooding boss when they made their Halloween-eve decision?

Did someone -- perhaps a Finance bureaucrat, or two, or three -- kinda leave out a few pertinent facts about the reality of existing corporate tax avoidance in Canada, and about the hundreds of million dollars in personal tax revenue pouring in from income-trust investors?

Is it possible that the Finance bureaucracy -- the gang that can’t calculate straight -- made the mistake of making calculations and presentations, to their political masters, based on the statuatory (maximum) rate of corporate tax that could be collected from existing common stocks -- versus the reality of how much corporate tax the federal government was actually collecting from those public entities after their efforts at tax avoidance?

Perhaps, Canada’s beloved tax collectors forgot to inform the Finance Minister, and his Big Boss, that many Canadian publicly-traded corporations typically “run their books” annually to create tax write-offs that are so large, you could even ram a Cabinet Minister’s mammoth pension through them.

Well, yes, you argue, but what if almost every publicly-traded corporation in Canada had turned itself into an income trust, if the government hadn’t acted? Wouldn’t this still have resulted in a harmful distortion of the Canadian capital markets, since many common stocks just aren’t meant to be income trusts?

Indeed. But who said the government shouldn’t have acted to squelch the conversion of unsuitable common stocks into income trusts? We certainly didn’t.

And what if by Halloween 2006, the capital markets had already become corrupted by greedy paper pushers on Bay Street -- earning tons of dough from creating income trusts that shouldn’t have been income trusts? Shouldn’t the government have acted then?

Yes, they should have, is our answer. If this were the case, then the Harper government would have been justified in stopping the creation of new income trusts, or the conversion of common stocks into new income trusts -- and then engaging in public consultation to discover a means of reasonably stemming such excesses -- without destroying the entire income trust industry, or extinguishing the savings of millions of trust investors.

That’s what Paul Martin’s Liberal government was inclined to do in 2005, before having second thoughts. But why the overkill, by the Conservatives, when it came to dealing with income-trust conversions in 2006? Why the onerous “all-fits-one” Flaherty tax on trusts that appears designed to kill the income-trust industry entirely, and to arbitrarily shift investment capital to less deserving -- and sometimes riskier -- common stocks?

Were there no other fiscal “remedies” open to Jim Flaherty and the Harper government?

Other Remedies? What Other Remedies?

Actually there were plenty of other fiscal “fixes” open to Jim and Stevie.

As suggested above, a reasonable remedy by the Harper government might well have been to stop the creation of further new income trusts, and/or stop the further conversion of common stocks into income trusts -- and then engage in a public consultation to discover a reasonable structural remedy for stemming the Bay Street excesses that had been identified -- without destroying the entire income trust industry, or the savings of millions of income-trust investors.

Or to fulfil their desire to appear to take “decisive action,” the Harper government could have immediately ended the creation of new income trusts, but “grandfathered” (exempted) existing trusts from any new tax measures -- ensuring the viability of existing trusts and investors’ savings in them.

The dynamic duo either didn’t hear about such “moderate” alternatives from their bureaucratic advisers; or they were so panicked about what they had read about income trusts in the Globe & Mail, they felt they needed to something, anything, to look like they were still in charge.

How to sum up this Keystone Cops maneuvering of a new government and Finance Minister clearly out of their depth? How about the following comments from respected financial columnist, Diane Francis, writing in the Financial Post on December 2, 2006:

"It's obvious that Prime Minister Stephen Harper, Finance Minister Jim Flaherty and the civil service simply did not do their homework before wreaking $30-billion worth of havoc on the income trust sector. Even worse than the immorality of breaking a promise people made financial bets on, the Prime Minister et al are absolutely incorrect in assuming their proposal will enhance tax fairness, eliminate tax leakage and increase productivity. It will do the opposite.

The policy is so naive that there should be a full-blown hearing by the Senate into the matter before it's approved. To rush it through, without sufficient examination, would be to exacerbate what can only be described as a massive policy blunder by politicians that clearly don't understand capital markets…

New proposed taxes on income trusts will force them to restructure back into traditional corporations. This will increase the tax leakage...

Why wouldn't the Department of Finance, the Minister and Prime Minister understand this? Because Ottawa's analysis dealt with posted tax rates, not with the actual tax rates paid after all the accounting tricks are used [by public corporations]. Corporations duck taxes while income trusts are tax-generating machines…

Finally, the biggest blunder of all is that this policy announcement has discounted the income trust sector by $30-billion which represents a huge whack of the economic base of Canada. This confiscation of value will pave the way for traditional corporations and private equity outfits to pick them [income trusts] off cheaply. These potential buyers, often foreign, will turn around and borrow huge sums to buy them [income trusts] - money which will be written off against profits for tax purposes. The resulting leveraged buyout of the income trust sector will cost Ottawa dearly [in terms of the taxes they can no longer collect], thus putting more pressure on taxes from ordinary Canadian families."

We'll be back in coming issues to provide you with more truth about income trusts and the Ottawa gangs that couldn't calculate straight.