LEST WE FORGET #2

Shameful Moments In Canadian History:
Stephen Harper Sells Out (Yet Again)!

The smoking gun(s):

http://www.youtube.com/watch?v=U9mibZYpVPY


The dirty deed and its aftermath:

TAXING TRUSTS WILL NOT LEAD TO TAX FAIRNESS

by Diane Francis
National Post
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 which 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. The root of the problem is that the decision was based on analysis by federal officials who regard RRSPs and pensions as tax "exempts" even though they are merely deferral mechanisms.

So the numbers were improperly counted when it comes to taxes paid by Canadian income trust unitholders. And the officials apparently missed the real source of leakage -- U.S. income trust owners, who pay only a 15% withholding tax. Not only was this ignored, but Mr. Flaherty even mused aloud that the 15% withholding tax should be even lower than it already is.

It gets worse. New proposed taxes on income trusts will force them to restructure back into traditional corporations. This will increase the tax leakage. A Post reader analyzed taxes paid by a corporation, Manulife Financial, and an income trust, CI Financial Trust. Manulife is a $40- billion market capitalization giant and CI Trust, $7.7-billion.

In 2005, Manulife's pre-tax earnings were $4.3-billion and the cash taxes paid were about 7% of earnings. It paid dividends of $926-million to shareholders, who were taxed at 18% rates. So the combined corporations' and investors' tax rates were equivalent to 25%. By contrast, the CI Financial Income Trust forecasted a 2006 distribution of $570-million and its unitholders would have tax rates of 35%.

Why wouldn't the Department of Finance, the Minister and Prime Minister understand this? Because Ottawa's analysis [regarding alleged 'tax leakage'] dealt with posted tax rates, not with the actual tax rates paid after all the accounting tricks are used.

Corporations duck taxes while income trusts are tax-generating machines because they are constitutionally set up to distribute a majority of their money to unitholders who pay full taxes, except for foreigners. (If Ottawa finally realizes that leakage is about the foreigners, then it should grandfather existing trusts and require future ones to have foreign ownership restrictions.)

On the issue of productivity, Mr. Flaherty and his Finance Department "pencils" get failing grades again. The theory of corporate taxation is that by imposing taxes on corporations, they will be encouraged to avoid them by keeping their cash flow then productively redeploying it. But here's how the real world works: Corporate managements usually deploy their cash surpluses to overpay themselves. Then they often get involved in unproductive, but tax-efficient, endeavours such as buying back stock, which, not coincidentally, also enhances the value of their own wallets. In addition, corporations use surplus cash to make sometimes foolish diversifications, acquisitions or sub-optimal investments in their own businesses. The examples are plentiful of such misadventures by cash-rich managements.

Finally, there's the governance issue. Many of us invested in the trust sector because we were sick and tired of lousy managements getting their sticky fingers on owners' funds. Besides, income trusts have more managerial discipline because they must make regular payments, which imposes on their managements a rigour that is otherwise non-existent.

As one reader summarized: "It is a simple truth that nothing Enron was doing, in terms of reporting as current earnings future questionable returns and concealing liabilities with dubious off-balance sheet debt parking, could have taken place if it was an income or royalty trust and forced to let investors know each and every month how much cash they were going to be getting."

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 these 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, thus putting more pressure on taxes from ordinary Canadian families.