TERRANCE CORCHORAN: TIME FOR COMPROMISE ON TRUSTS

END TRUST WARS

BY Terence Corcoran,
Financial Post
Published: Thursday, January 25, 2007


Eventually we may get to a rational point in the income trust debate, some higher plain where we can no longer hear the juvenile caterwauling that currently drowns out sensible discussion. We got a glimpse of what that point might look like in Jack Mintz's commentary on this page yesterday reiterating his proposal to end the double taxation of corporate dividends.

Prof. Mintz's ideas and views on trusts, published in detail in the Canadian Tax Journal last year, are a good start, but maybe there's more to be done. An RBC Capital Markets analyst has done just that, taking up the Mintz plan and merging it with another to create a tax regime for both corporations and income trusts that would resolve the current cause of the clash between the systems.

The Mintz plan aims to end the core corporate tax problem that still exists in the Canadian system. Corporations are taxed on their income, but dividends paid to investors in RRSPs and pension plans are subject to tax again when the dividends are distributed as retirement income. To end that double taxation, Prof. Mintz proposes that Finance Minister Jim Flaherty introduce a refundable dividend tax credit for all Canadians.
An example: If a corporation earns $100 in profit, it pays $32 in tax at the corporate level. If it pays a dividend of $68 with the remaining cash, the $68 will eventually become taxable again in the hands of a retired person. If we assume a top tax rate of 43%, that leaves only $38 in the hands of pensioners. That's not fair.

To fix that double taxation problem, Prof. Mintz proposes a dividend tax credit that would refund the original $32 paid by the corporation to the pension fund or RRSP holder. The pensioner would then effectively receive $100 and pay tax only after the money is distributed as retirement income some time in the future. All investors would be in the same after-tax position.

The Mintz plan, thus oversimplified, ends there. The expectation is that the plan, which effectively standardizes the corporate tax rate across all Canadian taxpayers, would end the demand for income trusts since there would be no tax advantages to the trust structure.

Dirk Lever, at RBC Capital Markets, takes the Mintz plan further by incorporating another idea, first suggested in December by PricewaterhouseCoopers. The PWC proposal was aimed at neutralizing the double taxation effect of Mr. Flaherty's new tax on income trusts. It follows the same track as the Mintz plan. The tax paid by an income trust under the Flaherty plan would be reimbursed to pension funds and RRSPs on distribution. The income therefore enters a pension fund tax free and would then only be taxable when it is paid to the final recipient of retirement income.

The PWC proposal, therefore, only aims to fix the double taxation of income trust distributions, while the Mintz proposal aims to fix the same problem on corporate dividend payouts. The RBC Capital Market plan joins the two proposals, creating many benefits for the whole Canadian corporate tax system.

First, the RBC plan puts income trusts and corporations on the same tax footing. Second, it means that existing income trusts may not have to go through costly conversions from the income trust structure back to corporate structure. Best of all, the plan ends what has long been a source of distortion in the Canadian corporate tax system, the double taxation of corporate profits that are distributed to Canadian investors.
As Mr. Lever puts it, a merger of the Mintz and PWC plans "will eloquently solve both issues." All Canadians can come out of the trust policy fiasco as winners.

Trusts and corporations could then exist side by side as far as the tax rates are concerned, all other things being equal. There may, of course, be other reasons for investors and corporate managers to favour one structure over another, but at least the investment and structural decisions will not be dictated by distortions in the tax system.

To download the RBC Capital Market research papers on corporate taxation, check the online "extras" at www.nationalpost.com. As the government and the Commons finance committee review the income trust issue, they should know that they have a solution at hand that transcends the political grandstanding and hysteria-mongering that now dominate the debate.

© National Post 2007