REPORT TO THE HOUSE OF COMMONS
ON THE DECISION TO TAX INCOME TRUSTS
RECOMMENDATION 1
It is imperative that a democratic government be as transparent as possible when levying a new tax so that it can be held to account by its citizens. The Committee, therefore, recommends that the federal government release the data and methodology it used to estimate the amount of federal tax revenue loss caused by the income trust sector.
RECOMMENDATION 2
The proposal to tax income trusts is of such significance and has had such a devastating effect on Canadian investors that Members of Parliament deserve a clear vote to best represent the interests of their constituents. The federal government should, therefore, separate it from the other sections of the Ways and Means Motion and table it in a stand-alone piece of legislation. The pension income splitting, the 0.5% reduction in the corporate tax rate in 2011 and the increase in the age credit amount should proceed as quickly as possible in their own separate piece of legislation.
RECOMMENDATION 3
Overwhelming evidence indicates that superior and far less damaging alternatives were available to the federal government. The Committee urges the government to consider implementing one of two such alternative strategies:
a)the federal government reduce its proposed 31.5% Distribution Tax on income trusts to 10%. This tax should be instituted immediately and should be made refundable to all Canadian investors. Furthermore, the government should continue the moratorium on new income trust conversions while remaining open to representations from sectors that feel they are well suited to the income trust structure; or
b) the federal government extend the proposed transition period from 4 years to 10 years.
LIBERAL OPINION
Having listened to all the witnesses, the Liberal Members of the Finance Committee believe that the government’s decision to tax income trusts was reactionary and ill conceived and reflects a poorly executed policy initiative.
The Committee heard from witnesses who made investment decisions based on a promise made by the Prime Minister not to tax income trusts, and lost substantial amounts of their savings when the Prime Minister broke that promise. The Liberal Members of the committee believe that the government acted recklessly and as a result ordinary Canadians have suffered unnecessarily.
The Finance Minister was unable to confirm that an impact analysis was conducted on the effect the new tax on income trusts would have on investors. Liberal Members of the committee believe that such a study should have been conducted and the results of that study considered when developing the government’s policy on income trusts.
The Minister of Finance justified the exemption of Canadian Real Estate Income Trusts by pointing out that they were exempted in the United States, but dismissed a similar American exemption for the energy income trust sector as irrelevant. The Liberal Members of the committee are concerned that such a contradictory approach to public policy is dangerous and not in the best economic interests of Canadians.
The Liberal Members of the committee are deeply concerned about the Minister of Finance refusal to release the data that supports his assertions regarding tax leakage, despite the Committee’s repeated requests for it. In the absence of such data, committee Members have had to rely solely on the advice of outside experts, who have calculated the amount of ‘tax leakage’ to be as low as $32 million or 14 times less than the Minister’s estimate.
While 70% of Canadians are not part of a defined benefit pension plan, the Liberal Members of the Committee recognize that income trust distributions provided many seniors with the regular income they require to maintain their lifestyle. There is no other high-yield investment vehicle available to average Canadian investors. (I’m not sure where John wanted the following comment added in, but he did remark: “The contrast of 25 billion market loss is painful and incomprehensible to investors.”
The Liberal Members of the committee recognize that not all corporations are well suited to the income trust structure. That said, several witnesses clearly indicated that certain sectors have used the income trust structure successfully to make reinvestments and increase their productivity. The Governor of the Bank of Canada has suggested that income trusts have been useful as a high yield savings vehicle, especially for seniors, and in contributing to the success and productivity of certain industries, notably in the energy sector.
The Liberal Members of the committee believe that reducing the 31.5 % tax to 10 % and making it refundable to Canadian investors is a better alternative to the plan proposed by the Minister, and the other alternatives discussed in committee. While a ten year “grandfathering” or extension would return some of the value to hurt investors’ portfolios, the former proposal would return far more of that which was lost.
Furthermore, the 10 % proposal would ensure that entities that are well suited to the income trust structure can continue to grow and invest in themselves, while the 10 year phase out would simply delay their death sentence.
As compared to the government proposal, the 10 % tax proposal is clearly superior. Experts agree that it would return some two thirds of the losses suffered by investors, would preserve Canada’s only high yield savings vehicle that is so valuable to seniors, and it would preserve a productivity-enhancing energy-sector. At the same time, expert testimony confirms that a 10 per cent tax that is refundable to Canadians would be enough to capture off shore leakage and ensure tax fairness. The income trust sector would not reduce government revenues or impose a higher tax burden on Canadian households.
Finally, under this proposal the moratorium on new trusts would be maintained for the time being while the government began consultations with sectors that feel they are well suited to the income trust structure. It is clear to the Liberal Members of the committee that the government did not think through the consequences of its ill-advised policy before taking action.
BLOC QUÉBÉCOIS
COMPLEMENTARY OPINION
The report does not take into account the Bloc Québécois’s recommendation
While the Bloc Québécois agrees with the report’s general direction as regards changes to the way income trusts are taxed, it stands firm on its position that the proposed four-year transition period should be extended to ten years. The Bloc maintains that the Conservatives’ election promise not to tax income trusts was irresponsible, given the structure of the Canadian economy. As a result of the Conservatives’ sudden policy shift on October 31, 2006, countless investors, caught by surprise, suffered major losses when unit values plummeted. Given this scenario, the Bloc Québécois would have recommended a transition period of ten years rather than four in order to mitigate the impact on small investors. This impact was artificially inflated by the Conservative’s decision to renege on their election promise.
The trust structure as a tax loophole: a threat to Canada’s economic growth
The Bloc acknowledges the importance of changing the way income trusts are taxed. At the outset, the income trust structure was intended to be used for mature asset classes that required little or no new capital; the reason being that all of a trust’s annual income must be distributed to unitholders, otherwise it is taxed at the highest marginal rate.
Because of the tax rates applicable to income trusts, corporations operating in fields that often require new capital investments started turning to the trust structure. Certain companies decided to convert to income trusts, not out of consideration for long-term growth but in order to take advantage, in the short term, of the beneficial tax rates that apply to trusts.
To avoid seriously compromising Canada’s potential for long-term economic growth, the government should definitely put an end to the open-ended opportunity of corporate conversions to income trusts. The Bloc acknowledges the appropriateness of this measure.
A four-year transition period penalizes small investors who trusted the Conservatives
The Conservatives made an irresponsible election promise that they would not touch income trusts during their term in office. The announcement that two key players, Bell and Telus, were planning to convert to income trusts changed things. The government had to take action, not only to preserve Canada's potential for economic growth, but also to avert what could amount to significant revenue leakages for the federal and provincial governments.
Nonetheless, the Bloc deplores the fact that the Conservatives chose to impose a transition period of only four years for existing trusts, rather than the ten-year period recommended by the Bloc Québécois. Given the election promise that income trusts would not be touched, this investment vehicle continued to be a relatively safe option, at least while the minority government was in power. That is why the value of income trust units remained so high. The Conservatives' surprise announcement, together with such a short transition period, magnified the effect of the market adjustment that struck the income trust sector.
That is why the least that could have been done in this situation would have been to allow a longer transition period, so as to somewhat mitigate the drop in the value of income trust units.
The argument that extending the transition period by six years would involve an enormous revenue loss—in the order of $3 billion, according to the Finance Minister—became unconvincing when we discovered that the Finance Minister was including tax deferred losses associated with RRSPs and RRIFs in this figure. Dennis Bruce, Vice President of HDR-HLB Decision Economics Inc., estimates this tax leakage to existing income trusts at $32 million a year. According to Mr. Bruce, extending the transition period to ten years would result in a federal revenue loss of $192 million. While the actual loss is probably higher, the Finance Minister has grossly exaggerated his tax leakage estimates.
Québec's Finance Minister, Michel Audet, acknowledged this fact in a letter to the federal Minister of Finance, in which he wrote, “In this regard, although until now Quebec has largely been spared tax losses resulting from conversions of corporations to flow-through entities, the conversions announced by certain large corporations that are more prominent in Quebec would have increased these losses to $150 million annually”.
Therefore, the Bloc Québécois believes that, while putting an end to conversions to income trusts, the government has the financial means to extend the transition period from four to 10 years, so as to allow some 2.5 million individuals who have invested in income trusts—thousands of whom are small unitholders—to mitigate the impact of the October 31, 2006 decision.
Double taxation
In general terms, double taxation occurs when the tax treatment of income does not look at whether other taxes have already been applied on this income. Double taxation exists when the tax system is not fully integrated. This is currently the case as regards the distributions and dividends paid to tax-exempt investors such as holders of pension plans or Registered Retirement Savings Plans (RRSPs). The Bloc Québécois recommends that the Finance Minister seriously consider the following two measures in order to eliminate double taxation.
1. A refundable tax credit for withdrawals from registered accounts based on taxes already paid on trust distributions. Withdrawals from registered plans would be taxed as they are now; however, the refundable credit would avoid double taxation.
2. A tax credit for dividends paid by corporations and held in registered accounts. Withdrawals from registered plans would be taxed as they are now; however, pensioners would be entitled to a dividend tax credit, as is currently the case with fully taxable accounts (no tax deferral).
These two measures are designed to resolve the problem of double taxation. In order to completely eliminate double taxation, the amount of the tax credit should be equal to the corporate tax rate or the tax rate applicable to income trust distributions, and should apply to all tax-exempt investors. In short, these two measures would significantly mitigate, if not eliminate, the problem of double taxation described above.
Conclusion:
The Bloc Québécois acknowledges that the decision to tax income trusts at a rate comparable to other businesses is justified, both in terms of Canada's longterm economic competitiveness and in terms of the pressures that the growing number of corporate conversions to income trusts could have had on the public treasury.
However, the Bloc condemns the fact that the Conservatives did not take into consideration the Bloc's recommendation to extend the four-year transition period to ten years for existing income trusts. The Conservatives' decision led to the severe market correction that impacted the income trust sector. In other words, the Conservatives could have backed down on their irresponsible election promise in a responsible manner, but did not.
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