Friday, April 27, 2007



By Dirk Lever
Securities Analyst
RBC Capital Markets
April 27, 2007


A man and his wife had the good fortune to possess a goose which laid a golden egg every day. Lucky though they were, they soon began to think they were not getting rich fast enough; and, imagining the bird must be made of gold inside, they decided to kill it in order to secure the whole store of precious metal at once. But when they cut it open they found it was just like any other goose. Thus, they neither got rich all at once, as they had hoped, nor enjoyed any longer the daily addition to their wealth.
Source: Aesop and Wikipedia


A country had the good fortune to create a new business structure that allowed the tax department to collect siginificant income taxes from law abiding, taxpaying citizens. Lucky though they were, the Tax Department began to think they were not collecting taxes fast enough. And figuring the structure was to blame, they convinced the politicians to pass a law to kill the structure, thereby opening the store of by-passed income taxes.

But when they killed the structure, they found that the businesses were quickly acquired by others who knew a thing or two about how to avoid paying income taxes. Thus, the tax department did not see a rush of new tax collection, as they had hoped. And they no longer enjoyed the annual addition to their coffers from this structure.
Source: RBC Capital markets


When one compares apples and oranges, the comparison is flawed. There are other logic flaws. Some have assumed that trusts are like any other Canadian business and are therefore “part of the average.” So will this high level analysis, which is nothing better than extrapolation of averages, generate accurate information? No!

There is a world of mathematics (statistics) built around the idea that if one analyzes enough data from a population, then assumptions can be drawn about the population itself. However, specifics only provide details about the general. Unfortunately, the reverse process does not work. You cannot apply the general to the specific; that analysis is flawed.

But that is what many trust critics have done: applied tax collection data from the general population of businesses to the specific businesses of the trust sector, and deduced that not enough taxes are collected. So they encouraged killing the Golden Goose.

But what is happening? The very trust businesses they wish to convert to corporate form are predominantly “Golden Geese”; the Golden Eggs akin to cash flows.

As trusts, they provided Golden Eggs for everyone who wished to purchase a monthly allotment; and for the most part, income taxes poured in. (Nobody can deny this; significant personal taxes on trust distributions to investors were, and are, collected by the Canadian government.)

However, the Golden Geese are now being purchased by private equity or large pension funds, and getting levered up. And consequently, through a combination of interest deductions and tax shield from the very assets of the business itself, no significant taxes are or will be collected by the Tax Department for years.

Many of these trusts are not “ordinary” businesses, so analysis built around the assumption that they are “ordinary” is fundamentally flawed. And flawed analysis begets flawed policies.

How many more trusts need to be bought before those that are trying to kill the Golden Goose finally realize the impact of their actions? They were warned, they ignored the warnings; now we see the warnings unfolding. Why is this necessary?


Canadian taxpayers will get burned, because more taxes will have to be collected to cover the “shortfall” from declining tax revenues from now privatized income trusts [no longer generating taxes from indvidual investors].

Retired Canadians will also get burned; and that is because when a successful trust is taken over, and the retirees receive their final payment on the sale (and a nice one at that for many of the announced takeovers), they cannot replace the generous cash flow streams [income] they once received.

It is almost like a Yogi Bera quip: “I am going broke from all the trusts I am selling at a premium.” Most trust investors were not after the capital gain; they were after the monthly cash flows.

Where do they invest their retirement nest eggs now?

Not everybody has multi-million dollar retirement funds, allowing them to invest in highly diversified portfolios [nor the over-generous indexed pension funds held by politicians and Finance bureaucrats] . And some people want to manage their own retirement money -- it is a form of independence.

This is a very important issue for Canadians; because if it is not your issue, it must be your parents’ issue!


Now that great trusts are being bought at premium prices (so much for trusts being “grossly over-valued,” as charged by those that clung to flawed financial analysis), and it is clear taxes will be avoided by the newly privatized trust businesses, what do the Trust naysayers have to say now?

We can see where this ship is headed, and it is not to the Port of Increased Taxes and Lower Values. And what about that massive scare about large Canadian Golden Goose businesses turning into trusts, causing tax leakage, lack of productivity and creating Canadian cash distribution zombies?

Well, in reality, these mega businesses (e.g., BCE) are being gobbled up by Private Equity, Pension Funds and Large Corporations who will ensure they maximize after-tax returns on the newly-bought businesses [ie, pay less tax than previously].

Do not get us wrong; we believe it is everyone’s right to maximize their after-tax investment returns. We just wish more Canadian taxpayers could co-invest in the Golden Geese – and Canadian investors were happy to pay their trust taxes!

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