Friday, April 13, 2007

FLAHERTY INCOMPETENCE DAMAGING CANADA!

'OUR TAX POLICY IS WRONG-HEADED'
--New Tory policies make things worse, tax lawyer says

by Diane Francis,
Financial Post
Published: Friday, April 13, 2007

John Brussa is one of Canada's top tax lawyers and, like most knowledgeable people, is furious about the Stephen Harper and Jim Flaherty tax policies.

He wrote to me recently with some observations about the state of Canada's economy and how the Tories are making problems worse. This is Economics 101.

"The tax policy in this country is wrong-headed under the current regime, and anyone, capitalist or socialist, nationalist or internationalist, should be concerned," he said.

Sound economic management should aim to keep the cost of capital as low as possible.

By breaking a promise to leave income trusts and oilsands taxation alone, the Prime Minister has introduced doubt into investors' minds.

"The question of how reliable our policies are must now be asked. It will undoubtedly raise the 'risk' premium demanded of Canadian investment," he said.

This makes a huge difference in Alberta, Saskatchewan and B.C. "In the Canadian oilpatch, we operate in a pretty marginal geological basin. What we have over places like Russia or Venezuela [where the geology is much more promising] is the comfort that investors take that the rules of the game will not be changed after an investment decision is made," he said.

"You would think that this level of comfort should be jealously guarded by our politicians since it directly ties to our level of prosperity. To blithely risk this based on dubious rationales seems the height of reckless and thoughtless behaviour."

Another key to growth is policies that reward equity investment and not debt leveraging. Harper and Flaherty flunk in that regard, too.

"That is just good sense in that debt increases systemic risk and equity is 'real' capital formation. It is the shock absorber for the system so that, in bad times, forced liquidations are not produced and prudent levels of capital investment can be maintained," Mr. Brussa said.

Ottawa's recent tax rule changes do the opposite.

"The government penalizes equity investment by imposing a 31.5% tax on equity investments in trust units. It therefore sets up a real incentive to capitalize enterprises with debt. Why? Because interest return is only taxed once while equity return is taxed twice," he said.

"Investments in trust units were equity investments; yes the investor took the risk, which was commensurate with his return, but the system was better served by encouraging permanent capital," he said. "The government's actions will encourage many trust assets to go into private hands [10% have already done so] as purchases are structured with maximum debt leverage and trust distributions are replaced with high-yield debt payment."

The Tories are encouraging foreign takeovers with their unfair measures.

"If an enterprise's free cash flow can go from being taxed at 31.5% to being taxed at zero, it does not take a Princeton undergraduate to realize that the assets and business will migrate to high-leveraged foreign ownership," he said.

Worst of all is the interest deductibility restriction on Canadian businesses buying foreign assets: "The recent budget discourages Canadian outbound investment by putting Canadian multi-nationals at a severe competitive disadvantage by making interest on money borrowed to fund foreign expansion non-deductible while encouraging nonresident inbound borrowing by removing the withholding tax on interest." Arguments that by preventing Canadian companies from expanding overseas they will do more in Canada are bogus:

"Canada is a very small market by international standards and if you follow this mercantilist approach, it will naturally result in size limitations for Canadian multinationals. Canada will be less likely to develop outwardly looking companies. Then you couple this with the enhanced ability to debt finance out of Canada by foreign multinationals operating in Canada by removing the Canadian withholding tax on interest paid to non-residents," he said.

"The result? Well, basically you produce formidable foreign competitors in the Canadian market, competitors who have a tremendous advantage in not only operating in Canada but in buying up Canadian enterprises. Canadian companies face the double whammy of being hamstrung from expanding out of Canada while simultaneously facing increased competition from foreign competitors operating in Canada with a cost of capital advantage," Mr. Brussa said.

"This is the opposite of what should be done."

dfrancis@nationalpost.com

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