FUROR BUILDS OVER FLAHERTY SELL-OUT OF CANADA

INCOME TRUST IMBROGLIO: Tories Throw (Baby) Investors Out With Bathwater

-- What could be wrong with the Tory plan to tax income trusts? What indeed...

By Roel Meijer
OTTAWA EXPRESS
April 19th, 2007

On Oct. 31, 2006, Halloween, Finance Minister Jim Flaherty announced an abrupt change in taxation for income trusts. Investors were outraged: The Conservatives' election platform had promised they wouldn't touch the trusts.

Income trusts in Canada are relatively small - most have a market capitalization under $1-billion (they first appeared in 1986 in the energy sector, and later in other industries). They are interesting for small investors because they pay high dividends (distributions). The trust itself pays few taxes; the government gets its revenues from taxing the shareholders' dividends. However, many shareholders, like pensioners, are - almost - tax exempt. Most trusts are too small to be interesting for institutional investors. Therefore, most shareholders are small and, importantly, Canadian.

Flaherty argued Canada was losing too much tax revenue through the income trust structures.

Taxing them like "normal" corporations was supposed to add $1-billion to Ottawa's coffers. Despite the outrage, many analysts agreed the government should "stop the bleeding." But not all.

In early November, the trusts lost $30-billion in value after investors bailed. A Nov. 2 report from Canadian investment firm Canaccord Adams said: "If the tax proposal is enacted as presented, we believe that Canada will lose control of its energy sector and investment activity will decline in conventional oil and gas production," and, "We believe this tax reform will reduce the standard of living for current and Become a member future retirees."

Wall Street "rebel" investment group Agora Financial's Eric Fry wrote on Nov. 3: "Seems fairly moronic to torch $30-billion of shareholder wealth for the benefit of capturing a couple billion dollars of taxes. The opportunity costs for the country of Canada could run into the tens of billions of dollars, if not hundreds of billions." The change in the trusts' taxation status, and the predictable loss in value that ensued, made them prime targets for large private equity groups and hedge funds, which are mostly American. And pay few taxes in Canada.

On April 9, The Globe and Mail reported that Flaherty's tax changes, which were supposed to have brought Ottawa more revenue, are having the opposite effect. Not only is revenue lost instead of gained, Canada is losing ownership of its resources in the process, and investment in the energy sector is decreasing. "It would only take slightly more than 15 per cent of the trust sector to be bought out by foreign private equity, and non-Canadian firms, before Ottawa was losing annual tax revenue equivalent to what it said eluded its grasp before the trust tax." In other words, Ottawa could lose

$5- to $6-billion annually. The article quotes Sandy McIntyre of Sentry Select Capital Corporation: "If so-called tax fairness was intended to accelerate the sale of Canadian companies to foreign entities, then it is a success. If it was intended to increase Canadian tax revenues, it is a failure."

Asked by Hour for comment, economist Tom Velk, Chairman of North American Studies at McGill, agrees the changes hurt Canada. He implies Harper and Flaherty were out of their league: "They should have thought it through more deeply," and, "They had no idea who was invested in income trusts."

Velk is a free-trade supporter who nevertheless has difficulties explaining how, with respect to income trusts, free trade is positive for Canada, but claims, "The foreign investors who are now buying up Canada's trusts may have a positive effect by making them more efficient." Yet these funds typically take the prime assets out and sell off the less-profitable remains. And, as Velk volunteers, often raid a company's pension plans.

What is increasingly clear is that what was sold to Canadians by the Harper Conservatives as an increase in tax revenues has turned into a fire sale of Canadian companies to foreign investors, a fire sale which may cost Canada billions in revenue for years to come, never mind stewardship of our own natural resources.