Income Trusts: The Undead of the Investment World

44 responses so far ↓

• 1 GIV // Sep 22, 2008 at 6:13 pm

  income trusts barely moved on the news

  They probably would have moved had investors not been more worried about the ongoing implosion of the global financial system, and the fact that the party pitching the income trust news have about as much a chance of forming the next government as you and I do, if the polls are to be believed.

• 2 Rita // Sep 22, 2008 at 6:38 pm

  Some trusts have substantial tax pools that could be applied to reduce the impact of the new tax for several years post-2011.

  From what I gather, after 2011 these trusts may pursue a hybrid model of issuing dividends and pursuing higher internal growth, so the trusts will likely continue to expand – as corporations, of course.

• 3 Jon202 // Sep 22, 2008 at 10:27 pm

  I like the idea of energy / resource trusts since resources aren’t unlimited so the flow-through model works well in that scenario. But business trusts (Pizza Pizza and Second Cup) just seem strange.

• 4 Four Pillars // Sep 22, 2008 at 10:33 pm

  The problem is that – not unlike the stereotypical arch-villain allowing the hero plenty of time to escape and foil the evil plan….the income trusts were allowed to live for quite a while and are doing a few dead cat bounces of their own.

  They never should have been allowed in the first place and personally I don’t see why anyone would be all that upset when they are gone.

• 5 moneygardener // Sep 22, 2008 at 11:04 pm

  Feeble attempt by the Liberals to garner votes. The market wouldn’t move for several reasons including the fact that the Liberals won’t get in.

• 6 Canadian Capitalist // Sep 22, 2008 at 11:35 pm

  GIV: I put it down to the market’s decision that the Liberals have little chance of winning. The markets weren’t down as much earlier in the day when the news was out and there wasn’t any bounce at that time either.

  Rita: Looks like most will convert to corporations.

  Jon: Yeah, most of these business trusts are micro-cap businesses that should never have been flogged to the public anyway.

  Mike: I consciously avoided income trusts for years, so I lost no money. I can see why people who lost money are pretty upset. I would be too if I voted Conservative believing they won’t tax trusts.

  MG: The market thinks so too. That’s why I think the market reaction isn’t good news for the Liberals. People voting with their money seem to think they don’t have much of a chance of forming government. Still, I wouldn’t write them off. They say a week is a long time in politics, so who knows?

• 7 Phil S // Sep 23, 2008 at 12:30 am

  I think the reason why the income trusts didn’t move on the news is because there is a VERY SLIM chance that the Liberals will actually come to power under Dion. Most likely, they will lead the opposition again. Still, it is good to finally have a political party that provides the revival of the income trust model as opposed to every single party having the same platform – it’s all about choice.

  The income trust model isn’t unique to Canada, as the media would seem to indicate. I think the USA is the originator of REITs and they allow mortgage companies to structure themselves as REITs as well. In addition, in terms of tax structure only, the USA also has BDCs (business development companies) which are similar in tax structure to income trusts, which makes them equivalent to business trusts as far as investors are concerned.

  As far as the tax leakage argument, the Conservatives only provided 18 blacked out pages as their proof of it. I hold a number of income trusts which were severely beaten up and the last time I checked, my personal marginal tax rate on the income from my income trusts are MUCH higher than the tax rate that any corporation pays. The income trust market MUST be revived in Canada, OR we else need a viable corporate bond market. Right now all of the broker dealers hold all of the marbles and we’re all subject to their ridiculously high hidden fees buried into the price of the bonds. It simply isn’t an open market, so we’re subject to the whims of each of our individual broker dealer. It should be openly traded on an exchange and basically the income trust model is precisely that!

  By the way, if it’s all about “tax fairness”, then why didn’t the Conservatives kill the trust model completely? The new rules only apply to publicly traded income trusts, which means that middle class Canadians get screwed. However, if you have millions of dollars and can take one of these income trusts private, or you put your own business into a trust model, then rich Canadians can continue to reap all of the benefits! Gee, you think the Conservatives didn’t want to piss off all of their wealthy benefactors? The rich get richer and ordinary hard working Canadian taxpayers get screwed again and again.

• 8 Truth in Trusts // Sep 23, 2008 at 7:13 am

  In recent days both Harper and Flaherty have said that the income trusts have regained their losses.
  These men are both incredible liars!!! They either have bad data or bad advisors or they just choose to lie!

  Why does the media not report the truth?

  At the close of business on September 22, 2008 the remaining income trusts are down $27.53 billion from their close on October 31, 2006.

  Forget the income trust index. Lazy people use that to calculate the gains/losses of income trusts. The link below shows each income trust and how
  much capital has been gained or lost since October 31, 2006.

  154 trusts are down and 39 trusts are up.

  http://tinyurl.com/53ctbd
  or
  http://www.4shared.com/account/file/64103503/25f140fb/Income_Trust_Losses_from_Oct_31_2006_as_of_Sep_22_2008.html

• 9 Robert Gibbs // Sep 23, 2008 at 8:20 am

  Leadership? Here’s Ten Reasons Why the Tax on Income Trusts Was a Public Policy “Train Wreck”

  There’s considerable evidence to indicate the Harper government created the appearance of a crisis or phony crisis to sell the tax.

  By W.T. Stanbury (Professor Emeritus, UBC) Sept. 22,2008
  The Hill Times

  Introduction: Let’s start with Stephen Harper’s proposition that the central issue in the current election campaign is “leadership.” Effective leadership should produce good public policies. In this piece, I argue that there are ten reasons why the huge tax on income trusts announced on October 31,2006, and made into law on June 22,2007, is the greatest public policy “train wreck” in decades. It puts in question Mr. Harper’s leadership skills, and that includes his willingness to tell the truth. The tax may also be an albatross for Finance Minister Jim Flaherty.

  1. Harper Denied He Reversed Himself

  The income trust tax was an obvious reversal of repeated promises by Stephen Harper when he was Opposition Leader in 2005 and during the last election campaign. This reversal was widely perceived to be a serious ethical fault and Harper provided no convincing reason why such a reversal was justified. Harper did not lie because he did not intend to mislead the public with his promises. However, on November 1,2006 in the Commons, Mr. Harper did lie about what he said during the election campaign. The clearest statement was in the party’s election platform released on January 13,2006. “A Conservative government will…preserve income trusts by not imposing any new taxes on them.”

  During Question Period on November 1,2006, the PM said: “The commitment of this party ….. was a commitment to protect the income of seniors”. On November 2, the PM said, ”this government will not apologize for trying to protect the interests of individuals and a tax system that makes big business pay its fair share.” You decide.

  2. Huge Capital Losses

  The S&P/TSX Income Trust Index. closed on October 31, 2006 at 164.86. Two days later, the index was at 138.21. That represents a loss of $32.5 billion to the owners of trust units. Two weeks later the index was at 135.51 representing a loss of $35.6 billion. To the extent that the Trust Index later rose to higher levels does not diminish this loss for two reasons. First, some investors had to have sold shortly after the announcement—otherwise the index would not have fallen. The index reflects real transactions at real prices. Second, any subsequent increase in the index is the result of the myriad variables that affect market value, such as interest rates, and energy prices (particularly
  important to the energy trusts), and the further one gets from the initial announcement date the more one has to factor in the relative price movement of other indices to which the trust index is historically correlated, i.e., the broader TSX common share stock index and/or the energy subsector thereof.

  3. Using a Methodology Known to be Greatly Biased

  The Department of Finance’s methodology used to estimate the so-called “tax leakage” of $500 million for the federal government in 2006 omitted the present value of deferred taxes on the 39% on trust units held in tax deferral accounts like RRSPs. The officials knew as early as March 2004 and again in the summer of 2005 that their methodology was seriously biased toward generating revenue losses when income trusts were compared to regular corporations. When these deferred taxes are included, there was no “tax leakage.” Thus a serious omission may well have resulted in misleading policy advice by officials to their Minister, and the PM.
  4. An Orwellian “Tax Fairness Plan”

  The stated justifications for the 31.5% tax on income trusts were at best seriously questionable. The Government’s use of language in the so-called “tax fairness plan” was reminiscent of George Orwell’s Ministry of Truth.

  The government made a great effort to frame the new 31.5% tax on income trusts as a matter of “tax fairness.” A frame is a conceptual structure intended to call up a wider/deeper set of constructs that will help to define a concept or issue in the way the framer desires. It makes use people’s prior modes of classifying information and issues; it takes advantage of embedded mental habits. The objective of such framing is to “ make a silk purse out of a sow’s ear.” The trust tax was bundled with three small tax cuts, two of which benefited seniors. But the benefits for seniors amounted to about 2% of their capital losses on trust units.

  An analysis of the new tax on some income trusts shows that the measure did not achieve “tax neutrality” as repeatedly claimed by the government. The tax added to the variegation in effective tax rates across types of business organizations, and by types of owners of these assets. The tax did not “level the playing field” as the Minister claimed so loudly and repeatedly. In fact, the tax was highly discriminatory— it exempted REITs ( which accounted for about 15% of the total market value of trusts on the TSX), and private flow through entities like those used by many law and accounting firms.

  5. Phony Crisis to “Sell” the Policy

  There is considerable evidence to indicate that the Harper Government created the appearance of a crisis or phony crisis to sell the tax. The government proceeded in secret during 2006, then made a dramatic announcement of strong action. Then it justified the move by claiming that there was a crisis which forced it to act as it did. The claims were couched in emotive rhetoric, primarily by Finance Minister Flaherty. Here is one of many possible examples. On November 9,2006, before the Commons Finance Committee, Flaherty was asked: “if we had maintained the status quo, was there any threat of it driving us into the red?” He said: “Over time, yes. There was a clear and present danger that Canada was going to become an income trust economy…” Ridiculous! The claimed tax revenue losses of $500 million in 2006, were a minute fraction of corporate income tax revenues of over $37 billion, and the current surplus of over $12 billion in 2006.

  A few minutes later, the Minister claimed that the “ erosion of the tax base [ said to be due to trusts ] would have meant that, to pay for… the health transfers, the post-secondary education transfers, the social transfers, and infrastructure, we would have had to tax more and more individuals and their families…” This apocalyptic rhetoric is false.

  6. A Zero Revenue Tax?

  The income trust tax is an extremely unusual tax.. No revenue will be collected, but the entities subject to the tax will disappear from public capital markets — which was the apparent point of the effort. The Department of Finance never gave any estimate of the amount tax revenue the new tax was expected to generate in any of its documents. This was most unusual; the officials evidently knew that no revenue would be collected because the tax did not apply until 2011 and by then there would no longer be any of the income trusts subject to the tax.

  7. Many Misleading Statements By the Minister

  Finance Minister Flaherty was the point man for the trust tax. He made endless misleading statements in support of the government’s action. He claim that the tax would result in $2 billion in revenue losses for the provinces over four years was unfounded as it failed to take into account the redistribution affects among provinces. Flaherty claimed that the proposed conversion of Telus and BCE to trusts would cause huge tax losses was false since both companies had already stated that their cash corporate income taxes would be negligible for the next several years.

  The Minister ( and an official!) testified on January 30,2007 that the drop in the market value of trust units immediately after the announcement of the new tax was evidence of so-called “tax leakage.” This is an elementary, but serious error. The drop was due to the introduction of the tax. Asset values and changes in taxes on those assets move inversely to each other. The fall in value would have occurred even if the tax rate on trusts had been higher than on corporations!

  8. Very Large Adverse Economic Consequences

  Most serious, was the evident failure of the Harper Government to anticipate the reasonably predictable adverse consequences of the tax. They have been huge (and are still being felt in September 2008). One of the most important induced effects of the tax has been (and will continue to be) a decline federal (and provincial) tax revenues due to the takeover of the devalued income trusts by entities which pay lower taxes than did the trusts, i.e., foreign interests, domestic-private equity funds, and domestic pension funds. With some leveraging, foreign owners, subject only to the 15% withholding rate, can reduce the effective tax rate to near zero.

  9. Punitive Remedy, When Better Alternatives Were Available

  The government’s “remedy” for the purported problems associated with the rapid growth of income trusts ( a 31.5% tax on the distributions of some publicly-traded trusts ) was far hasher than it needed to be. What were the practicable alternatives? a) Suspend the advance approval of proposed new trusts as the Liberals did on September 19, 2005 (recognizing that that such an action would likely cause a drop in the market price of income trust units due to uncertainty). – and simultaneously announce a transparent, consultative process to review the issue with a public report in three months; b) Declare a moratorium on new trusts – and simultaneously announce the same process; c) Impose a tax on income trust distributions at source of 7% to 10%. Witnesses made it clear that such a tax would be sufficient to actually level the playing field based on the effective corporate income tax rates—which vary by sector and firm; d) Apply alternative c), but make the tax refundable to Canadian residents. (This might violate the “national treatment” provision of NAFTA.); e) Lower the corporate income tax. The Liberals had started to lower the corporate income tax (and they increased the dividend tax credit) to reduce the gap between the two different legal forms of organization of businesses, trusts and corporations. On October 30,2007, Flaherty—but it came far too late for the trusts. announced much larger cuts in the corporate income tax. One expert, Dennis Bruce, pointed out that the various reductions since 2004 effectively eliminated the claimed “tax leakage’—even using Finance’s biased methodology.

  10. Closed Process—But Secret Lobbying by Certain Interests.

  There was no public consultation process in 2006 preceding the imposition of the 31.5% income trust tax like that which occurred in 2005 under the minority Liberal government. The growth of income trusts could have been temporarily halted in the fall of 2006 by doing what the Liberals did on September 19, 2005: suspending advance tax rulings for proposed trusts by the Department of Finance.

  There was secret lobbying in 2006 of the PM and Finance Minister by CEOs and company directors ( see Globe and Mail, Nov.2,2006 ). They wanted the trend to convert corporations to income trusts stopped due to the pressure of competition, and the reduced discretion they would have as head of an income trust. It appears that contrary arguments were not heard. How come only the opponents of trusts knew it was a good time to lobby?

  To summarize—the income trust tax is an outstanding example of how not to make tax policy. It resulted in a “train wreck” whose effects continue to reverberate—perhaps in the current election campaign.

• 10 Potato // Sep 23, 2008 at 10:35 am

  Also, trust investors have already gone through one iteration of a government promising not to tax trusts and then doing the exact opposite, so the lack of price movement on the announcement might have as much to do with trust (if you’ll pardon the pun) as it does with the perceived chance of the liberals winning.

• 11 Canadian Capitalist // Sep 23, 2008 at 10:56 am

  Derek DeCloet wrote about this topic in today’s Globe:

  https://secure.globeadvisor.com/servlet/ArticleNews/story/gam/20080923/RDECLOET23

  Phil, I agree with you regarding suggestions that O&G trusts are like master limited partnerships and should have been classified as qualified FTE. I don’t think businesses should have been allowed to become trusts in the first place.

• 12 Anon in Montreal // Sep 23, 2008 at 12:31 pm

  I learned from my dad, who learned the hard way, that you should always be very wary of all “tax shelter type” investments that sound too good to be true.

  Income trusts fit the bill, and it was only a matter of time before they were brought back into line, by whichever party was in power at the time.

• 13 J.ELLEFSON // Sep 23, 2008 at 1:29 pm

  IT’S ABOUT THE INCOME STUPID. –TRUSTS ARE PROVIDING A MONTHLY PAY, SAFE 8% VERSUS 4%, INVESTMENT VEHICLE. THEY ARE A PERFECT WAY FOR SENIORS TO MONETIZE THEIR LIFE TIME SAVINGS . AND RIF PAYOUTS HOLDING TRUSTS ARE BEING TAXED AT THE 45% CDN MARGINAL TAX RATE, ISN’T THAT ENOUGH??

  Conservatives broken promise on taxing Income Trusts

  It has been stated by the media, that 2 ½ million Canadians own income trusts, and of course, all are adults and voters in Federal elections. The Conservatives made an election promise to not corporately tax Income Trusts but broke that promise and applied a +30% tax to income trust distributions. I.T. distributions are my main source of monthly retirement income and I’m part of that large group of Canadian seniors who do not have a company pension nor a defined benefit pension plan as civil servants have. That +30% corporate tax will reduce the annual cash flow to our RIF’s that my wife and I live on by $9000 each. (And the rest of the IT cash flow is double taxed again as it is withdrawn from our RIF’s, by the personal tax system affecting all income). Income trusts were bought for their monthly distribution payments and the Conservative tax policy will eventually gut and destroy these high yield investment vehicles, so important to seniors’ pension income stream. I believe there is a huge senior voter income trust undertow against the Conservatives, which is limiting their rise in the polls despite their income tax and other tax reduction initiatives. The income trust debacle is going to harbor bitterness amongst Canadians for years. I know I will not vote for nor financially support the Conservative party because of their punitive taxation on seniors owning Income Trusts and the ultimate destruction of a secure monthly pension cash flow investment vehicle. Fear of the senior vote stopped Mulroney in his tracks when he attempted to quit indexing the Old Age Security pension; it could happen again. I hope so.!

  Jack Ellefson CGY. 403-239-5705

• 14 Dividend Growth Investor // Sep 23, 2008 at 2:02 pm

  Wow this makes me wonder if the US gvt would ever change the taxation on MLPs, BDCs and even REITs. I guess it pays to not be overly concentrated in a single asset type – holding your whole retirement portfolio in income trusts is a recipe for disaster in the making.

  What happened to the good old diversification thing.

  In the end however income trust investors could benefit if oil and gas keep reaching all-time-highs each year..

• 15 Anon in Montreal // Sep 23, 2008 at 3:16 pm

  Income trusts will never go back to the way they were, no matter who is in power in the next 1, 2, or 5 elections.

  As soon as the trickle of companies turning into income trusts became a torrent, their fate was sealed.

  I understand that some people lost money on this, but it seems unfair to me that a business entity could radically change its tax rate simply by shuffling papers and converting from a company to a trust.

  Furthermore, these conversions were undermining Canadian industry by forcing our best companies to drastically curtail their growth potential (a trust must distribute most of its income, and therefore cannot invest as much in itself).

• 16 Canadian Capitalist // Sep 23, 2008 at 3:18 pm

  Jack: Of course, the Tories have broken their promise. But I doubt income trust distributions were ever either “safe” or “secure”. Look at the number of trusts that cut distributions. Many of these trusts are small or micro-cap equities with risk commensurate with this asset class. And an adverse tax decision was always a risk in these securities.

  DGI: Of course, any government could change the rules at any time. The chances may be low but it is still there.

• 17 J.ELLEFSON // Sep 23, 2008 at 4:33 pm

  Canadian Capitalist DGI.
  Safe investments are 4% GIC’s or 4% 10 year Canada bonds. A diversified portfolio of trusts carefully selected can easily generate 8%. How can a pipeline utilty trust be any riskier than a Trans Alta or a Trans Canada Pipeline. And apparently the Real Estate Investment Trusts are a good thing, as they missed the tax hit. As an investor, I do not consider the government to be my enemy and to be an element of the risk analysis.

• 18 Gordon Henry // Sep 23, 2008 at 4:53 pm

  The decision to phase out income trusts, with the exception of real estate trusts, was an intelligent and reasonable decision that had to be made. To those who think that the Liberals are going to reverse this decision need only to hark back to their promise to eliminate GST. The circumstances are very very similar politically although slightly different financially

• 19 Dividend Growth Investor // Sep 23, 2008 at 5:17 pm

  CC,

  Anything can happen at any time. I learned this a long time ago.

  J.ELLEFSON,

  I wasn’t sure if you were refering to me or CC. Gvts could be your greatest ally or greatest enemy. As for the diversified portfolio of trusts you still have the issue that you are investing in something that has similar characteristics.

  For example If I purchase a diversified portfolio of high-yield junk bonds that’s just one separate asset class that I own. In order to be truly diversified I should also own diversified portfolio of domestic and internatioanl small,mid large cap dividend stocks, diversified portfolio of reits, diversified portfolio of other bonds and things like land, forests etc. And even then I might lose money, because the hot investment of the next 100 years could be land on the Moon.

• 20 Phil S // Sep 23, 2008 at 6:14 pm

  CC. Why shouldn’t income trusts have been created in the first place?

  If I stepped out the door and hung a shingle on some small business, let’s say a restaurant, where I’m the sole proprietor, then 100% of the business’ income goes into my taxable income. The restaurant and I are the same taxable entity because the income generated by that restaurant = my income.

  Income trusts are exactly the same thing, I bought 1000 shares of Prime Restaurant. Whatever income is generated by Prime Restaurants goes into my pocket where it is 100% taxable in my hands. From a taxation standpoint, shouldn’t the two be the exact same thing?

  In reality, of course, the restaurants owned by Prime Restaurants ARE fully taxable private entities. The Prime Income Fund is the master franchiser and also provides funding to the restaurants from the proceeds of the equity issue. Only this income fund, which in reality is structured more like a corporate bond, is the actual income trust entity and its earnings are passed directly through to the unit holders, where it is 100% fully taxable – in my case, at my full marginal rate. If I bought a corporate bond, it would be the exact same thing. If I opened my own restaurant as a sole proprietor, it would be the exact same thing.

  Why should one structure not be permitted and the other ones continue to exist? One reason is for the broker / dealer fat cats to make a mint off of us for selling corporate bonds instead of having a nice exchange traded transparent fee. In the case of a restaurant, many of us might actually be able to afford to open one… But in the case of an oil & gas well, or a hotel, or something else that is capital intensive, then only RICH Canadians can go out and open one of those businesses – middle class people like me would be screwed. So, as I said, the rich get richer and the middle class gets to fight over scraps with the poor.

• 21 Potato // Sep 24, 2008 at 1:05 am

  Anon in Montreal (#15) has a good point: when the trickle of conversions became a torrent, it was clear there was a problem. I haven’t been convinced, personally, that there was a huge, crisis-like tax leakage problem. But there clearly was some kind of imbalance just because so many companies were trying to become income trusts.

  The Tory Tax however was punitive, and by the same measure is clearly too far in the other direction: trusts are beating a path back to convert back to regular dividend-paying corporations. It was also rash, which is a whole other kettle of fish when the government interacts with the capital markets.

  If I had to pick a number out of the air of where the balance point is, where a mature company could choose to become a trust or not based on factors other than tax efficiency, and have a fair tax regime, I would have guessed somewhere in the 10-20% range (though I haven’t studied the issue in any kind of detail), so I like the liberal plan. I’m a trust investor, and I like having options, so I think the trust structure should remain a viable option, but yes, it shouldn’t be a privileged one. Some investors would prefer to have corporate income taxed at the corporate level rather than their marginal rate; others (i.e., me) would prefer to have it passed through to them, especially if they pay little tax or can defer it. Aside from tax, there’s the benefits to setting up a steady stream of payments with a decent yield rather than less-predictable capital appreciation. Some mature companies seem well-suited to just spinning off their income to the owners, rather than trying to grow and reinvest when it’s not appropriate anymore… but I have trouble thinking of many companies that actually do that. Perhaps it’s because up until recently the income tax structure was available to them, or because according to another post I read (and which I can’t find any more — if anyone has a reference I’d appreciate it) regular corporations have an incentive to grow even if it’s not optimal. I’m not even talking the Warren Buffet “dividends are a sign of weakness — that we can’t think of anything better to do with your money than you can” kind of reinvestment bias, but that there were tax implications to sitting on your laurels as a corporation, and it was better to pile on debt and make a leveraged acquisition (or be bought out) than to become a cash cow.

• 22 Canadian Capitalist // Sep 24, 2008 at 11:15 am

  Jeff: The government may not be our enemy but their motivation isn’t the same as an investor’s. A negative tax law is always a risk and were a big risk for income trusts (every analyst report mentioned an adverse tax ruling as a risk in these securities). The previous Liberal government were proposing changes as well and if they had a majority or a good shot at re-election they would have enacted an adverse change as well.

  DGI: I agree with you on a diversified portfolio. Income trusts were mostly small caps with a high distribution, with risks commensurate with that asset class.

  Phil: The fundamental problem is double taxation and income trusts were simply a dodge around that. So, a government has two options: (a) address the fundamental problem (b) shut down the tax dodge. Guess which was the easier route?

  As soon as large corporations threatened to convert, the fate of income trusts was sealed. They couldn’t let existing trusts grandfathered because companies that are already trusts would have an unfair advantage.

  I’m not sure if private income trusts are allowed under the new legislation (if so, the question would be why) but income trusts are not like bonds. They are also not like corporations because though the underlying business was a corporation, it paid out all its cash to the trust and in practice, paid no taxes.

  Potato: I think the taxes were fair because income trusts and corporations now have a level playing field. If trusts paid less tax than corporations, businesses would have an incentive to convert even if the difference isn’t as lucrative as before. Imagine if our biggest companies wanted to convert to an income trust (they pay less tax and get a valuation boost), the tax loss to the government isn’t pocket change anymore.

• 23 Phil S // Sep 24, 2008 at 8:21 pm

  CC. That’s absolutely not true, from a taxation standpoint. Corporations pay interest on their bonds from pre-tax income. If the interest that they pay on their corporate bond is greater than their profit, then the corporation also pays no tax. The interest paid on the corporate bond is 100% taxable in the hands of the bondholder. As a result, I don’t know how you can say that corporate bonds and income trusts are different from one another. From a legal standpoint, they are different and in fact a corporate bondholder is better off than an income trust unit holder because they would be ahead of the unit holder in line for the trough should the business go bankrupt.

  Also, there is such a thing called a “payout ratio”, where most of the GOOD income trusts didn’t pay out 100% of their funds from operations. The last time that I checked, I think RioCan is only paying out somewhere in the neighbourhood of 80% of their funds from operations. Every business, no matter how stable, needs to stockpile some amount of cash for a “rainy day”. There are, of course, other examples of where some trusts were paying out more than 100% but they were the first ones to go “kablooie”. If you look at the quarterly report for the income trusts which are paying less than 100% of their FFO, then you will see that they do in fact pay corporate tax.

  Don’t believe everything you hear in the media, especially from slimy politicians. Look for yourself, the truth is all in the financial statements.

• 24 Phil S // Sep 24, 2008 at 8:29 pm

  Oh and if you’re referring to BCE considering converting to an income trust… Wait until the private equity guys load BCE up to the gills in debt. Then they will pay the same amount of tax as if they were an income trust because they will show very little profit after all of their expenses (interest) is tallied.

• 25 Canadian Capitalist // Sep 25, 2008 at 12:32 pm

  Phil: A corporation that borrows money can deduct interest payments before paying a tax but these interest payments *must* be made and principal on the bond is due on maturity. They don’t have a choice about this. It doesn’t matter if business conditions are bad or good, as long as they are solvent, they have to make these payments or face the consequences. Income trusts have no such obligations.

  The only difference between an IT and corporate structure is where business income is taxed. For ITs it is taxed entirely at the hands of the individual. This difference in tax treatment is advantageous to ITs. That’s why there was a pop whenever an IT conversion was announced. If every corporation in Canada organized themselves as ITs, the government would have faced a significant loss of revenue.

  It’s true that BCE is now loaded with debt and will pay little or no tax. But that’s not a permanent state of affairs. The private equity guys will plan on paying down the debt out of business income and BCE will again start paying tax, which is not true if BCE became an IT.

• 26 J.ELLEFSON // Sep 25, 2008 at 1:49 pm

  This letter was sent toPremier Stellmach. His answer was that it is a complicated matter.

  I look forward to your comments, knowing as we all know that REITS are tax exempt and the USA has $500B of MLP’s

  Corporate Taxation of Income Trusts.

  Royalty trusts have been used to finance close to $100 billion dollars of petroleum activity mainly in Alberta, and mainly by small to medium sized producers. I was very surprised to learn (see on TV) that Alberta is supportive of the Federal government’s application of 30% corporate tax on trusts as it might benefit Alberta by $450million. (Per year)

  My basic question to you, is wouldn’t you rather have another 100 billion of oil/gas activity in our province as it would surely generate in excess of $450 million in economic activity and taxes. Now as it turns out the $450 million may evaporate because private equity (read civil servant pension plans) are buying up the trusts for their rich cash flows and will not be paying corporate income tax anyway.

  Am I missing something here? Please help me.

  Can you imagine the hue and cry that would come from Quebec if the Federal government destroyed/killed $100 billion of economic activity in their province? Your PC government has let Alberta down on this matter and I believe you should be publicly reversing your position and support the groups that are fighting this bad federal legislation. Alberta needs Royalty Trusts for the financing of its oil and gas activities!
  Even the Federal Liberal party agrees to the need for royalty trusts for oil and gas development. Please take a stand on this before it’s too late.

  I would be pleased to receive a response to my letter

• 27 Potato // Sep 26, 2008 at 7:10 am

  “The only difference between an IT and corporate structure is where business income is taxed.”

  And also what income was taxed. For regular corporations, it’s net income that’s taxed, but for trusts it’s distributed cash flow that’s taxed.

• 28 Truth in Trusts // Sep 26, 2008 at 7:31 am

  “If every corporation in Canada organized themselves as ITs, the government would have faced a significant loss of revenue.”
  Canadian Capitalist please provide data or a link to back up your claim.

  “As a result of the corporate deductibility of interest and other generous tax deductions afforded corporations (and not income trusts), the actual level of overall taxes paid by Canadian corporations is not the statutory rates of 21% for non resources companies and nor is it the 25% statutory rate for resource companies, but rather it is 6.2%, according to Statistics Canada for the year 2003 (Financial and taxation statistics for enterprises, 2003 – Catalogue no.61-219-XIE).”

  If the average corporate tax is is 6.2% then it is much lower than the average tax rate of income trust unitholders.

  Thanks

• 29 Canadian Capitalist // Sep 26, 2008 at 12:00 pm

  Truth in Trusts: According to the report you’ve cited above:

  “Taxable income rose 18.4% to $170.8 billion, generating $55.0 billion in corporate taxes payable to government
  treasuries. The federal portion amounted to $37.3 billion, while the provinces claimed $17.7 billion.” That would work out to a total tax rate of 32.2%. Even if you consider taxes paid as a percentage of operating profit, it is 20%.

  Here’s an investment report that discusses why some form of tax on income trusts was inevitable.

  http://www.leithwheeler.com/pdf/LeithWheelerQ42006Outlook.pdf

• 30 Truth in Trusts // Sep 26, 2008 at 12:14 pm

  Leith Wheeler??

  How about Price Waterhouse.

  http://www.pwc.com/ca/eng/ins-sol/publications/itr_1206.pdf

• 31 Canadian Capitalist // Sep 26, 2008 at 12:35 pm

  Truth in Trusts: Thanks for the report. I read through it but the report only seems to question if the government’s decision was the right way to address income trusts. I didn’t find a convincing case that the government faced significant loss of current revenue.

• 32 Truth in Trusts // Sep 26, 2008 at 2:13 pm

  CC, agreed. There is no convincing case that the government faced a significant loss of revenue. That is why the “tax leakage” argument used to justify the tax on the trusts is and was a sham.

  Connors Brothers announced yesterday that they were being sold to a US private equity firm. Connors paid $40,000,000 in annual distributions. After being taken over by private equity they will not pay any taxes year after year. Income trust unitholders used to pay taxes on those $40 million. Every Canadian will now have to make up the make up the difference.

  Since Flaherty’s October 31, 2006 announcement 30 trusts have been taken over by private equity firms or pension plans. Those 30 trusts paid $1.370 billion in annual distributions. The annual taxes on those distributions are now gone, possibly forever. Once again Canadians will make up the difference of this “true” tax leakage that Flaherty has created.

  http://www.4shared.com/account/file/49239156/a29e664a/IT_Takeouts_and_Distn_Lost_based_on_Oct_31_closings__022808_.html

• 33 Canadian Capitalist // Sep 26, 2008 at 3:21 pm

  Truth in Trusts: Errata. I meant “I didn’t find a convincing case that the government *didn’t* face a significant loss of revenue”.

  Can you explain why private equity will not pay any tax whatsoever on any acquisition they make, whether it is a corporation or income trust?

• 34 Truth in Trusts // Sep 26, 2008 at 7:18 pm

  CC, Deloitte Touche says that the buyers are largely tax-exempt.

  Buyers are largely tax-exempt:
  Buyers in the 40 announced deals were equally split between strategic and private equity, as well as between domestic and foreign. But in terms of tax revenue for the Canadian government, the news was not so balanced: 70% of the purchasers are tax exempt pension/private equity funds or foreign buyers who pay little if any tax in this country.
  What structures were buyers using to acquire trusts? In 22 of the 40 transactions, trust units were acquired; in the other 18, the purchaser acquired shares of subsidiary corporations, trusts or partnerships. The method of acquisition has significant implications for the buyer, trustees and unitholders. The entity left “holding the bag” has to bear the cost and risk associated with the wind-up of the engineered trust. A caveat for future purchasers: all parties should consider the implications of a proposed structure when assessing the value and risk of an offer for a trust.
  Based on our involvement with over 20 income trust buyout transactions in the past year we believe that the buyout momentum will continue. The current M&A slowdown is primarily driven by “mega” transactions exceeding $1 billion in size. The income trust market, particularly the business trust segment, is comprised of medium-sized companies that are ideal for financial and strategic buyers. Clearly, volatility in the income trust sector is far from over.

  http://www.deloitte.com/dtt/article/0,1002,sid=3634&cid=177044,00.html?WT.mc_id=caen_theme_IT

  And Diane Francis’ article about the same topic:

  http://network.nationalpost.com/np/blogs/francis/archive/2007/12/09/carney-flaherty-harper-sell-out-canada-deloitte.aspx

• 35 J.ELLEFSON // Sep 26, 2008 at 7:33 pm

  government greed:

  Here’s some simple mathematics for retired seniors holding income trusts in their Registered Income Funds (RIF’s -the vehicle paying monthly income to retirees and the alternate to pension plans.). For the next four years seniors will continue to get a $1/unit distribution from ordinary trusts. In 2011, the $1/unit distribution will be reduced to less than 70 cents/unit after payment of government corporate taxes. Seniors then take the 70 cents as a payment from the RIF. For seniors, trust income was used in a diversified portfolio to increase the yield, and the trust payments are coming out of mature RIFs at the top marginal tax rate, 45% Canadian average. So governments get another 31 cents of the original $1/unit distribution. Wow, talk about government taxation productivity! Talk about corporations paying their fair share. Governments are to receive more than 60% of the original $1/unit distributed from income trusts under the new Conservative fair share tax plan of corporately taxing income trusts. But Teachers pension plan, Imperial oils pension plan, professional corporations are allowed to hold onto income generated in their business without corporate taxation. Moneys paid to pensioners and money paid to owners of professional services business’ , are taxed in the hands of the recipients just as the trusts were before the Halloween Masaacre imposed on trusts by the Conservatives . Energy Trusts were a large source of financing for the small oil producers in Alberta. Jobs are gone in the service and oil production business of Alberta as a result of the loss of this very efficient business model. Before you vote, talk about this matter with your tax consultant, your stock broker or even the invester relations department of an Oil/Gas income trust in Calgary.

• 36 John // Sep 27, 2008 at 5:54 am

  Some trusts have found other ways to maximize distributable cash. Investors in income trusts have been handsomely rewarded over the past few years.

  John
  Investment Banking Jobs

• 37 Truth in Trusts // Sep 27, 2008 at 7:41 am

  John

  “handsomely rewarded”?

  At the close of business yesterday the remaining 192 trusts are down $31.375 billion from their close on October 31, 2006.

  Please see my file on losses as of Sept. 22, 2008

  http://www.4shared.com/account/file/64103503/25f140fb/Income_Trust_Losses_from_Oct_31_2006_as_of_Sep_22_2008.html

• 38 Canadian Capitalist // Sep 27, 2008 at 11:34 am

  Jeff: Yes, it sounds bad. But what you have left out is that contributions were made to a RRSP with pre-tax dollars but any investments held in taxable accounts were made with after-tax dollars. And, what you’ve also left unsaid is that Canadian dividend stocks were subject to the same treatment you’ve described before the income trust decision.

  That isn’t the issue here. The issue is the tax treatment of income trusts were much better than corporations when trusts are held in a tax-deferred account. And according to Finance, 39% were held in pension accounts, enjoying a much favorable treatment than corporations.

  Is there a case that that should be changed? Yes, absolutely. Is it better to lower taxes on dividends? You bet. Or reduce corporate taxes? Yes, of course.

  John: I notice that you’ve included REITs in your list, which are exempt from the income trust decision. Also, it is meaningless to compare prices of trusts between Oct. 31, 2006 and now. Why? Because a number of trusts have ROC distributions that should be accounted for. Even then, it isn’t an apples-to-apples comparison. Income trusts as a group are down 20% from as recently as June 2008. Your numbers would be completely different if you use those prices as of June 16, 2008.

• 39 Truth in Trusts // Sep 27, 2008 at 1:21 pm

  CC, REITS are not exempt from the income trust decision; they must meet a series of conditions relating to the nature of their income and investments to be excluded from the SIFT definition

  “Even then, it isn’t an apples-to-apples comparison. Income trusts as a group are down 20% from as recently as June 2008. Your numbers would be completely different if you use those prices as of June 16, 2008.”

  Do you have the data on all of the trusts for this time period or did you do a calculation that is a “meaningless” comparison of the prices of the trusts because you used a subset of the trusts (i.e. a trust index)?

  Yes my numbers would be completely different for every day that the market has been open since October 31, 2006. And your point is…

  BTW, any thoughts on the takeovers and the lost annual tax revenue on $1.4 billion in distributions?

• 40 A Lap Of The Blogs : WhereDoesAllMyMoneyGo.com // Sep 27, 2008 at 2:34 pm

  [...] Capitalist gives a brief history of the Income Trust taxation issue, now that it seems to be back on the table for the upcoming [...]

• 41 Canadian Capitalist // Sep 29, 2008 at 12:18 pm

  Truth in Trusts: Yes, REITs must qualify as exempt but the biggest ones (RioCan, H&R, Calloway, CAR.UN) are expected to. So, it’s not correct to pin the blame of REIT price decreases on the income trust decision.

  The point is that if you had run your numbers just three months back, you would have shown a profit despite the income trust tax decision. Just as it is not correct to argue that there was no effect of the decision because you showed a profit then, it is incorrect to now say that the entire losses over a two year period are due to the tax.

  On one hand, you are saying that income trust acquisitions by pension funds in 2007-08 have resulted in 100% loss of revenue and on the other, you are saying that pension funds holding income trusts resulted in no tax leakage in 2006. How is that possible? If there is a tax leakage now, surely there was the same tax leakage prior to the decision. And aren’t you ignoring that these trusts will start paying a tax in 2011 and the decision stopped the deluge of planned conversions that had a significant threat to current government revenue. Also, corporate taxes are now coming down that should benefit all investors.

• 42 Truth in Trusts // Sep 29, 2008 at 12:23 pm

  CC, very good, take a look at Flaherty’s logic. Lots of opinions here, very few facts.

• 43 J.ELLEFSON // Sep 29, 2008 at 5:49 pm

  CC—Maybe by 2011, there won’t be any trusts left to pay the +30% tax. Private equity and Pension plans will do their best to get ahold of their rich cash flow.
  SOMEBODY WAS CRITICISING THE UNDERWRITING FEES FOR TRUSTS AS EARNED BY THE BROKERAGE INDUSTRY. ARE THE FEES NOT THE SAME FOR ipo’S FOLLOWING THE CORRECT CDN CORPORATE MODEL?
  WAIT TILL WE LEARN OF THE FEES CONNECTED TO THE BCE TAKEOUT.
  ANNUAL DEPOSITS TO RSP’S AND PAYMENTS TO YOUR CO PENSION PLAN RECEIVE THE SAME TAX DEDUCTION TREATMENT.

• 44 Hal // Oct 5, 2008 at 11:31 pm

  real simple: Stephan Harper campaigned that he would never allow any party to tax income trusts then taxed them.

  Stephan Harper put the stamp of approval on income trusts and many retired Canadians bought trusts when he became Prime Minister because of that seal of approval.

  What Harper did makes no sense at all. There is no provable tax leakage and only fools believe that BS. Canadas books in fact show zero tax leakage but rather MORE tax was collected from unitholders.

  It was all ascam to take retired Canadians money and give it to private equity groups – which is exactly what has happened.

  I will never vote for the Conservatives again as long as I live no matter who is in the party. I’d vote for the green party before I’d touch the Cons. That says it all.

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