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moneysense.ca, 1/11/06
Notes on Income Trusts
- There is a bit of a debate on whether the government collects less taxes overall from the income tax sector. Part of the debate is over whether income trusts held in pension funds and tax-deferred accounts like RRSPs result in less taxes collected by the government. I am neutral on this point because both sides have valid arguments.
- The tax issue that really bugs me is the free ride that foreign investors get from owning these securities. As shown in the latest report from Leith Wheeler, a US investor would pay 44% of earnings as taxes in the corporate form and only 15% in the trust form. Some reports estimate that 22% of all income trusts are held by foreign investors. Why should Canadians subsidize the returns of foreign investors at the expense of their income taxes?
- Mr. John McCallum, Liberal finance critic attacked the Government’s decision to tax income trusts as “Black Wednesday”. While the TSX Composite fell 294 points or 2.38% and income trusts suffered a blood bath with the sector falling 12%, the fall in the TSX Composite doesn’t qualify for the epithet reserved for October 19, 1987. On that “Black Monday”, the Dow Jones Industrial Average fell a stunning 22.6% and markets around the world fell equally sharply. A similar fall today would have meant that the TSX closed 2789 points lower.
- Today’s market action shows the importance (yet again) of constructing a diversified portfolio. Unless you had an extremely overweight position in income trusts, your portfolio would have emerged relatively unscathed. The S&P 500 closed down 0.74%, the Canadian dollar dropped, EAFE markets treaded water and bonds went up a bit.
- Do you think the howls from Bay Street seem to be louder this time around because they did not get hints about an upcoming decision from their friends in Government? And yeah, these are the same people who brought such wonderful trusts as Spinrite, Hot House Growers, Gienow Windows & Doors public and pocketed millions in investment banking fees.
- I was surprised that the NDP and the Bloc support the Government decision which likely means that the new proposal will easily gain Parliamentary approval. But then, Mr. Layton probably has never seen a tax proposal he did not like.
- Check out this column in The Globe and Mail website on how the trust changes will affect income taxes.
moneysense.ca, 1/11/06
As I mentioned yesterday I had about 25% of my portfolio in income trusts. Some of those managed to do not too badly and it looks like there was an over-reaction on some of them (ENF.UN was down about 12% and to me a pipeline is almost an ideal business to be in an income trust but I digress). I managed to pick up Canadian Oil Sands (COS.UN) so now my portfolio is just over 27% income trusts. My portfolio took almost a 3.5% haircut yesterday. I think for the most part there was a bit of over-reaction and there should be some recovery over the next few trading days but there could still be some trusts that fall further.
What I am trying to figure out now is if it even makes sense for a company to remain a trust after 2011. If they have to pay just over 30% tax on distributions vs. around 20% corporate tax on earnings (which could then be paid out as dividends), why wouldn’t they just take the earnings and pay dividends? If that is what this leads to, I can live with the beating my portfolio took yesterday, I would rather have dividend income than “other income” and “return of capital”. Anyway, we have at least 4 years to figure this out now and hopefully things will normalize in the market a little bit over the next couple of weeks.
I’m frankly pissed off at this move by the Conservatives. Yes I’ve heard the arguements that trusts are unfairly taxed and all that, but I feel the government has shown that they need to keep out of the market’s way.
They created thsi problem in the first place, if they felt it needed fixing there must be other more gradual ways to do it! For crying out loud, they will give the enviornment till 2050, why four years till they change this. This panic selloff was not called for at all.
How can they justify “evening out” the playing field when they have wiped out $27,000,000,000 of people’s capital from the market? How is the average senior supposed to see that money again? They haven’t got years to regain that money! They haven’t got that many years to benefit from the bigger exemption or income splitting neccessarily.
Pundits always say how the poor seniors will be affected by new rules to govern the financial industry. If this is such a grave concern, let’s increase corporate taxes to the same level as income taxes and use the surplus to increase thier pensions. (and maybe a few other things like health care). But oh wait, that would affect big business profit. They would rather have poor seniors set on fire then see that happen.
0xcc: Looks like trusts will be treated exactly like a corporation after 2011. IMO, you were overweighted in trusts but now of course it is a moot point because in a few years, trusts will be no different than common stocks. Also, I think you were wise to hold on and not panic.
James: I understand the pain of losing a big chunk of capital from the technology crash. I am also saddened to see that many seniors were badly burnt yesterday.
We can argue whether the government did the right thing or not, but the fact of the matter is governments do these things and the risk should be factored in before investing. It is so important to diversify, diversify and diversify.
I think I was (and still am) a little overweighted in trusts and my longer-term plan is to reduce that weighting (by adding to other investments, not by selling trusts). I think that the trusts that I am invested in make sense as a trust (I have a combination of pipelines, power companies and a couple of energy trusts) and I invested in them on that basis as well as the sector exposure of the individual companies. I also held on to them based on Mr. Harper’s election promise that a Conservative government wouldn’t touch trusts. I guess I sould have learned from Mr. McGuinty’s promise of not raising taxes “one penny” in Ontario when he got elected.
Most of the trusts I hold are in a non-registered account so it looks like this will have no impact on me other than the valuation hit I took yesterday (and doesn’t appear to be totally finished yet).
Of course, no politician should be trusted to keep their word. Their promises are worthless. Remember Harper is the guy who wanted an elected senate, which actually only meant an elected senate when Liberals are in power. This latest move drew support from the McGuinty Liberals. That should tell us something!
Wow! I have never never never supported the Conservative Government in Canada…never! I’m reconsidering this position now.
[...] Canadian Capitalist » Notes on Income Trusts. the canadian government announced yesterday that income trusts will essentially not exist after 2011. Canadian stocks took a shit kicking as a result. the link gives a good summary of what happened. I, personally, was very unimpressed with the Liberal party’s reaction (which was over-exaggerated scare mongering). [...]
US investors who hold Canadian royalty trusts receive no benefits and place no burdens on the Canadian government. The dividends we receive from Canadian royalty trusts are taxed at 15%, the same tax rate that Canadian residents pay on the dividends they collect from any US stocks they own. The 15% tax rate is determined by a tax treaty between Canada and the US.
If the proposed taxation on royalty trusts becomes law, the people of Canada will probably see a transfer of the petroleum producing royalty trusts to foreign ownership. The US and China will end up controling much of the oil and gas resources in Alberta.