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moneysense.ca, 1/02/07
The Income Trust Circus
The income trust tax levy has now become a political and media circus. First, the Canadian Association of Income Trust Investors took out full-page ads in newspapers ridiculing claims by the government that trusts cause tax leakage. Meanwhile, maverick MP Garth Turner held a news conference on Parliament Hill complete with disgruntled investors and a demand for compensation in the form of tax write offs.
The party then moved to the Committee hearings where Finance Minister Jim Flaherty stood his ground and refused to budge from his Halloween decision. There would be no exemptions for energy trusts and he refused to increase the tax holiday period to 10 years.
My guess is the Tories are going to refuse to even contemplate any changes and claim that they did the right thing even if it hurt many investors. They are also likely to hope that more people are happy with the tax breaks in the next budget compared to those who are very unhappy about the income trust taxes.
As an aside, you may want to check out this report from money manager Leith Wheeler on income trusts. The report was published before the decision to tax income trusts was made.
moneysense.ca, 1/02/07
I read somewhere that Australia and I think GB? had the same problem with income trusts but in those countries the government “closed the loophole” before half the country had converted to trusts. The problem in Canada is that the government waited too long to do it smoothly. Had they done this even a year earlier it would gone a lot better.
Another side of the problem is the advisors/clients who bought into some ridiculous yields. If someone offers up a security that has a 12% yield – I don’t need to do any analysis to know that the quality of the issue is not there – or maybe there’s something else wrong with it. Either way it’s too good to be true and it won’t last.
I think you’ve hit the nail on the head Mike. Especially with your last comment about advisors/clients and their poor investment choices. My advisor kept me away from income trusts altogether and kept his older clients away from them too, at least the low-quality ones.
The previous government should have moved decisively on income trusts and held their ground. I hate to support taxes but grandfathering existing trusts is not an option. Why can CI Funds be an income trust but not AGF or Investors Group?
This should not have come as a surprise. Many pundits have been criticizing trusts for a long time e.g.;
1) Al Rosen has criticized the lack of reporting laws and thus the proliferation of some low quality, risky investments http://www.canadianbusiness.com/columnists/al_rosen/article.jsp?content=20060213_74464_74464
2) Jack Mintz, one week before the announcement, published as editorial about the imminent need to address the trust issue
http://www.canadianbusiness.com/columnists/jack_mintz/article.jsp?content=20061023_82041_82041
I truly feel sorry for those folks who took a huge hit after the trust announcement. But what options did Flaherty have? It had to be done. He chose to make a ‘surprise’ after-hours announcement rather than to let it leak to the priviledged few who could reap the benefits.
I think the only reason it came as a surprise was because of how emphatic the government was when they were being elected that they would not do it.
Even with it being an election promise, I could understand them having to change it if they would just give a reason WHY it is necessary… but Flaherty refuses to.
That said, I didn’t put any money in income trusts anyway so it’s not me he owes an explanation to.
Think about underlying interests. CEOs of Trusts are interested in their shareholders, and their personal stock options. Government is interested in health care, military equipment, schools etc. in short the public services we need.
Income trusts were a debacle from the start, and as a vehicle, because they were based on the idea of avoiding tax (see Telus, BCE etc) were deserving of being shut down. The liberals tried too, they just didn’t have the guts to stay the course.
I think the Tories were foolish to make a promise not to act on income trusts. Even in 2005, a flood of companies (CI Funds chief among them) were becoming trusts. I just don’t buy their argument that they didn’t see this coming.
Personally, I don’t see the problem and the government could have attacked the “perceived” tax leakage in a much more effective manner.
1. Consider that many of the income trusts have some or most of their income coming from US assets, and in those cases there are many non-Canadian assets being drawn down for income. The media would have you believe that it’s all foreigners squirreling money out of Canada. We’ve been squirreling away more money out of the USA using the same structure.
2. To address the “tax-leakage” to foreign investors, the government could have just raised the withholding tax on foreign accounts from 15% to something more in line with the US, which I think withholds 30%.
3. Also keep in mind that the government has to approve new trusts anyways. If their concern was specifically over BCE and Telus, they could have just turned them down.
4. With regards to the accounting issues, that’s the OSC’s job to clean up. Keep in mind that there are many corporations out there with shoddy accounting, so those issues are not limited to businesses structured as income trusts.
5. For RSPs and Pension Funds holding income trusts, the government will get that tax revenue anyways when people draw money from those funds. They will just get it later rather than sooner. And when you consider that the initial pop in price when a corporation converts to a trust also gives governments huge up-front revenues in capital gains taxes, it certainly seems fair to me.
For example: I held CIX before they converted and believe me, I recorded a HUGE capital gains tax bill on that conversion. Also in 2006, I suffered a HUGE loss after Oct 31 on the exact same investment – so I sold it off for tax loss purposes. If the government hadn’t killed the trusts on Oct 31st, then I would have paid a lot more tax money on capital gains taxes than I will now.
Although I’m still reasonably young in age, in investing terms I’m now an old disgruntled bugger of a small investor.
Phil: I realize that the claim of “tax leakage” is like waving a red flag at investors. Finance is also not helping matters by not telling us how they arrive at the estimate (which is $500m one day, $1B the next).
Re: your points. Apparently #2 is not possible without extensive discussions with the U.S. #3 is not accurate. Proposed trusts do not need government approval – just a tax ruling saying that they are in compliance with existing rules. I’ll agree that #5 is debatable and is only an issue if every corporation in Canada became a trust.
“I just don’t buy their argument that they didn’t see this coming.”
I buy it. They have no strategy whatsoever. Look at the debacle they are in now with global warming. They didn’t see that coming either. Looks like Harper completely flipped flop today on that too.
And those who invested big time in trusts and lost anything significant…no different than those who dumped their savings in to Nortel, or those who invested in Bre-X. You can only blame yourself.
Dave. Income trusts weren’t a “sector”. They are a class of business, like a corporation or limited partnership, but a class of business that is like a mixture of debt and equity. We don’t have a viable corporate bond trading market in Canada, and income trusts were really just filling that void.
Nortel and Bre-X I didn’t buy because they were assets in specific sectors. For income trusts, it’s like as if the government suddenly one day says, I think BONDS shouldn’t be allowed and we’re going to cancel them all. Haha… You idiots who bought bonds should have known all along that the government doesn’t like debt. Too bad, so sad buddy. Here’s a tax write-off for your loss.
Anyways, I decided to vote with my feet and will invest my money elsewhere, so I’m over it now. Time to move on. Might as well benefit from this trust fiasco by buying the private equity and LBO firms (mostly american I suspect) who are likely to profit from taking out the dead trusts.
Many seniors with small pensions invested in Income Trusts for the cash flow so they could survive in their retirement years. They had the confidence to invest in Income Trusts for the following reasons:
The Federal Government (Harper) promised not to tax Income Trusts and indeed promoted the value of these investments for seniors.
The Bank of Canada Governor (David Dodge) praised Income Trusts.
The Provincial Governments legislated for the removal of unlimited liability to enable Pension Fund funds to invest safely into Income Trusts.
Toronto Stock Exchange included Income Trusts into their indices.
Mutual Funds and Pension Funds invested heavily in Income Trusts.
Many brokers and investment analysts promoted the purchasing of Income Trusts.
Many Income Trusts had a record of paying steady distributions that were over what was available in money markets.
Globe Fund rated many Funds of Income Trusts as 4 and 5 stars.
Institutional investors were investing in them e.g.; CPP and Teachers Union.
Fixed income rates were barely above inflation.
Dividend stocks had very low payouts.
Stocks did not provide cash flow and were a gamble on capital gains.
With Royalty Trusts you were purchasing actual inventory in the ground.
While some may have been aware of their character flaws, most seniors did not know that Harper and Dodge were distorting the truth.
It’s the same story all over again. Stocks in the 1920s, tech stocks in the 1960s and 1990s, real estate in the 2000s. Some asset class, sector, or fad comes along and everyone is buying it. It all sounds too good (to be true). Things shift far away from equilibrium and they have to come back eventually.
http://en.wikipedia.org/wiki/Income_trust#Investor_risks
(Notice “the higher the yield, the higher the risk”, “income trusts do not guarantee minimum distributions or even return of capital” and “Exposure to regulatory changes” and note the source, a 2005 TD Waterhouse paper).