FINA Committee Report

The unexpected Conservative decision on Oct. 31st to break their campaign promise not to touch income trusts justifiably ignited a storm of controversy. The Conservative election promise was ill-conceived and opportunistic. It is unfair that those who had trusted the Conservative promise and invested on that basis suffered personal financial losses.

The unfortunate fallout from having to reverse that promise serves to highlight the pitfalls of the political opportunism that has plagued the treatment of income trusts by both this and the previous Liberal governments. It also points to the recklessness of continuing to put partisan political gain on this issue ahead of promoting sound public policy — a course currently being enthusiastically pursued by the Liberal Party.

Indeed, the continued Liberal political exploitation of this issue has been utterly shameless. They have proceeded as though every point they and the trust lobbyists have argued has been proven accurate rather than flawed and contentious. They have even turned on the very Finance Department officials upon whose expertise they themselves had relied until just over a year ago.

By attacking the government for its belated but necessary corrective action on trusts and the NDP’s support of that public policy decision, the Liberals are trying desperately to divert attention from their own responsibility in this matter — something conveniently not reflected in the Liberal/Bloc Report. The Conservative broken promise is only part of the story.

What is the Liberal record? In income trusts, like so many other areas while government, they did what they do best — nothing! The Liberals stood by and watched while income trusts grew from a relatively obscure tax gimmick to $200 billion in capital holdings. Finally in the fall of 2005, they had acknowledged the threat of tax leakage and economic drag and appeared ready to act. On the eve of the election, however, they backed off, crassly putting their political fortunes ahead of the public interest.

This was a particularly cynical move as the need for action was blatant. Trusts had ballooned tenfold in just over three years (from 2004 to 2005, the sector increased more than 18 per cent). Business trusts, in particular, were on the rise with giants like BCE rumoured to be readying to carve off elements into trusts. Even financial institutions like RBC publicly entertained the possibility. As expected, these trends continued.

If the Parliament that followed has been faced with the need for urgent action on trusts, it was the Liberals that created that need.

It is generally accepted that the government’s tax change sounds the death knell for the future of income trusts. It is no surprise, therefore, that it has triggered a ferocious lobbying effort by those with a stake in the trust sector to force the government to reverse course.

The impact on small investors pales in comparison to the hit on Bay Street’s banking elite. The banks themselves have projected that closing down new income trust conversions could cost them as much as 2 to 4.5 per cent of earnings. It will mean losses in wealth management, investment banking commissions, associated legal fees and more. Small wonder that the elite community of investment bankers, corporate lawyers, underwriters and other trust ‘mechanics’ are lobbying so hard to turn back the clock.

Neither is it surprising that this elite corporate group is working hand-in-hand with its natural political ally — the Liberal Party — in an effort to revive the income trust corpse. The Liberals have manufactured one political issue out of holding Finance Committee hearings that would have been scheduled within weeks anyway, and another from demanding Finance Department documents that it knows to be beyond departmental officials’ authority to release.

Now we have the Liberal/Bloc Report with Liberal-authored recommendations that aim to prolong the income trust tax holiday, re-open new income trust conversions, tilt the investment playing field back in favour of trusts, and segregate income trust taxation from inter-related measures in the forthcoming legislation.

Recommendation demanding information: Anyone who ever tried to pry even the most basic information from the Liberal bunker when they formed the government can appreciate the depth of irony in the current Liberal crusade to have Cabinet documents unlocked for the asking.

Recommendation on splitting the government’s ways & means motion: This would separate inter-related elements of the motion that, taken together, improve the income security of Canadian seniors. It signals more Liberal antics ahead and demonstrates their refusal to acknowledge the overall public policy merits of the motion.

Recommendation to reduce income trust taxation to 10 per cent and to conditionally allow new trust conversions: This is simply a back-door attempt to negate the government’s actions. Although in the short-term it would mitigate losses to remaining individual and major investors and speculators, it would permanently restore trusts’ pre-announcement advantage over standard corporations. It totally ignores the negative features of trusts drawn to the Committee’s attention repeatedly by independent expert witnesses.

Recommendation to extend grandparenting from four to 10 years: While presented in the guise of a compromise, this maneuver would, in fact, negate the positive effects of the announcement and would mean business-as-usual for trusts. It was not supported by the independent witnesses before the Committee — referred to by one as “letting a problem fester unnecessarily”. The market value would rebound slightly giving major investors an opportunity to unload their units on unsophisticated newcomers. Any gain, of course, is unfairly denied to those who have already sold off their investment at deflated prices. This measure has the support of the Bloc which has come down squarely on both sides of the trust issue.

What the Liberal/Bloc Report fails to recommend is action on the serious transparency and accountability issues raised by independent analysts. We believe these should be at the core of any discussion about the future of income trusts. The Chair of the Accounting Standards Board has called income trust yield reporting “inaccurate and potentially misleading”. This same message was delivered by witnesses.

The NDP, in the interests of protecting seniors and other individual investors, has repeatedly drawn this problem to the public’s attention. We have introduced a bill in Parliament to clarify where the higher returns on trusts are coming from and hope the government will incorporate this initiative into its forthcoming bill.

Also of concern, independent studies show that income trusts have been overvalued by as much as 40 per cent and will inevitably drop in value. More than 20 per cent of the business trusts that have come on stream since 2001 are down 20 percent in value, while two out of three business trusts and paying out more than the underlying business is bringing in. Industry studies do not mention this. Neither does the Liberal/Bloc allialnce.

Corporations have openly admitted that their attraction to income trusts has been because of the tax advantage. Concern over the resulting loss in tax revenue has been noted by the federal and all provincial governments, irrespective of political stripe. Industry studies claiming no tax loss from trusts or even increased tax revenue have not survived rigorous scrutiny, characterized by one expert witness as “simply nonsense on stilts”. Deferred taxes do not answer the needs of governments for stable, adequate and predictable revenue sources today and in the short-term. It has been pointed out that industry calculations ignore the generous tax benefits already in place for RRSPs and pension funds, for example. The upfront contribution deduction for such plans and not having to pay taxes on investment income within them offsets other tax factors. It has been shown that there is, in fact, both a short-term and permanent revenue loss when income trusts in RRSPs and pension funds are compared to corporations in the same plans.

Similarly, arguments that the proposed changes will disadvantage us in relation to US Master Limited Partnerships do not hold up when the special tax added by the IRS on MLPs in tax deferred accounts is factored in. The proposal actually evens things up.

Finally, that corporations may have access to other loopholes to avoid tax payment should be a cause of concern. It is not a justification for income trust tax leakage. Now that this tax loophole has been closed, it is time for the government to move on and tackle international tax havens and other schemes that are unfairly shifting a greater share of tax onto ordinary working Canadians.

Witness after witness, including the Bank of Canada, supported NDP concerns that business income trusts were inappropriate business structures that could undermine the long-term growth of a dynamic economy. Problems, we were told, could be acerbated by an economic downturn and a tightening of access to capital — trusts’ lifeblood. Suggestions that trusts lead to stricter management practices and investor control were also contested. Only the banking elite could find it humbling that the average trust CEO reportedly makes only $1.4 million annually.

Despite Liberal and Bloc political maneuvering, multi-million dollar campaigns, e-mails, attack ads and the unprecedented use of investor lists, the case for reviving income trusts has failed on the evidence. Despite the appalling route through Liberal inaction and Conservative betrayal that brought us here, the public interest is now best served by decisive action on taxing income trusts and getting on with building the dynamic economy that will benefit all Canadians and provide income security well into the 21st century.