FINA Committee Report

The Bloc acknowledges the importance of changing the way income trusts are taxed. At the outset, the income trust structure was intended to be used for mature asset classes that required little or no new capital; the reason being that all of a trust’s annual income must be distributed to unitholders, otherwise it is taxed at the highest marginal rate.

Because of the tax rates applicable to income trusts, corporations operating in fields that often require new capital investments started turning to the trust structure. Certain companies decided to convert to income trusts, not out of consideration for long-term growth but in order to take advantage, in the short term, of the beneficial tax rates that apply to trusts.

To avoid seriously compromising Canada’s potential for long-term economic growth, the government should definitely put an end to the open-ended opportunity of corporate conversions to income trusts. The Bloc acknowledges the appropriateness of this measure.

The Conservatives made an irresponsible election promise that they would not touch income trusts during their term in office. The announcement that two key players, Bell and Telus, were planning to convert to income trusts changed things. The government had to take action, not only to preserve Canada’s potential for economic growth, but also to avert what could amount to significant revenue leakages for the federal and provincial governments.

Nonetheless, the Bloc deplores the fact that the Conservatives chose to impose a transition period of only four years for existing trusts, rather than the ten-year period recommended by the Bloc Québécois. Given the election promise that income trusts would not be touched, this investment vehicle continued to be a relatively safe option, at least while the minority government was in power. That is why the value of income trust units remained so high. The Conservatives’ surprise announcement, together with such a short transition period, magnified the effect of the market adjustment that struck the income trust sector.

That is why the least that could have been done in this situation would have been to allow a longer transition period, so as to somewhat mitigate the drop in the value of income trust units.

The argument that extending the transition period by six years would involve an enormous revenue loss — in the order of $3 billion, according to the Finance Minister — became unconvincing when we discovered that the Finance Minister was including tax deferred losses associated with RRSPs and RRIFs in this figure. Dennis Bruce, Vice President of HDR–HLB Decision Economics Inc., estimates this tax leakage to existing income trusts at $32 million a year. According to Mr. Bruce, extending the transition period to ten years would result in a federal revenue loss of $192 million. While the actual loss is probably higher, the Finance Minister has grossly exaggerated his tax leakage estimates.

Québec’s Finance Minister, Michel Audet, acknowledged this fact in a letter to the federal Minister of Finance, in which he wrote, “In this regard, although until now Quebec has largely been spared tax losses resulting from conversions of corporations to flow-through entities, the conversions announced by certain large corporations that are more prominent in Quebec would have increased these losses to $150 million annually.”

Therefore, the Bloc Québécois believes that, while putting an end to conversions to income trusts, the government has the financial means to extend the transition period from four to 10 years, so as to allow some 2.5 million individuals who have invested in income trusts — thousands of whom are small unitholders — to mitigate the impact of the October 31, 2006 decision.

In general terms, double taxation occurs when the tax treatment of income does not look at whether other taxes have already been applied on this income. Double taxation exists when the tax system is not fully integrated. This is currently the case as regards the distributions and dividends paid to tax-exempt investors such as holders of pension plans or Registered Retirement Savings Plans (RRSPs). The Bloc Québécois recommends that the Finance Minister seriously consider the following two measures in order to eliminate double taxation.

1. A refundable tax credit for withdrawals from registered accounts based on taxes already paid on trust distributions. Withdrawals from registered plans would be taxed as they are now; however, the refundable credit would avoid double taxation.
2. A tax credit for dividends paid by corporations and held in registered accounts. Withdrawals from registered plans would be taxed as they are now; however, pensioners would be entitled to a dividend tax credit, as is currently the case with fully taxable accounts (no tax deferral).

These two measures are designed to resolve the problem of double taxation.

In order to completely eliminate double taxation, the amount of the tax credit should be equal to the corporate tax rate or the tax rate applicable to income trust distributions, and should apply to all tax-exempt investors. In short, these two measures would significantly mitigate, if not eliminate, the problem of double taxation described above.

The Bloc Québécois acknowledges that the decision to tax income trusts at a rate comparable to other businesses is justified, both in terms of Canada’s long-term economic competitiveness and in terms of the pressures that the growing number of corporate conversions to income trusts could have had on the public treasury.

However, the Bloc condemns the fact that the Conservatives did not take into consideration the Bloc’s recommendation to extend the four-year transition period to ten years for existing income trusts. The Conservatives’ decision led to the severe market correction that impacted the income trust sector. In other words, the Conservatives could have backed down on their irresponsible election promise in a responsible manner, but did not.