FINA Committee Report

TAXING INCOME TRUSTS:
RECONCILABLE OR IRRECONCILABLE DIFFERENCES?

ACHIEVING TAX NEUTRALITY

1. Witnesses’ Comments on Taxable Investors

   The Committee was reminded that the The Budget Plan 2006 announced an increase in the gross-up and dividend tax credit in order to eliminate the double taxation of dividends from large corporations at the federal level. This change, however, does not affect tax-deferred or non-resident investors, who — for tax reasons — continue to prefer the income trust structure.

2. Witnesses’ Comments on Tax-Deferred Investors

   A number of the Committee’s witnesses pointed out that investors in tax deferred accounts are not eligible for the dividend tax credit that is available to those who invest in taxable accounts. According to Mr. Dirk Lever, this situation could result in a form of double taxation, which can be avoided through investment in income trusts. The Committee was told that taxation of income trusts in the manner that has been proposed would result in double taxation of tax-deferred investors.

   In the view of Mr. Don Francis, the objective is to kill income trusts through double taxation of income trust distributions in retirement accounts.

   Mr. Gordon Tait told the Committee that, under the proposed income trust tax regime, a pension plan beneficiary or someone with a RRIF that has an income trust investment would have every $1 in cash distributions taxed at the rate of 31.5% at the trust level; as the income is paid out to the pension beneficiary or the trust unitholder, additional taxes would be paid. For some unitholders, an effective tax rate of up to 58.5% would be faced, with the result that 41.5 cents of every $1 in cash distributions would be received by the unitholder. Mr. Tait believed that the proposed Distribution Tax should not be applied to trusts held inside RRSPs, RRIFs and pension plans.

   According to Ms. Diane Urquhart, however, net double taxation within RRSPs and pension funds does not occur. In her view, the absence of net double taxation is a consequence of the structural benefits within RRSPs and pension funds themselves, since there is an up-front deduction and the deferral of taxes on investment income.

   Mr. Tait also questioned why only publicly traded trusts would be assessed the proposed 31.5% Distribution Tax. In his view, only smaller Canadian investors — who buy publicly traded trusts because of the limited capital they have to invest — would pay the proposed tax, while public pension funds, large private equity funds in Canada, and U.S. private and public investors would not be required to pay the proposed tax. He indicated that the proposed taxation of income trusts would create a two-tiered investing landscape.

   Mr. Cameron Renkas also commented on the need to level the playing field — from a tax perspective — not only between corporations and trusts, but also to ensure that publicly traded trust unitholders are treated the same as non publicly traded trust unitholders.

   This point was also made by the Canadian Association of Income Funds, which noted that the 31 October 2006 federal announcement would not include private trusts and other non-public partnership arrangements.

3. Witnesses’ Comments on Non-Resident Investors

   In his appearance before the Committee, the Minister of Finance indicated that income trust distributions are being received by a large number of non resident investors who, in his view, are reaping a financial windfall. He noted that the 15% withholding tax paid by these non-resident investors is far less than the tax rate paid by Canadian trust unitholders.

   Mr. Yves Fortin commented on non-resident trust investors and suggested that the proposed Distribution Tax would lead to virtually complete divestment from trust units; it is unlikely that these investors would reinvest those funds in other Canadian instruments, which have a lower yield. He also noted that the government would lose the withholding taxes that are currently paid, thereby reducing tax revenues.

4. Witnesses’ Comments on Selected Implications of the Proposed Income Trust Tax Regime

   1. International Parity?

      A number of the Committee’s witnesses suggested that the assertion that other countries — particularly the United States and Australia — had, in the past, acted to shut down flow-through structures similar to Canadian income trusts is not entirely accurate. Mr. Cameron Renkas informed the Committee that U.S. flow through structures — which include about 214 publicly traded flow-through entities with a market capitalization of more than $465 billion — are virtually the same as Canadian income trusts. Like the Canadian Association of Income Trust Investors, he also suggested that — unlike Canada — the trend in the United States appears to be increased support for the flow-through structure. Moreover, he noted that, in the United States, exemptions were provided for such sectors as: oil and gas; production; transportation; refining; mining; fertilizers; propane distribution; timber; and real estate.

      The Canadian Association of Income Trust Investors also commented that selectively choosing the economic policies of other countries is a dangerously simplistic approach to policy development when it occurs without a complete understanding of the broader context within which those policies were developed. Moreover, according to the Association, it cannot be assumed that the countries have been well served by the policies, either at the time they were developed or since they have been implemented. Finally, it told the Committee that it is hard to believe that a policy adopted in the United States in 1987 is the best policy for Canada in 2007.

      Similarly, Mr. Renkas said that it is difficult to make comparisons to one small aspect of a country’s tax policy without regard to how it fits into the broader tax system.

      Written submissions to the Committee from individual Canadian investors questioned why Canada must be aligned with other jurisdictions if Canada has an investment class that is unique and beneficial to Canadian markets and investors, and that is attracting foreign capital. The question of whether the federal government would consider doing away with the dividend tax credit because such a credit does not exist in the United States was posed.

   2. Foreign Ownership and Control?

      Mr. Cameron Renkas informed the Committee that, in his view, U.S. flow through entities could, in the future, acquire Canadian trust assets, given their significant cost of capital advantage and the suitability of these assets for their structure. In his opinion, such acquisitions would most likely occur with respect to energy and resource-related trusts.

      The Canadian Association of Income Trust Investors described the 31 October 2006 federal announcement as having created “the perfect storm” for foreign private equity firms, who would engage in opportunistic buying and income stripping value-maximization techniques. Such private equity ownership would, in the Association’s view, lead to foreign control of sectors of the Canadian economy and could lead to head office decisions being made outside of Canada.

      Similarly, the Canadian Association of Income Funds told the Committee that, with depressed valuations, many income trusts are susceptible to acquisition by private equity funds or by private investors.

      In the view of the Coalition of Canadian Energy Trusts, should a significant portion of trust assets revert to foreign ownership, tax value would most likely be lost to Canada in the form of deductible interest which would be subject to a 0-10% withholding tax and of taxation of capital gains in foreign jurisdictions. Comments were also made about the exposure of Canadian corporations to leveraged buy outs, a loss of head office jobs and a repatriation of $10 billion in previously foreign controlled assets by the trust sector.

      In the context of the existing 15-25% withholding tax on distributions to non resident investors and the tax revenues that are collected as a consequence, witnesses noted that non-resident investors do not use Canadian services or infrastructure even though taxes are paid by them. From this perspective, Mr. Gordon Tait noted that withholding taxes do not need to be as high as Canadian tax rates, since non-resident investors do not use Canadian health, education or social security systems or infrastructure.

      In a written submission to the Committee, Swank Capital, LLC. asserted that, with the proposed income trust tax regime, Canadian conventional oil and natural gas production would suffer and U.S. energy firms would become more aggressive acquirers, with Canadian control of the Western Canadian Basin reduced. As well, the submission, which largely focussed on oil and gas, suggested that implementation of the proposed income trust tax regime would result in the disappearance of trusts.

   3. Losses to Investors and Income Security Implications?

      Witnesses told the Committee that Canada’s seniors have borne a disproportionate share of the $30-$35 billion loss in market value that occurred following the 31 October 2006 federal announcement. Written submissions received by the Committee from individual Canadian investors commented on such issues as: income trust investments that were made following assertions that trusts would not be taxed; the extent to which retirement plans must be changed, and some returns to work must occur, as a consequence of the loss in trust unit value; and the extent to which economic prosperity may be harmed by the more limited ability of seniors to purchase goods and services.

      The Coalition of Canadian Energy Trusts also spoke about the capital and income losses for investors — with the associated loss in tax revenues — as well as the ripple effect of these losses, including for charitable organizations. The Canadian Association of Income Funds characterized the response to the 31 October 2006 federal announcement as a multi-billion dollar meltdown of investor savings that sounded the death knell for the income trust sector.

      Mr. Yves Fortin suggested that, because of nearly double taxation of distributions, holders of RRSPs and RRIFs as well as pension funds would have to shift their investments to assets that have a lower yield, which would result in lower annual retirement income in addition to the heavy capital losses that have been experienced. In his view, lower retirement income would lead to lower tax revenues and more pressure on Canada’s social welfare system. In characterizing the attitude of the Minister of Finance as callous, he argued that there is a clear need to adopt measures to compensate those who lost a “chunk” of their retirement savings.

      In describing the 31 October 2006 announcement as a rash and reckless action by the Minister of Finance and as the Halloween massacre, Mr. William Barrowclough commented on the reduced stream of income that some retirees are likely to experience. In his view, regular cash flow is of primary importance to retirees. Moreover, he believed that what he characterized as the impending death sentence for income trusts is likely to limit the extent to which income trust values will rebound, which has implications for the capital held in income trusts.

      Similarly, Mr. Dave Marshall indicated that the 31 October 2006 federal announcement resulted in a sledgehammer being taken to retirement savings and future income, while Mr. Jean-Marie Lapointe described the financial losses he has experienced since the announcement.

      Canada’s Association for the Fifty-Plus shared its view that if the federal government implements its income trust tax proposal as planned, there would be more loss of income after four years on a regular basis.

      The written submission by the iTrust Institute to the Committee questioned how recouping an estimated $500 million annually in taxes from existing taxpayers justifies an instant destruction of $20 billion from the tax base and a decline in the relative value of the Canadian dollar.

      A number of the Committee’s witnesses as well as some of the written submissions received by us commented that the tax fairness plan announced on 31 October 2006 will result in more Canadian seniors becoming reliant on the nation’s social security system. Mr. Gordon Tait questioned the longer-term repercussions of not providing sufficient income alternatives for retirees as well as the cost of the additional burden on the government.

5. Witnesses’ Comments on Other Options

   1. General Comments on Other Options

      Witnesses appearing before the Committee commented that it is not necessary to destroy the entire income trust sector in order to control the undesirable proliferation of income trust conversions. According to the Canadian Association of Income Funds, a sledgehammer approach to the income trust sector was taken when only tax-exempt entities and non-resident investors were the root cause of the problem; a chainsaw was used rather than a scalpel.

      According to Mr. Gordon Tait, a system that allows both traditional corporate structures and income trusts should exist, recognizing that certain industries and/or large corporations could be prohibited from becoming trusts, consistent with the concept of restrictions on foreign ownership levels that currently exist for key Canadian industries. He believed that there are alternatives to the proposed income trust tax regime that would provide a better solution for the federal government, businesses and investors, and urged elected Members of Parliament to consider other policy alternatives.

      According to the Canadian Institute of Chartered Accountants, prior to the 31 October 2006 federal announcement, the taxation of income trusts did not meet the criteria that are thought to be desirable in a tax system: the promotion of economic growth and competitiveness through a broad tax base and low tax rates; neutrality; and fairness. In the Institute’s view, tax neutrality did not exist, since there was an incentive to structure as an income trust rather than a traditional corporation, and a growing tax leakage was occurring with respect to both the units held by tax-exempt and non-resident investors. Of these two factors, the Institute argued that the lack of tax neutrality was the more important.

      A similar point was made by Mr. Finn Poschmann, who mentioned the Technical Committee on Business Taxation’s central recommendation of a neutral tax policy with respect to corporate capital structures. As noted by him, this neutrality would be possible through a corporate distributions tax, which he characterized as being similar — with respect to income trusts — to the mechanism proposed by the federal government on 31 October 2006. While suggesting that the government’s decision was ultimately correct, he also argued that there is greater scope for reforming the tax system.

   2. Tax-Deferred Investors

      Within the context of the potential income trust conversions that prompted the 31 October 2006 federal announcement, Mr. Gordon Tait shared his view that much of the problem is the result of a tax system that is not fully integrated. Moreover, he noted the lack of consideration of other policy choices as well as of debate and consultation among policy makers. Mr. Tait suggested that the proposed income trust tax regime goes farther than is needed to accomplish the federal government’s objectives, and is causing unnecessary harm to seniors and retirees. He believed, however, that the proposed regime would more than level the playing field and would effectively discourage or prevent corporate conversions to income trusts.

      Mr. Tait argued that if the system of double taxation were eliminated with respect to both taxable and non-taxable accounts, and if corporate income and dividends were taxed at the same level as interest, then there would be no tax incentive to convert to an income trust. While he supported the proposed and enacted measures regarding corporate taxes and the dividend tax credit, which would create a level playing field between trusts and corporations for taxable Canadian investors, he expressed the view that a two-tiered investing landscape — which favours large institutional investors, private equity investors and large pension funds over ordinary Canadians — should be avoided. In his opinion, the refundable portion of the dividend tax credit should be extended to dividends on shares held inside retirement accounts.

      Mr. Cameron Renkas recommended a refundable dividend tax credit based on actual corporate taxes paid, available for dividends paid to all Canadians; this measure would eliminate the double taxation of dividends and should remove the incentive for corporations to convert to income trusts simply for tax reasons. He believed that the decision to convert to an income trust should be based on the merits of the particular business and its suitability for the trust structure.

      Mr. Dirk Lever presented a proposal to the Committee that he believed would level the playing field but that would protect business values and eliminate double taxation. In his proposal, Canadian corporate dividends received by Canadian taxpayers and pension beneficiaries would be taxed once and would be eligible for the dividend tax credit, while non-resident investors would face corporate income taxes and withholding taxes on the dividends they receive. Regarding trust distributions, Canadian taxpayers and pension beneficiaries would be taxed once and would be eligible for a distribution tax credit, while non-resident investors would face corporate income taxes and withholding taxes on the distributions they receive. The proposal for a refundable tax credit was supported by Mr. William Barrowclough in his appearance before the Committee.

      Mr. Finn Poschmann indicated that upstream taxes paid on distributions to pensions and RRSPs should be refunded to unitholders and to shareholders.

      According to the Canadian Institute of Chartered Accountants, while the 31 October 2006 federal announcement was an important step in the right direction in order to level the playing field between traditional corporations and income trusts as well as to address the issue of tax leakage, an additional change should be studied by the Department of Finance to enhance the neutrality and fairness of the tax system: the proposed Distribution Tax and the dividend tax credit should be fully refundable to all Canadian investors. In the Institute’s view, this additional change would make the Canadian tax system fully integrated, with no discrimination among Canadian investors. Nevertheless, issues that would have to be considered include: fiscal and interprovincial implications; the need for such sector-specific exemptions as REITs; and adequate sources of financing for small and medium-sized businesses that wish to trade publicly.

      A number of written submissions also commented on the issue of double taxation, and supported a distribution tax credit and/or extension of the dividend tax credit to tax-deferred investors.

   3. Non-Resident Investors

      Mr. Cameron Renkas told the Committee that the income trust asset class is maturing and may require certain refinements. He also indicated that, like other jurisdictions, income trusts play an important role in Canadian capital markets. That being said, in order to address the issue of tax leakage to non-resident investors, he recommended one of two alternatives to increase the taxes collected from non-resident investors without harming the savings of Canadians: increase withholding taxes to non-resident investors in a direct manner, or indirectly increase the withholding tax through a combination of a small distribution tax of 5-10% and a fully refundable tax credit available to all taxable and tax-deferred Canadian investors.

      Mr. Gordon Tait also suggested, as an issue that needs additional study, a measured increase in the amount of tax charged to non-resident investors by 5-15%. In his view, the proposed income trust tax regime would increase the rate of tax applied on a trust held by non-resident investors to a level that he described as inexplicably high.

      Mr. Yves Fortin shared his view that, due to much higher taxation under the proposed income trust tax regime, non-resident investors would divest their income trust units, with the result that the federal government would lose the quasi-totality of the withholding taxes currently collected.

      Pengrowth Energy Trust suggested that capital, which seeks the highest return at the lowest risk, does not have to come to Canada.

EFFICIENT CAPITAL MARKETS AND BUSINESS STRUCTURES

1. Witnesses’ Comments on the Productivity of Income Trusts

   In his appearance before the Committee, the Minister of Finance suggested that conversions to income trusts were starting to occur in areas of the Canadian economy that require investment and reinvestment; he characterized this situation as dangerous for our economic growth and our future prosperity. Particular mention was made of the knowledge-based sectors of our economy.

   Witnesses provided the Committee with divergent views on the extent to which income trusts make productivity-enhancing investments. In commenting on the growth potential of income trusts, the Canadian Association of Income Trust Investors cited an article which asserted that income trusts have invested their capital and grown their businesses at an impressive rate; this assertion is based on a PricewaterhouseCoopers survey.

   Mr. Don Francis told the Committee that, in his view, the income trust structure is not associated with reduced productivity and competitiveness.

   Within the context of general economic principles and his understanding of the structure of the Canadian economy, the Governor of the Bank of Canada told the Committee that while the income trust structure might be very appropriate in circumstances where firms need only to manage existing assets efficiently, the structure is definitely not appropriate in circumstances where innovation and new investment are key. In his view, to the extent that the income trust structure was being favoured in these cases, incentives for innovation and investment were lower, as was the potential for future productivity growth.

   In the view of Mr. Al Rosen, in some income trusts, money is not being reinvested.

   According to Mr. Finn Poschmann, an income trust cannot grow organically through retained earnings. In his view, it can only grow through issuing new debt (which is costly, raises total risk and reduces distributions to unitholders) and/or issuing new trust units, which is dilutive to existing unitholders.

   Professor Ramy Elitzur suggested that companies that are naturally income trusts do not invest in capital, which means that they do not grow. He believed that the long-term detrimental effect of this situation on the economy is very intuitive.

   Standard and Poors Canada told the Committee that it is difficult to generalize about the extent to which income trusts engage in sufficient appropriate reinvestment within their businesses. We were informed that this issue requires a fundamental, case-specific examination of each income trust, including its business risk and financial risk characteristics; in this regard, income trusts are like traditional corporations.

2. Witnesses’ Comments on Investment Options

   A number of witnesses commented on the need by Canadian investors for investment options, particularly for income-producing investments. According to the Governor of the Bank of Canada, income trusts can benefit investors through the opportunities they provide for diversification, since they can have different risk-return characteristics than equities or bonds. To the extent that this result occurs, income trusts can be said to enhance market completeness and, thereby, to support financial system efficiency. He also noted, however, that different risk return characteristics may not enhance market completeness if they arise from differences in tax treatment.

   Mr. Cameron Renkas identified flow-through structures as a tax-efficient means by which excess cash flow can be passed from mature businesses to investors, who then have such options as reallocating this capital to higher-growth investments, spending the capital (with the associated economic benefits) or using the capital to enhance their savings. In his view, the structure meets the needs of an ageing population for high-yielding investment options.

   Mr. Renkas also told the Committee that while the U.S. flow-through market totals $475 billion, it comprises a small part of the nearly $6 trillion high-yield market in the United States; despite having a similar demographic profile in terms of the need for income, Canada’s high-yield market is approximately $200 billion, consisting almost entirely of income trusts. In his view, given a ten-to-one population equivalent, Canada should have a $500-$600 billion high-yield market. He questioned why the federal government would want to limit the investment alternatives available to investors and wondered about the longer term repercussions of not providing sufficient income alternatives for Canadian retirees.

   In describing income trusts as an important “made-in-Canada” investment choice, the Canadian Association of Income Trust Investors suggested that, to the extent that this choice will be denied to Canadian investors, Canadian investment capital will move to global capital markets. If this situation occurs, Canadian retirement savings will finance the growth and prosperity of U.S. companies for the benefit of the U.S. economy. According to the Association, income trusts need to remain as a vibrant and sustainable part of Canadian capital markets going forward; people’s lifestyles and standards of living are fundamentally at stake and the only investment vehicle that has any hope of providing retired Canadians with the ability to maintain their lifestyle after they no longer receive employment income should not be lost.

   Mr. Gordon Tait shared his view that income trusts meet the investment objectives and risk profiles of a large segment of investors; it cannot be assumed that the capital invested in trusts would necessarily be invested in equity. He indicated that trusts have provided higher returns with less volatility than equities, and are the de facto high-yield investment vehicle in Canada. In his opinion, given the demographic profile of Canadians, the preference for income trust vehicles rather than equities had little to do with tax considerations and much to do with the preference for income-oriented returns rather than capital appreciation-oriented returns. He questioned why the federal government would want to limit investment alternatives for Canadians and where Canadians who do not belong to defined benefit pension plans would turn for yield and income.

   According to Mr. Jeffrey Olin, investors — including seniors — have investment alternatives to income trusts which can provide predictable, yield-driven returns and cash flow in excess of Guaranteed Investment Certificates or bonds. As an example, he mentioned convertible debentures, which provide a regular distribution of interest income and, compared to income trusts, would generally be a less risky investment since debenture holders have an entitlement to a corporation’s cash flow in preference to equity holders.

   Mr. Tait also commented on Canada’s need for foreign investment in order to fully develop our economic potential. He told the Committee that, in theory, non resident investors who are discouraged from investing in Canadian income trusts could invest in bonds, debt obligations or common equities, or could engage in direct investment; in practice, however, bonds or other debt obligations are not a very good alternative to a trust from a tax perspective, the Canada Revenue Agency does not collect taxes on capital gains realized by foreign investors and the tax implications of direct investment are not clear. In his view, this complex area requires additional consultation and analysis.

   Not all witnesses, however, agreed that investments in income trusts are appropriate for all investors. Ms. Diane Urquhart described these investments as too risky for seniors and other conservative investors because the income trust business model is flawed, there are financial reporting concerns with income trusts, and income trusts are marketed on the basis of a cash yield measure that — in most cases — is inaccurate, misleading and inflated. She suggested that the income trust product has benefited the vendors and the promoters of income trusts.

   Ms. Urquhart also asserted that the majority of income trusts pay distributions that exceed their income, without disclosure to distinguish between income and the return of capital. She cited evidence which suggests that return of capital distributions are being financed by funds saved by not maintaining and not replacing depreciating capital assets (which will reduce the future value of the business and will ultimately require reduced distributions or the raising of equity) and raising credit in advance. She also indicated that excess distributions might occur through debt financing, cash reserves from prior equity issuances and accumulated retained earnings, changes in working capital and customer purchase goodwill.

   The TAMRIS Consultancy similarly argued that many income trusts have been distributing a portion of their capital in addition to a return on their capital. In its view, many trusts are also using debt and capital raised from new issuance to fund distributions that exceed their cash flow. It argued that investors have been led to believe that income trusts provide both high yield and high rates of capital growth over the long term, which they do not; income trusts have a short-term investment objective.

   Mr. Jeffrey Olin also told the Committee that many income trusts pay out distributions that exceed the value of their taxable income in order to be competitive from a yield perspective.

   Similarly, Mr. Al Rosen told the Committee that it is frequently the case that income trusts distribute a return of capital. He expressed his view that there is nothing wrong with returning capital, provided unitholders understand that their distributions include a return of capital. Within the context that income trust unitholders were not fully informed about their yield and the basis of their distributions, Mr. Rosen also indicated that the federal announcement on 31 October 2006 was long overdue, since action was needed.

   According to the Canadian Association of Income Funds, the term “return of capital” is a misnomer and infers that people are receiving their own money, which is not correct. The Association said that, in fact, return of capital is the tax deferral of that particular corporate entity being flowed through into the hands of the unitholder.

   The disclosure issue highlighted by Ms. Urquhart was also noted by The TAMRIS Consultancy, which indicated the existence of asymmetrical information: trust unitholders are unaware that a portion of their yield is a return of their capital and that a portion of their recent return is highly leveraged to the economic cycle and the demand for income trusts. Moreover, it believed that income trusts have grown through Initial Public Offering (IPO) issuance as well as through post-IPO acquisition, and that much of the gain results from the transfer of capital from other business structures, economic sectors and asset classes; income trusts focus on acquisitions that provide cash flow and tend not to operate in the growth sectors of the future. Finally, it argued that income trusts have not been sold to assist retired individuals in meeting their income needs but rather because of the revenue they generate for financial institutions as well as for private equity and institutional investors that used them as exit routes.

   Similarly, the Small Investor Protection Association indicated, in its written submission to the Committee, that business income trusts can be risky investments and that many are not suitable as investments for seniors. A similar point was made by the National Pensioners and Senior Citizens Federation, which advocated a regulator to address concerns about investment losses resulting from inappropriate advice from investment professionals.

3. Witnesses’ Comments on Business Structure Options

   In his appearance before the Committee, the Governor of the Bank of Canada stated that the income trust structure appears to improve access to market financing for some firms. In a manner similar to the diversification benefits for investors, to the extent that these firms have improved access to capital, market completeness is enhanced and financial system efficiency is supported. He also noted, however, the existence of very significant tax incentives to use the income trust structure in cases where this structure would not have been the appropriate form of corporate organization from a business efficiency perspective; by providing incentives that resulted in the inappropriate use of the income trust structure, the tax system created inefficiencies in capital markets that, over time, would lead to lower levels of investment, output and productivity.

   The Governor also indicated that the proposed federal income trust tax regime would appear to level the playing field in a substantial manner. In his view, for the income trust sector to deliver efficiency benefits through its enhancement of market completeness, it is critical that the tax system provide a level playing field. He said that the proposed changes to the taxation of income trusts would make the system more neutral and more conducive to higher output and better performance in the future.

   A level playing field was also supported by Mr. Jeffrey Olin, who expressed his general support of governmental pursuit of policies that level the playing field — from a tax perspective — between trusts and corporations.

   Mr. Gordon Tait told the Committee that the income trust structure is well suited to many businesses and the industries in which they operate. He believed that many trusts have demonstrated their ability to operate efficiently as a trust while continuing to grow. In his view, there is no economic law or principle which prescribes a single form of business organization for each type of business or each industry.

   The Canadian Institute of Chartered Accountants shared the view that income trusts have a role to play in Canada’s capital markets and are appropriate for some businesses, since they provide a source of financing that might not otherwise be available, particularly for small and medium-sized businesses. It also indicated, however, that the status quo was not an option and commended the federal government for taking action.

   Similarly, Mr. Dirk Lever told the Committee that income trusts have been a viable source of capital for many small and medium-sized Canadian businesses. He believed that income trusts can “live alongside” corporations.

   In the view of Mr. Cameron Renkas, flow-through structures encourage investment in mature businesses or industries which, without attractive reinvestment options, would otherwise have their capital trapped without an efficient use. He believed that the flow-through structure is an efficient means by which excess cash flow can be passed from mature businesses to investors.

   The Committee was informed by the Coalition of Canadian Energy Trusts that the trust structure is the ideal model for the nation’s mature hydrocarbon basins, having — since their introduction in 1986 — played a unique role in maximizing oil and gas production and reserve recovery as well as in providing essential capital to the energy industry. The Coalition indicated that a focus on optimization of existing conventional oil and gas pools extends their effective working life, with associated direct and indirect economic benefits, and creates new productivity in certain areas. In the Coalition’s view, the traditional corporate structure is less efficient for mature oil and gas assets and would result in lower provincial and federal tax revenues. It believed that the proposed taxation of income trusts could have such unintended consequences as a reduced energy supply and environmental impacts, since trusts are the primary entities focussed on material reductions in the nation’s greenhouse gas emissions through carbon dioxide-enhanced oil recovery and sequestration projects.

   The Canadian Energy Infrastructure Group, in its written submission to the Committee, asserted that the income trust structure is ideal for Canadian energy infrastructure assets. It believed that the trust structure in this sector has been a catalyst for investment and growth in long-life, physical assets that are critical to the development of new energy supplies and the establishment of Canada as a world energy superpower; as well, the structure maintains Canadian ownership of critical energy infrastructure.

   In mentioning the situation that exists in the U.S., the Canadian Energy Infrastructure Group noted the precedent provided for unique treatment of energy infrastructure. It also drew a parallel to REITs, noting that energy infrastructure trusts — like REITs — represent stable, long-life, hard assets. In its view, with the proposed taxation of income trusts, there is a higher potential for acquisition of critical Canadian energy infrastructure; it is unlikely that these assets would be owned by publicly traded Canadian corporations.

   In the view of Mr. Jeffrey Olin, such fundamentally important decisions as corporate or ownership structures, as well as investment decisions, should not be exclusively — or even primarily — driven by tax considerations. He noted that the traditional corporate structure provides greater flexibility for boards of directors and the management team to manage the business affairs of the entity than is associated with the income trust structure; that being said, conversions may occur in order to gain tax benefits, even if the trust structure is not the structure that is most suited to the business model. He believed that the consequence may be that trusts have less internal capital available to pursue growth initiatives or reinvestment in capital expenditures, which could compromise the long-term prospects of the entity or the economy in general.

   According to Mr. Finn Poschmann, income trusts do not have special governance features that make them more responsive to unitholder interests, and nor do they do a better job of holding managers to account for financial performance. He also argued that the risks and assets that income trusts bring to the retail marketplace do not differ from those available through traditional corporate structures.

   Manulife Financial told the Committee that the Canadian income trust sector is increasingly populated by businesses other than those whose principal activity is the operation of real estate or royalty-producing assets, and suggested that it is worth remembering that it was for these businesses that the current income trust regime was originally designed. It was argued that the income trust structure may not be appropriate for some of the businesses that have converted and the desirability of a tax regime that would discourage the accumulation of an appropriate level of retained earnings by the corporate sector was questioned. Moreover, it was suggested that, if left unchecked, the income trust sector would encompass the core of the Canadian economy, which would not be good for the country.

   In the view of Professor Ramy Elitzur, who supported the proposed income trust tax regime as a step in the right direction, many existing income trusts should not have this corporate structure. In his view, in order to convert to an income trust, a company should meet certain conditions: it should be mature; it should have a lot of time remaining as a mature company; and it should have stability in revenues and expenses.

4. Witnesses’ Comments on Accounting

   A number of the Committee’s witnesses argued that some income trusts suffer from incomplete and inaccurate disclosure of information. According to Ms. Diane Urquhart, the Canadian Accounting Standards Board should require income trusts to report both income distributions and return of capital distributions. She also believed that provincial trust laws should restrict distributions to income, with periodic return of capital distributions occurring through transparent special return of capital distributions. In her view, provincial/territorial securities commissions should establish and enforce a requirement for income trust prospectuses and other public disclosure documents. In the view of Mr. Dave Marshall, the reporting standards of existing income trusts should be reformed.

   In his appearance before the Committee, the Governor of the Bank of Canada identified two areas in which the standards for income trusts differ from those for corporations, and where improvement is needed: accounting and the distribution of revenue; and governance.

   Standards and Poors Canada told the Committee that a study of the consistency and adequacy of financial reporting by income trusts identified substantial inconsistencies in the reporting practices of income trusts which, in some cases, resulted in significant overstatements of distribution capabilities. We were also informed, however, that market participants have — in recent months — improved the quality and consistency of income trust reporting and disclosure, in part as a result of disclosure standards issued by the Canadian Securities Administrators and the Canadian Institute of Chartered Accountants.

   The Canadian Institute of Chartered Accountants told the Committee that it had issued guidance for income trusts which recommended standardized reporting for the term “distributable cash” and enhanced disclosure of the strategies used by management to determine what percentage of a trust’s cash is distributable to investors; the focus is the source of the cash and whether the cash flow is sustainable.

   In its written submission to the Committee, the Small Investor Protection Association argued that seniors are losing their savings due to inappropriate actions and outright wrongdoing by the investment industry. It noted the lack of a federal authority with responsibility for investment protection or the prevention of financial elder abuse; accounting issues were also noted in the submission. Mr. Al Rosen also commented that, in Canada, there is no one looking at the interests of investors.

   In the view of Mr. Don Francis, income trust accounting is not worse than corporate accounting.

CONCLUSION