FINA Committee Report

Government Response to the Fourteenth Report of the Standing Committee on Finance

Taxing Income Trusts: Reconcilable or Irreconcilable Differences?

Mr. Brian Pallister, M.P.
Chair of the Standing Committee on Finance
House of Commons
Ottawa, ON   KlA OA6

Dear Mr. Pallister:

Please find attached the Government’s response to the Report of the Standing Committee on Finance, Taxing Income Trusts: Reconcilable or Irreconcilable Differences?, tabled in the House of Commons in February 2007.

Let me begin by expressing my appreciation for the work of the Committee, which plays an important role in advising the Government on fiscal and economic policies in Canada.

The decision that was taken on October 31st, 2006, is all about fairness.

• Fairness for Canadian taxpayers and their families who should not be asked to pay more and more, while some corporations pay less and less;
• Fairness within the corporate sector, by removing the tax distortion in favour of income trusts relative to corporations; and
• Fairness for all Canadian governments, federal and provincial, by preventing a significant loss of tax revenue.

Let me address each of the recommendations in the Committee’s Report in turn.

Detailed Responses to the Recommendations

Recommendation 1: Release of Data and Methodology

Response

The background document, entitled Estimated Federal Revenue Impact of Flow-Through Entities, was made public during my appearance at the Committee. It details how the Department of Finance derived the estimates and provides all the relevant background data and methodology needed by the Committee. The document has been available on the Department of Finance website since January 30, 2007. The Committee will recall that the accounting of the estimated federal revenue loss indicates tax leakage of $500 million for 2006 from income trusts. At the time, I also indicated to the Committee that this estimated revenue loss was conservatively estimated.

The Government has chosen not to adopt the other two recommendations contained in the Committee’s Report for the following reasons.

Recommendation 2: Tabling Legislation

Response

The Report suggested that the Government table a stand-alone bill for the Distribution Tax on income trusts.  In recognizing the importance of the income trust legislation as a key part of the government’s overall economic plan and because of the key accompanying tax relief measures for seniors and pensioners, the Government determined that it was most appropriate to include this measure in the budget bill. You will note that this important legislation received Royal Assent on June 22, 2007.

Recommendation 3

1. 10% distribution tax
2. Transition period from 4 to 10 years

Response

The recommendation that the 31.5% Distribution Tax on income trusts be reduced to 10% is both unfair and unworkable. Unfair, because this suggestion would indefinitely maintain the tax advantage of trusts over all other corporations. The resulting economic distortions would continue on the shoulders of hardworking Canadian taxpayers. Unworkable, as it would do very little to stem the documented massive tax leakage, both federal and provincial, caused by income trusts.

If this recommendation had been supported, tax-exempt and non-resident investors in existing trusts would retain a distortive tax incentive to invest in income trusts over corporations. In addition, exemptions from the 10% tax for certain sectors would likely create further uncertainty in the market and return the income trust market to the path of accelerated conversions that existed prior to the Tax Fairness Plan announcement. The proposal is also silent on the necessary details surrounding normal growth or acquisitions in this sector, and could easily reactivate the plans of some large companies to convert to trusts. This Government agrees with hardworking Canadians that all sectors of the economy are expected to shoulder an equitable and appropriate portion of the tax burden.

This recommendation also suggested that the Government extend the proposed transition period from four to ten years. This would clearly be costly and unfair to ordinary Canadians. As I indicated in my appearance before the Committee, a longer tax holiday period for trusts would just mean more tax unfairness for a longer period of time.

Most of all, it would create a greater and unfair financial burden on Canadian taxpayers. Extending the transition period from four to ten years would cost the federal treasury approximately $3 billion. It would also cost provincial treasuries. Alberta would lose over $2 billion and Quebec would lose hundreds of millions of dollars. Letters of support for the Tax Fairness Plan from provincial Finance Ministers can be viewed at http://www.fin.gc.ca/news07/data/07-007_4e.html.

Finally, I would like to note that the Tax Fairness Plan includes numerous tax reduction measures, including introducing pension-income splitting, enhancing the Age Credit for low-income seniors, and reducing the corporate tax rate to 18.5% in 2011. With Royal Assent, the Tax Fairness Plan alone will provide taxpayers with $1 billion in tax relief.

I would like to once again thank the Committee for its work. The Government looks forward to the Committee's continuing contribution to the development of fiscal and economic policies in Canada.

Sincerely,

James M. Flaherty