OTTAWA – It was a figurative razor blade in the apple for Canada’s income trust conversion gang this Halloween.
Late Tuesday afternoon, Federal Finance Minister Jim Flaherty announced a "Tax Fairness Plan for Canadians" which talks about a number of things, of course, but squarely targets the escalation in income trust conversions in Canada.
The market opening this morning might be ugly for telecom stocks, especially Bell Canada Enterprises and Telus Corp., which have announced plans to convert to an income trust. Telus shares spiked up about 20% when it made its announcement in September. The government’s move will also impact those that have already made the switch such as Bell Aliant, Bell Nordiq and Amtelecom, for example.
(It’ll also dramatically change the tone and the content of the BCE press releases and third quarter conference call with the financial community set for this morning.)
The conversions to a trust have been done by companies in a number of sectors as a way for the corporations involved to lower – in some cases dramatically – the amount of corporate tax they will have to pay, by distributing much of the company’s free cash to unit holders, who then, theoretically anyway, would pay the tax on their monthly distributions.
Another worry is that with so much of the funds generated by the trusts going to unitholders that the corporations would have trouble investing in new technologies and competing.
The income trust loophole will vanish, however, as the federal government says it will now tax the corporations on their monthly disbursements, as well as the unitholders.
In market value, the number of income trusts in Canada in 2006 approaches $70 billion, said Flaherty, and the amount of tax dollars potentially taken out of the economy would be too much to bear, he said.
"Despite the provisions in Budget 2006 to reduce the level of taxation on corporate dividends, the landscape has changed dramatically in the short time I have been Minister of Finance," he said in his speech.
"We have seen a growing trend towards corporate tax avoidance. Top Canadian corporations, operating within the current rules, have announced their intention to convert to income trusts. They feel compelled to seek more favourable tax treatment by capitalizing on an available tax rule.
"This trend has now moved into the core of our industrial and knowledge-based economy. It is a trend that has caused me growing concern. If corporations don’t pay their share of taxes, this tax burden will shift onto the shoulders of hardworking individuals and families," he added.
"This is simply not fair."
Calling the trend towards income trusts "an economic distortion that is threatening Canada’s long-term economic growth," because it limits "the ability of Canadian capital-intensive corporations to invest, to grow and compete in this highly competitive global economy," those corporations must now be pushed back in another direction.
"If we continue down this road… (w)e will find ourselves with a tax system that is less fair and an economy that is less productive and competitive.
"Clearly, Canada is out of step in its treatment of income trusts. The structure being used in this country was shut down in the United States and Australia."
For income trusts that begin trading after today (Hello Bell and Telus), these measures will apply beginning with their 2007 taxation year. Look for BCE and Telus to abandon their plans to complete the trust conversions.
"BCE and Telus will not be able to become income trusts and have the tax benefits that are currently available," Flaherty said during the press conference.
For existing income trusts, the government is proposing to provide a four-year transition period. They will not be subject to the new measures until their 2011 taxation year.
The government did throw the corporations a bone, though, saying it will be reducing the general corporate income tax rate by one-half percentage point as of January 1, 2011 to 18.5%. "As a result of this measure, there will not be more government revenue generated from the corporate sector," said Flaherty in his speech.
There are other elements to the new Tax Fairness Plan that will assist pensioners (allowing income splitting).
"Our Tax Fairness Plan will deliver over a billion dollars of new tax relief annually for Canadians," said Flaherty.
