Income trust party is over

[CanadaEH]

How's this going to affect ACE and its income trusts?

Income trust party is over

Surprise move breaks major Conservative campaign promise to avoid taxing trusts

STEVEN CHASE

From Wednesday's Globe and Mail

OTTAWA — The federal government slapped a levy Tuesday on income trusts — which pay little or no corporate tax — to stem a growing revenue bleed and curb the growth of a vehicle it says threatens Canada's economy.

The surprise move breaks a major Conservative campaign promise to avoid taxing trusts.

Finance Minister Jim Flaherty said he had no choice because he feared that increasing numbers of corporations were preparing to convert to trusts — a trend he said threatened Ottawa's tax base.

"Quite frankly, things changed a great deal this year and we're faced with a situation where Canada was moving to an income trust economy," Mr. Flaherty said, noting that in 2006 alone, the market value of companies converting to trusts was approaching $70-billion.

"Left unchecked, such corporate decisions would result in billions of dollars in less revenue for the federal government to invest in the priorities of Canadians."

Federal officials said they were also concerned about the prospect of financial institutions such as banks — or portions of bank assets — converting to trusts.

Income trusts pay little or no corporate tax, instead shovelling out the bulk of earnings to investors, who are taxed individually. Critics said Ottawa and the provinces never recouped all the lost revenue and ended up losing hundreds of millions of dollars in revenue each year.

Mr. Flaherty announced that Ottawa will start taxing trusts in the same manner as corporations, effective immediately for new trusts and starting in the 2011 tax year for existing trusts.

He acknowledged this will force Telus and BCE to reconsider their plans to convert to trusts that would have ranked as the largest in Canadian history.

The measure is expected to roil markets today, driving down the unit prices of most trusts and hammering the shares of Telus and BCE.

Tax expert Jack Mintz, with the University of Toronto's Rotman School of Management, predicted that Ottawa's actions will spell the end of conversion plans for both companies.

"I would not expect the trust conversions to go ahead. That's for sure," he said.

The tax rate on trust distributions will start at 34 per cent — to mirror federal and provincial taxes on companies — and will drop to 31.5 per cent by 2011. Ottawa will remit to the provinces a 13-percentage-point share of the revenue.

This effectively ends any tax advantages for investors in trusts over corporations.

Finance watchers said they expect the measure to stop almost all corporate conversions to trusts — and may encourage some that have already converted to rethink the move.

"Perhaps over the next four years, some who have already converted may go back to a corporate structure," Toronto Dominion Bank chief economist Don Drummond said.

Mr. Flaherty said this will restrain a wave of conversions that he said threatens corporate productivity, because pressure on trusts to distribute all profits cramps Canadian productivity by eroding trusts' ability to reinvest and innovate.

The trust tax is certain to hammer the retirement savings of millions of Canadians who've come to rely on trusts for hefty returns, including many seniors, whom the Tories consider a key voting group.

The Conservatives tried to cushion the blow of the trust tax by unveiling more than $1-billion in annual tax breaks for seniors and enacting a half-percentage-point rate cut in the general corporate tax rate, to take place in 2011.

The corporate tax cut will "ensure there will not be more government revenue generated from the corporate sector," Mr. Flaherty said.

The senior-targeted tax relief, which goes into effect in 2007, takes two forms. Ottawa will allow senior couples to split their pension income and thereby reduce their income tax bill. It's also boosting a tax credit for low-and middle-income seniors called the Age Credit Amount by $1,000, to $5,066.

Concern over income trusts spiked in mid-October when Mr. Mintz estimated that Ottawa and the provinces stood to collectively lose $1.1-billion in annual revenue after Telus and BCE converted.

Yesterday, Mr. Flaherty said federal government losses alone were about $500-million annually and would have climbed to $800-million after Telus and BCE converted.

The Tories are tackling what the Liberals left unfinished last year. The Liberals considered everything from a trust tax to lightening the tax burden on corporations. They eventually decided to cut the effective rate of tax on corporate dividends. This reduced the tax advantages of trusts, but critics considered it a half measure.

Liberal finance critic John McCallum accused the Conservative Party yesterday of hurting Canadians' retirement savings by breaking their campaign pledge.

"I think Canadians who invested in income trusts secure in the belief that the government will keep its word will have a real shock," Mr. McCallum said. "There's absolutely no doubt there's going to be some big losers out there as a consequence of this broken promise."

The New Democrats, however, praised the Tories for closing the tax gap between income trusts and corporations.

[LongTimer V]

About time,should pi$$ off Dagger and all his corporate buddies

Guess who was gonna pick up the tab ??

[dagger]

About time,should pi$$ off Dagger and all his corporate buddies

Guess who was gonna pick up the tab ??

Tell that to the millions of unit trust holders. If you think this is only about corporations, you're pretty dense.

[CanadaEH]

ACE was down $5.75 at one point.. has recovered a little as of 6:45PST.

[Guest prob30]

On a positive note- hey dagger - the yield on the vaunted CJT.UN is WAAAAAAAAYYYYY up today!

[dagger]

On a positive note- hey dagger - the yield on the vaunted CJT.UN is WAAAAAAAAYYYYY up today!

Guess who bought at $5.77?

There are some great yields out there. Even with the new rules, if you lock in a well-managed company yielding 20%, no tax is going to make it a bad long-term investment.

[Guest prob30]

Nicely done. Hopefully you got some off the table above $10, but either way that's a nice return. Now the question- buy more, or lock in the gains and move into the high dividend payers which are sure to get a nice bounce from all this trust money flowing out.

But I disagree on your tax assessment. More taxes can only do one thing to companies and trust alike, no matter how well-run- and that's kill them. The distribution tax will no doubt call into question the intelligence of a 20% yield and cause some to abandon the trust model no?

[dagger]

The distribution tax will no doubt call into question the intelligence of a 20% yield and cause some to abandon the trust model no?

And how's that? If the after-tax yield is reduced to 15 percent, and most dividend paying corporations aren't paying more than 7-8 percent, which will you take?

If you take a company like CargoJet with an all-leased fleet, what exactly would they do with a pisspot full of cash? Do you think they want to buy A-380 freighters?

[Guest prob30]

Clearly 15% is better, or was that a rhetorical question?

In terms of tax efficiency, which is really what this debate is about, given the announcement a reversion to the traditional corporate structure may (again, depending on the tax rate on distributions) make more sense than the trust structure. A distribution is just a dividend by another name- obviously one would take 15% over 7% or 4% every day of the week no matter what its called. It's money!

Really the driver that allows trusts to pay out such high yields is their tax efficiency. Once that is removed, I hesitate to expect that a 20% yield will continue to be possible. In other words, do I really believe that some podunk little cargo airline (in the context of the global marketplace) that operates a handful of 727's is actually that much better run than a, say, Citigroup? No, but due to their tax advantage it appears that way. That tax advantage will now be removed. The yields won't, can't, remain that high in light of this.

[Stickle]

This is clearly a sign that the Conservatives are not much better than any other political stripe. Promises mean little, if anything. We've seen them back peddle on a few smaller things but this is huge and will have a significant impact on my family.

Surely they were not as naive to realize this during their campaign. If this takes away from their revenue base "to spend on priorities for Canadians", cut expenses in other ways. I have yet to see them make the government significantly smaller and more efficient like they said they would.

[dagger]

Clearly 15% is better, or was that a rhetorical question?

In terms of tax efficiency, which is really what this debate is about, given the announcement a reversion to the traditional corporate structure may (again, depending on the tax rate on distributions) make more sense than the trust structure. A distribution is just a dividend by another name- obviously one would take 15% over 7% or 4% every day of the week no matter what its called. It's money!

Really the driver that allows trusts to pay out such high yields is their tax efficiency. Once that is removed, I hesitate to expect that a 20% yield will continue to be possible. In other words, do I really believe that some podunk little cargo airline (in the context of the global marketplace) that operates a handful of 727's is actually that much better run than a, say, Citigroup? No, but due to their tax advantage it appears that way. That tax advantage will now be removed. The yields won't, can't, remain that high in light of this.

Cargojet vs Citigroup? A strange analogy. Some global monoliths make smaller margins than a lot of junior companies. Big monoliths make a lot of questionable decisions trying to use shareholder equity. If they are good, they make more good ones than bad one, and will ideally be persistently profitable. You trade off yield for security, versus a Cargojet which can be a very well managed company with substantial yields but a higher risk profile.

If structure was the root of performance, yields for all trusts would be the same, but they are not. There are some trusts that are in a good business and are well-managed. A trust like Versacold in the cold storage logistics business has been very acquisition-minded as a trust, and has generated excellent earnings. Another logistics trust, Livingston has been a stellar performer. There are others that shouldn't be trusts. Even with lower after-tax yields, some trusts will easily outperform the TSX, and because they can grow, so can their yields, whether you call them distributions or dividends. The same will apply to well-managed energy trusts - if oil prices are high, you can use any structure you want - they will outperform just about any investment.

[AIP]

Pardon my not so business like mind, but wasn't this inevtiable ??

Particularily after Telus and Bell ?? I am sure many others were lined up behind them to follow suit.

The fed (no matter who is running the show) could not possibly take a hit to its coffers like this.

The regular Joe (individual tax payer) has shouldered enough of a tax burden in this country, imo.

[dagger]

Pardon my not so business like mind, but wasn't this inevtiable ??

Particularily after Telus and Bell ?? I am sure many others were lined up behind them to follow suit.

The fed (no matter who is running the show) could not possibly take a hit to its coffers like this.

The regular Joe (individual tax payer) has shouldered enough of a tax burden in this country, imo.

A lot of regular Joes own trusts, too

While the conversion phenomenon was out of control, there were several possible remedies.

The most obvious was to bring in a mini-budget and lower taxes on dividends to US levels. At the same time they could have frozen trust conversions.

The main reason the Tories (or Liberals) don't like trusts is that they don't get any political benefit from them. Tories and Liberals much prefer doling out pre-electoral bonbons, like giving billions to this special interest or tax cuts to hockey moms to buy sports equipment for their kids.

[Thebean]

A lot of regular Joes own trusts, too

While the conversion phenomenon was out of control, there were several possible remedies.

The most obvious was to bring in a mini-budget and lower taxes on dividends to US levels. At the same time they could have frozen trust conversions.

The main reason the Tories (or Liberals) don't like trusts is that they don't get any political benefit from them. Tories and Liberals much prefer doling out pre-electoral bonbons, like giving billions to this special interest or tax cuts to hockey moms to buy sports equipment for their kids.

I'm as conservative as you can get, yet I strongly think the conservatives did the right thing for the long term benefit of Canada's economy.

Anyone who thought the Trusts would continue unabated, given what was happening in US, Oz and UK were dreaming.

The Liberals left it alone pre-election, hoping they'd get Bay Street's support. Had they won, you know Manley would have closed the loophole as well.

The Bloc and NDP will support it. The liberals will try to make political hay out of it, but its a done deal.

[AIP]

I'm as conservative as you can get, yet I strongly think the conservatives did the right thing for the long term benefit of Canada's economy.

Anyone who thought the Trusts would continue unabated, given what was happening in US, Oz and UK were dreaming.

The Liberals left it alone pre-election, hoping they'd get Bay Street's support. Had they won, you know Manley would have closed the loophole as well.

The Bloc and NDP will support it. The liberals will try to make political hay out of it, but its a done deal.

I cannot believe I am doing this, but I gotta go with the Bean on this one.

As much noise as there will be in YOW over this, you can bet yur boots that it was going to happen.

Curious Dag; Freezing trust conversions ? would that not have left open litigation from other companies who wanted to go this route ??

[FA@AC]

Pardon my not so business like mind, but wasn't this inevtiable ??

If it was inevitable, the Conservatives must have known so and ought not to have made their campaign pledge not to do what they just did. This reminds me of the Liberal promise to do away with the GST. Gotta love politicians.

[LongTimer V]

Hey Dagger,i'm dense eh.Well what does that make you?

Air Head comes to mind.I'm just trying to think of a opposite to dense.

One thing for sure,this is NOT a do nothing government,and that i like, even if i don't agree with all their moves.

[handyman]

He wakes, takes a swig from his pint and hurls an insult and back to sleep he goes.

[dagger]

I cannot believe I am doing this, but I gotta go with the Bean on this one.

As much noise as there will be in YOW over this, you can bet yur boots that it was going to happen.

Curious Dag; Freezing trust conversions ? would that not have left open litigation from other companies who wanted to go this route ??

I'm pretty sure much had to be done, but I haven't seen a comment yet - even those favorable to shutting down the option - that says the government got it right on how to do it.

[Guest rattler]

If it was inevitable, the Conservatives must have known so and ought not to have made their campaign pledge not to do what they just did.  This reminds me of the Liberal promise to do away with the GST.  Gotta love politicians.

Quite right, here is what they did say.

The plan

A Conservative government will:

• Confirm its commitment to the Canada Pension Plan (CPP) and Old Age Security (OAS) as well as the

Guaranteed Income Supplement (GIS) as fundamental guarantees of income security in retirement years.

• Stop the Liberal attack on retirement savings and preserve income trusts by not imposing any new taxes

on them.

• Protect the integrity of the CPP investment fund to stop politicians from raiding it to balance the budget

or pay for other political projects.

• Protect seniors from over-taxation by raising the pension income tax amount that is eligible for a federal

tax credit from $1,000 to $2,000 per year in 2006, and to $2,500 in five years.

• Appoint a Seniors Council comprised of seniors and representatives of seniors’ organizations to advise the

minister responsible for seniors on issues of national importance..

Real tax relief

for Canadians

With all the waste and corruption in Ottawa, Canadians deserve to keep more of their own money.

A Conservative government will deliver real, visible, and immediate tax relief to all Canadians.

The plan

A Conservative government will:

• Reduce the GST by one point right away, to six percent. And we will reduce the GST by another point,

to five percent, over five years. The GST affects everyone – families, seniors, and young people just

getting started in life. Cutting the GST will help everyone deal with the rising cost of living, put money in

people’s pockets, and spur the economy immediately.

• Maintain the GST/HST credit in the federal personal income tax.

• Eliminate the capital gains tax for individuals on the sale of assets when the proceeds are reinvested

within six months. Canadians who invest, or inherit cottages or family heirlooms, should be able to sell

those assets and plough their profits back into the economy without taking a tax hit. It is time government

rewarded Canadians who reinvest their money and create jobs.

http://imaginesask.ca/Platform.pdf

[GDR]

I'll add my 2 cents worth for what it's worth, (less than 1 cent).

They did the right thing. Income trusts created an uneven playing field for both companies and investors.

Trying to look beyond my own self interest, I think that income splitting is a fair approach as I am in favour of couples that are financially interdependent being treated that way by the tax system. I would like to have seen them go further and apply it to earned income as well.

The increase in the old age exemption is a positive move as well.

The last two items will help in many cases to mitigate the effects of the change in income trusts.

It was well done in that there were obviously no leaks as in the Goodale mess.

I am definitely extremely disappointed that they broke a campaign promise to do it. The only thing that I can say in their defence in this regard is that if you make a mistake do what you can to correct it. That does not help financial planners and companies who planned on the existing rules being maintained as promised however.

Greg

[ccairspace]

Hey Dagger,i'm dense eh.Well what does that make you?

Air Head comes to mind. I'm just trying to think of a opposite to dense.

Clever?

[FA@AC]

How has this affected the market so far? I haven't followed the TSE today other than within my own investment accounts, but most of the stuff I hold seems not yet to have been affected. The one income trust I have (Yellow Pages) is off as one would expect, but my other stuff is pretty much unchanged. I had wondered if some of the blue chip stuff would rise as people sold trusts and put money in dividend stocks instead. Not much change in my own portfolio, though.

[FA@AC]

How has this affected the market so far? I haven't followed the TSE today other than within my own investment accounts, but most of the stuff I hold seems not yet to have been affected. The one income trust I have (Yellow Pages) is off as one would expect, but my other stuff is pretty much unchanged. I had wondered if some of the blue chip stuff would rise as people sold trusts and put money in dividend stocks instead. Not much change in my own portfolio, though.

Never mind my post above. Just realised that I had been looking yesterday's close rather than today's prices. Not clever.....

[GDR]

Income-trust crackdown: The inside story

By SINCLAIR STEWART AND ANDREW WILLIS, From Thursday's Globe and Mail

Three weeks ago, almost to the day, Michael Sabia dropped an early-morning bombshell on Canadian investors: His company, BCE Inc., was planning to follow the lead of archrival Telus Corp. and transform its storied telephone operations into a $27-billion income trust.

It was a surprise to almost everybody. Everybody, that is, except Jim Flaherty. The night before, Mr. Sabia had tracked down the federal Finance Minister in Vancouver, where he was giving a speech on money laundering, and politely informed him of his intentions.

In most circumstances, this would have been regarded as a courtesy call. But for the burgeoning income-trust sector, it was the coup de grâce.

For several months, Mr. Flaherty and his team had been fretting about the rampaging advance of trusts. They had caught wind of rumours that Suncor Energy Inc. and EnCana Corp. were each modelling trust conversions that could be valued at close to $40-billion, opening the door to mass conversions in the oil patch.

High-profile directors and CEOs, meanwhile, had approached Mr. Flaherty personally to express their concerns: Many felt they were being pressed into trusts because of their duty to maximize shareholder value, despite their misgivings about the structure. Paul Desmarais Jr., the well-connected chairman of Power Corp. of Canada, even railed against trusts in a conversation with Prime Minister Stephen Harper during a trip to Mexico, and told him he should act quickly to stop the raft of conversions, according to sources.

Amid this escalating tension, Mr. Sabia's phone call became a flashpoint, prompting the federal government to accelerate its crackdown on the sector. Mr. Flaherty was convinced the twin conversions of icons such as Telus and BCE would incite other corporate titans to follow in their wake.

Faced with this prospect, a select group of a dozen people in the Department of Finance and the Prime Minister's Office, sworn to secrecy, redoubled their efforts to stem the rising tide. By Tuesday, they had come up with plans for a new tax on trust distributions, among other measures, and Mr. Flaherty unveiled them in a surprise Halloween announcement.

While his officials worked frantically behind the scenes, Mr. Flaherty remained characteristically reserved in public.

“We do remain concerned about the issue and continue to monitor the situation,” he told reporters after the BCE announcement, the same answer he had provided a month earlier, when Telus informed the markets it would convert.

Privately, however, his mind was all but made up. He knew that virtually every major company in Canada, from the banks to the insurers to the big oil and gas plays, had begun modelling the trust structure. Some had even informally approached Ottawa about the possibilities for their business, further spooking the Conservative government.

“It was clear from the BCE people that they felt compelled to follow Telus, and that taught us a lesson — quite clearly and dramatically — that if other sectors imitate that sector, we'll see a domino effect,” Mr. Flaherty told The Globe and Mail's editorial board Wednesday.

He declined to identify which companies he expected to embark on a trust conversion, although he acknowledged he had heard of “one or two” in the league of BCE and Telus, and that he had concerns in other sectors such as financial services and energy.

Only last winter, in their campaign platform, the Tories promised to preserve the trust market and not impose any new taxes. Yet as the spate of conversions hurtled toward the $70-billion mark, that resolve began to fade.

The problem, however, was more than merely reversing a campaign pledge: It was avoiding the pitfalls of the former Liberal government, whose handling of the file was besieged by accusations of leaks that are now the subject of an RCMP investigation.

Mr. Flaherty kept the circle of insiders very small in an effort to maintain absolute secrecy, yet there were some hints of what was coming.

A week after BCE announced its planned conversion, the Prime Minister was feted in the oak-panelled dining room of the Toronto Club by deal-maker Tony Fell of RBC Dominion Securities Inc.

As three dozen CEOs sipped their after-dinner coffee, Mr. Harper gave a brief speech on foreign policy. Then Ira Gluskin, a money manager who holds $802-million of trusts, stood up and pointedly asked what the government planned to do with the sector, considering BCE's decision.

“Harper hummed and hawed and basically avoided answering,” said one CEO in the room. “I took it as a sign that this was something the government was worried about.”

The market never caught on. Indeed, Mr. Flaherty's decision was made several weeks ago, with the intervening time spent hammering out last-minute details.

Ottawa felt it could not risk another major conversion and decided to announce its new rules Tuesday — an easy night, as it turns out, to have a caucus meeting and prepare MPs for a possible voter backlash.

In the final hour before markets closed, a group of bureaucrats were glued to their computer screens, scanning stocks for any telltale signs that word had leaked out. They were prepared to take extraordinary steps and pull their announcement if trust units staged suspicious dives, but nothing happened; the markets never suspected a thing, something that was clearly evident when Mr. Flaherty announced the trust crackdown on live television about 5:30 p.m.

For at least an hour, as the information trickled out, confusion reigned. In Toronto, most bankers and CEOs had already left the office and were on their way home to take their children trick-or-treating.

At Telus headquarters in Vancouver, where it was still midafternoon, the reaction was disbelief.

In Montreal, the mood was decidedly more upbeat. Sources said BCE's Mr. Sabia was a reluctant convert to the trust model, and “there was dancing in hallways at Bell” after Ottawa's announcement.

Reaction among foreign investors, who have enjoyed feasting on the uniquely Canadian income-trust offerings, was decidedly negative. Wednesday morning, some U.S. clients of one Canadian trader were describing Mr. Flaherty as the “Chavez of Canada” in reference to the Venezuelan President with a penchant for nationalizing oil plays.

Mr. Flaherty knew it wouldn't be a popular decision in some quarters, but he was hardly exercised. After his announcement, he went straight into a meeting with the Tory caucus and, along with Mr. Harper, informed the group of the new rules.

There was some concern about irate investors, but the reaction was mostly positive, according to people at the meeting.

Afterward, Mr. Flaherty phoned provincial finance ministers in Quebec, Alberta and Ontario to discuss his rationale. The first two were clearly on board, while Ontario was more lukewarm.

“You have to either leave it alone or fix it,” Mr. Flaherty shrugged Wednesday. “We were going to see the two largest telecommunications companies in the country not pay corporate taxes. That's a clear and present danger to fairness in the Canadian tax system. I thought we had to act.”

With a report from Eric Reguly