Cutting dividend taxes a win- win proposition
Banks, Ottawa would both be better off
One
of the more interesting
events this week was when a couple of the banks called for a reduction on dividend income taxes. Without the cut, the banks said they’d be forced to think about spinning parts of their business into income trusts, such as their wealth management arms.
That’s hitting the government where it lives, after it put out a consultation paper last week that highlighted concern about the tax revenues its losing because of income trusts.
But calling upon the government to lower dividend taxes and therefore slow down the income trust gravy train could prove to be a double-edged sword for the banks.
Let’s start with why the banks would like to see the cut.
First, there’s little doubt that lowering dividend taxes would make bank stocks more attractive to investors. BMO Nesbitt Burns analyst Ian de Verteuil recently estimated that the double taxation — the combined individual and corporate tax — on bank dividends is more than 54%. Any reduction on that lofty figure would be welcome news for investors.
Lowering the dividend tax would also level the playing field for the banks against their competitors, such as mutual fund company CI Fund Management Inc. and investment dealer GMP Capital Corp. As pending trusts, both of those companies are receiving fat, premium valuations from the market, a clear competitive advantage.
The highly-regulated banks would also probably rather not spin off units, because of the complexity and cost of such a move, according to Veritas Corp. analyst Ohad Lederer. They’re also likely unwilling to part with or become partial owners of key businesses like their brokerage and wealth management arms.
So that sums up why banks are pushing for dividend tax cuts. But in doing so, they could also be hurting themselves.
There’s little doubt that the booming income trust market has been a gold mine for the investment bankers at the banks. There’s a fortune to be made lending money to trusts and underwriting the IPOs and unit offerings.
In the second-quarter alone, there were 16 income trust initial public offerings (IPOs) valued at $1.4-billion, according to FP Data Group. That’s about $70-million in fees up for grabs from IPOs in one quarter alone and this has been going on for years.
In fact, the income trust underwriting business has become so dominant that it has pretty much choked out the common equity underwriting business. As BMO Nesbitt Burns strategist Ben Joyce pointed out this summer, the amount of common shares in Canada actually shrank last quarter for the first time in 42 years. All the new underwritings are in income trusts.
“ This spectacular transformation has been unique to the Canadian market, thanks to favourable tax treatment for trusts relative to common stock,” Mr. Joyce said.
Even the mutual fund arms of the banks have been heavily dependent on income trusts lately. Despite having about a third of the industry’s net assets, the banks raked in half of Canada’s August net mutual fund sales, according to a report by National Bank Financial analyst John Aiken. A lot of what the banks are peddling is income and dividend funds.
So what will happen in the end? The banks didn’t manage to win Ottawa over on the mergers issue, but this time their desires seem a lot better aligned. The banks don’t want to convert to trusts, and the federal government doesn’t want to lose any more tax to trusts.
The banks might lose some money on underwriting an ongoing trust boom, but they’ll find another investment fad to sell. It’s also unlikely that mutual fund sales of dividend and income funds will drop off much for them, since the big appetite for income from Canada’s ageing population should keep demand for these products going for years.
This may simply be a case where a concession on dividend taxes will make both sides happy.