A taxing issue for income trusts
Street debates future of a beloved asset class
About 30 Bay Street movers and shakers — investment bankers, fund managers and analysts — gathered yesterday to toss around ideas on the future of income trusts. But the message they left with may not be what they wanted to hear.
Jack Mintz, chief executive at C. D. Howe Institute, was the centrepiece of the Desjardins Securities roundtable at Toronto’s St. Andrew’s Club and he provided his analysis about leveling the playing field between trusts and corporations by neutralizing the Canadian tax structure.
Mr. Mintz has provided this analysis several times in the past few weeks since Ottawa decided to suspend tax rulings for income trusts, throwing the trust market into uncertainty.
One way to level the playing field, Mr. Mintz said, is to lower tax on dividends.
Corporate taxes could also be slashed to eliminate the tax advantage for trusts, he said, repeating arguments about two weeks ago before the Senate standing committee on banking, trade, and commerce.
But after different tax scenarios for income trusts and corporations were discussed, one of the last men to hold the floor — John Ulmer, a tax lawyer at Davies Ward Phillips & Vineberg — pointed out that overhauling Canada’s tax structure could open up a Pandora’s Box of possibilities that could create further headaches.
“ You don’t get tax reform of that magnitude that quickly,” the tax lawyer told the group.
“Fundamental tax reforms will take years.”
Take, for example, the option of taxing trusts. That would “level the playing field” between trusts and corporations, but it would also create another tax loophole companies could exploit, he explained in an interview after the roundtable.
Income deposit securities, or IDS units, would suddenly become in vogue on the TSX. These securities are capable of skirting corporate taxes and trust taxes, and that would make them as popular as income trusts are now, he said.
So Ottawa would then have to deal with that disparity. Fixing the IDS loophole, however, means addressing interest deductibility. And touching those rules would send ripples through the industry.
“Interest deductibility is an issue that affects everybody — it affects corporations, it affects trusts, it effects individuals,” he said. This domino effect is not lost on the Finance Department, Mr. Ulmer reminded the audience.
“ The reason that things don’t change overnight is that first [the government] has to decide what they want to do and then they have to figure out all the potential ramifications,” Mr. Ulmer said.
“It is very difficult to make changes that don’t impact other areas.”
Tax reform is unlikely to happen by February, when some expect a new budget to be delivered, Mr. Ulmer reminded the group.
And as Mr. Ulmer laid out his case for patience, Mr. Mintz — a chief advocate of widespread tax reform — nodded in agreement.
The roundtable happened as RBC Capital Markets analyst Dirk Lever released a report predicting that trusts could lose between 25% and 30% of their value if trusts were taxed like corporations — and that’s on top of the 7% the trust sector has shed since Ottawa’s advance tax ruling decision.
Mr. Lever also argued that trusts deliver more taxes to the government in their present form than they would as standard corporations.
“The amount of taxes collected from the business trust sector is likely greater today than it could be if the business trusts were converted back into corporate form,” he said in a research note. The reason, Mr. Lever explained, is that retail investors pay income tax on the distributions, thus putting more money into the government’s coffers than corporations.
He figures that income trusts puts about $3.3-billion into government coffers per year from individual taxes currently.
While the Street debated the future of their beloved asset class, one point of uncertainty was removed from the income trust picture yesterday. Standard & Poor’s said it will go ahead as planned with its previously announced plans to add income trusts to the S&P/TSX composite index.
But this announcement doesn’t eliminate the fundamental tax question swirling around income trusts. Another message from the roundtable yesterday was the Bay Street has to encourage their clients to defend trusts.
Oscar Belaiche, a portfolio manager at Goodman & Company and roundtable participant, urged clients in a Sept. 28 letter “to call or write their MP to express their concerns with the actions taken by the government and its potential impact on their personal wealth.”
Frank Mayer, a Desjardins real estate analyst and roundtable guest, surveyed the room and calculated that the group controlled between $20-billion and $40-billion in assets, depending on whether you tossed in pension funds.
“Perhaps it is time we take up the challenge,” he said.
But that brings us back to Mr. Ulmer. The fund managers can push all they want, but Ottawa will have to take its time.
“[ The government] really created a conundrum in terms of political pressure to have a solution. But the solution might well be what [Mr. Mintz] is saying: We really have to look at fundamental tax reform. But that is not very likely, in my mind, that you’re going to have by February.”