Canada backpedals on taxing popular trusts

Federal election campaign forces Goodale to end contentious income trust issue; says he won’t hit sector with new taxes

Gary Park

Petroleum News Canadian Contributing Writer

In what is being described as a deathbed repentance, the Canadian government has removed the cloud hanging over income trusts since mid-September by scrapping any thoughts of taxing the highly popular investment vehicles.

However, Finance Minister Ralph Goodale said nothing specific about whether action might be taken against foreign investors.

But some observers warn that foreign owners of trusts and tax-deferred pension funds still pose a tax problem and could force the government to intervene at some later date.

With a federal election suddenly on the horizon, Goodale opted to cut taxes paid by investors on conventional stock dividends rather than changing the tax treatment of the trusts, thus narrowing the gap between trusts and dividend-paying stocks.

That was his second flip-flop in less than two years as Ottawa grapples with ways to stem revenue losses from trusts which hit C$300 million in 2004 — roughly 1 percent of corporate income tax collected in the 2004-05 fiscal year — and are expected to reach C$600 million to C$1 billion this year.

2004: foreign investments targeted

In September, still anxious about the drain on federal revenues from trusts, which sidestep corporate tax by paying most of their cash flow to investors, he spooked the stock markets by launching a review of the trust tax structure.

Within days the trust sector had shed billions of dollars in market value, plummeting from their combined high of C$160 billion and trusts started slashing their cash payouts, while conventional companies stalled plans to convert.

This time investment banks, pension funds and retail investors mobilized and swamped Goodale’s office with protests.

Initially, Goodale said he would disclose the findings of a public consultation process by spring 2006. He trimmed that to January, then to December and finally, prior to defeat of the minority Liberal government, he jumped the gun Nov. 23.

His surprise announcement came five weeks before a deadline for trust stakeholders to submit their views on how trusts should be taxed.

Goodale blamed his hasty response on the improbable alliance of federal opposition parties — right-wing Conservatives, left-wing New Democrats and Bloc Quebecois, whose major goal is to achieve independence for Quebec — who teamed up to topple the government of Prime Minister Paul Martin Nov. 28, forcing an election vote on Jan. 23.

“Quite frankly it’s become clear in the last few days that the opposition is absolutely determined to bring Parliament to an end,” he said.

“In that context, while I would have preferred to have the full consultation process and have the benefit of that … I decided it was in the public interest to bring this to a definitive conclusion now.”

Personal tax rates on dividends dropped

The result will be that total personal and corporate income tax paid on dividend income will be roughly equal to the total taxes paid if that income were earned by a trust.

Goodale predicted the dividend tax move “will encourage savings in investment and is fully consistent with (the government’s) plan for growth and prosperity.

“At the end of the day, we are going to achieve greater fairness and balance” in the tax system, he said.

But there were also strong indications that the announcement was made in haste.

Goodale’s parliamentary secretary, John McKay, told a TV network that the government planned to impose a modest tax on income trusts.

Goodale said McKay was mistaken, adding “We are not proposing any tax on trusts.”

John Dielwart, president and chief executive officer of ARC Energy Trust, said McKay’s blunder sent “consternation and confusion” through trust ranks until Goodale cleared the air.

Dielwart said he understood the Liberal government had intended to impose a tax on trusts, but abandoned the idea because of stiff opposition from pension funds and trusts.

Wilf Gobert, vice-chairman of investment dealer Peters & Co., and Gordon Kerr, chief executive officer of Enerplus Resources Fund, said that removing the cloud over trusts should enable them to resume growth and acquisitions.

Monte Solberg, finance spokesman for the Conservatives, suggested the disconnect between McKay and Goodale was a “gong show … but that’s what happens when you make up policy as you go along.”

Five-year high

But the Conservative and New Democratic parties have called for the Royal Canadian Mounted Police or the Ontario Securities Commission to investigate whether details leaked from Goodale’s office, triggering a flurry of trading in the hours before Goodale’s announcement.

“When huge amounts of money exchange hands just before a government financial announcement it looks bad,” said Judy Wasylycia-Leis of the New Democrats. “Was there a leak? Did insiders profit? Canadians need to know exactly what happen.”

Goodale vigorously denied any suggestions of a leak or that anyone benefited from advance notice.

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