Finance Committee on Feb. 13th, 2007

[The Chair, Conservative, Brian Pallister]

I'll call the committee to order now.

Pursuant to Standing Order 108(2), we meet today for our study on income trusts. We have several witnesses to present their points with respect to the income trust issue.

To the witnesses, welcome. Thank you for taking the time to be here and to prepare your reports and whatever work you've submitted to the committee members. I understand that some of that work is being distributed as we speak.

I believe you've been apprised of the fact that you have five minutes to make your remarks. I will indicate when you have one minute remaining. Unfortunately we'll have to unceremoniously cut you off at the end of your five minutes. I hope you understand in advance the reason for that, which is to allow for an exchange with committee members so that they can pick your brains on the issues you're speaking to today.

Again, thank you for being here. We appreciate your time.

To committee members, we should have approximately 30 to 35 minutes for questions, so I encourage your focused attention.

We'll begin with a representative from HDR/HLB Decision Economics, Mr. Dennis Bruce, vice-president.

Welcome, Mr. Bruce. Five minutes to you.

[Dennis Bruce, Vice-President, HDR|HLB Decision Economics]

Thank you, Mr. Chair. I am pleased to return to provide additional evidence on the tax leakage issue.

As stated on February 1, we believe the Department of Finance sharply overestimated tax leakage at $500 million for 2006. Our figure, after making appropriate adjustments to the department's approach, is a tax leakage of $164 million. But today I will focus on addressing the cost of extending the transition period from four years to ten years.

If we look at extending the transition period, HLB calculates $32 million of federal tax leakage per year. The total cost of the six-year extension is $192 million, as opposed to the department's estimate of approximately $3 billion. Notwithstanding identical methodologies, the HLB calculation differs sharply from that of the department.

There are four significant factors at work that I will address in turn.

First, the Department of Finance's exclusion of already legislated corporate income tax changes through 2010 results in an overstatement of tax leakage. The evidence provided by the Department of Finance in its backgrounder, and by the minister in his statement before the committee, makes no reference to the impact of already legislated tax changes. While the minister indicated that the $3 billion estimate is the result of multiplying the department's $500-million-a-year figure by six, no formal written documentation has been provided that explains the department's calculation. That includes the materials provided last week by the Department of Finance.

I recognize that in response to committee questions on February 1, departmental officials stated that projected growth in the trust sector would offset the impact of legislated corporate tax reductions. I find this to be a most extraordinary notion for a sector in which no new conversions are allowed, where constraints are to be imposed on the growth of each individual trust, and where the increase in tax burden is known to be significant under the proposed rules. In fact, very few trusts are likely to remain in the current form over the medium to long term.

Second, the exclusion by the Department of Finance of deferred taxes results in an overstatement of tax leakage. In ignoring the present value of tax revenues and deferred accounts such as RRSPs, the department has quite inappropriately adopted a one-year budgeting framework to analyze a policy proposal with multi-year implications.

We do think the department acknowledges this point in principle by allowing in its calculations tax revenues, from shareholders of corporations, from capital gains that may not be realized until future years, when the shares are actually sold or disposed of. It is inconsistent to not apply the same logic to tax-exempt accounts and include the value of deferred taxes from income trust investors.

Third, the overestimation of tax-exempt unit holders by the department results in an overstatement of tax leakage. In its 2005 public consultation paper, the department used HLB's figures for the proportion of tax-exempt investors. We have since updated that figure. However, we did so shortly after the consultation paper was released. Since then we have collected additional information that corroborates a revised number. The department, however, continues to rely on our out-of-date figure for the analysis.

Fourth and finally, the overestimation of ongoing corporate tax rates in the energy trust sector results in an overstatement of tax leakage. The department's assumption for the effective corporate tax rate in the energy sector has been arbitrarily increased to reflect the favourable market conditions that happened to prevail in 2006. This reasoning, by the way, is a departure from the more appropriate approach the department used in its 2005 public consultation paper.

To conclude, the combination of the four factors I've discussed leads the department to overstate by a factor of about 15 the tax leakage associated with extending the transition period to ten years. In short, the total cost of extending the transition period for income trusts is $192 million, not $3 billion as the department has provided.

I'd be pleased to answer any questions from committee members during our remaining time today or after the session.

Thank you very much for the time.

[The Chair, Conservative, Brian Pallister]

Thank you very much, Mr. Bruce.

We will continue with Al Rosen, president of Rosen & Associates Limited.

Welcome, Mr. Rosen. It's over to you.

[Al Rosen, President, Rosen & Associates Limited]

Thank you.

I have some handouts. Are they being passed around? Is there one page or are there four pages? I need a clarification. Is there only one page?

[The Chair, Conservative, Brian Pallister]

That handout can go around, but the other one has names in English. If we could have the agreement of all committee members, we would be able to hand it out, otherwise it will require translation.

Do any committee members object to it being handed out?

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

Yes, it's okay.

[The Chair, Conservative, Brian Pallister]

All right. The handouts are going around right now, Mr. Rosen.

Please commence.

[Al Rosen]

Thank you.

The first handout is only one page, and it has columns one, two, three, and four on it.

This is a live and actively traded income trust, at the moment, and it's trading for around $9. The name has been withheld, but you'll see that we have tracked nine years, from 1997 through to 2006.

The first column is the sale of trust units. It starts in 1997, with $80 million, and it works its way down to 2004, with $85 million. The next column is debt and redemptions. Column three is the income or the loss for those years. The fourth column is distribution. If you add up the distribution, you can see it comes to $335 million over that period of time. You can also see that the income loss is $133.6 million. The translation is that the distributions are 250% of income and they paid out $201 million in excess of what they earned.

Backing away from this for a minute, we work with two corporations. Number one is the Accountability Research Corporation, which does this type of thing. Our second business is forensic accounting, and we're very heavily involved in securities problems. Intertwined with the tax is all of the reporting that is going on.

You can see from this particular situation that the typical lingo for this is a pyramid scheme, or if you can prove conspiracy, recklessness, and so on, it becomes a Ponzi fraud. Having tracked most of this material for several years, my concern has been extensively along the lines of these pyramid schemes and Ponzi frauds being well over half of the income trusts.

If you turn to page 17, you'll see something that starts with “Medical Facilities - IDS”. This is a study we did that was published in November 2005, and I have deliberately brought this material today to show what the situation was like before we had the various flip-flops happening.

The first column is income as a percentage of what was distributed. You can see with the first three, with the dashes, that the income was in fact a loss. As you work down the columns—and there are roughly 50 companies here—you see that very few of them were actually distributing out of their net income. It was coming from other sources.

The next column is the cash yield as of November 9, 2005, and I might add that things have become substantially worse since then. For example, Medical Facilities had 10.90% of a cash yield. This is cash being distributed to people compared to the trust unit price at the time. How much of that 10.9% came from income? It was zero. It was all a return of capital.

There is nothing wrong with returning capital, as long as you tell people that is where it is coming from. The fraud allegations come in as a result of not telling people what the sources are. This is of deep concern to us.

If you keep working your way down the columns, you can see that very little income is being produced by a large percentage of these particular trusts. Overall, you are seeing 4.97% in the third column, and you're seeing 2.98%, which is a straight return of capital. That has become significantly worse since then.

As in the first example I used, you can see how serious the problem is. It's not being regulated. The securities commissions came up with something a couple of weeks ago that does not regulate this. The chartered accountants are not regulating it. They have one subgroup, which is not part of the standards board, that I think has a good idea that needs to be developed.

The next page, as you can see, starts with heating oil partners at the top left. The first column over is the issue date, when these items were sold, and then what the offering value to the public was, and then you see the current value and the decline. These declines go from 100% down to 30%, which is where we cut it off. Since then, this table has tripled in numbers and problems.

If we go to the next table, this is one of capital maintenance. The argument is that we are simply distributing back to you depreciation and the tax savings. This is sheer nonsense for two-thirds or three-quarters of the trusts we track, which is most of the business trusts. If you look at the column, you can see that maintenance capital expenditure is 0%, so the money is not being reinvested. What's happening here is quite different from the stories we see in the media. The figures really tell you a totally different story.

[The Chair, Conservative, Brian Pallister]

I have to cut you off, but there will be time for questions, of course.

We'll continue now with Jean-Marie Lapointe. Welcome, and we'll go over to you for five minutes, sir.

[Jean-Marie Lapointe, As an Individual]

Thank you, Mr. Chairman. You are a sports enthusiast, a marathon runner. You're asking me to be a sprinter, when I'm in no shape to be one! I would need more than five minutes to make my presentation.

Have all committee members received the green folder made of recycled paper? It contains charts and figures, but no particular comments.

[The Chair, Conservative, Brian Pallister]

Please proceed, sir. That will be distributed as you are making your presentation.

[Jean-Marie Lapointe]

First off, I'd like to talk about these charts. Let me say right away that in these files—

[The Chair, Conservative, Brian Pallister]

We'll go to Monsieur Thibault.

[Robert Thibault, Liberal, West Nova, NS]

Mr. Lapointe plans to refer to his documents. We need copies to follow along with him. Can we take a few moments to pass around these documents, so members can follow his presentation?

[The Chair, Conservative, Brian Pallister]

Proceed if you wish.

[Jean-Marie Lapointe]

Fine then.

I drew up these charts on my own PC. They show the situation of my immediate family members. Chart 1 shows the investment curve of my grandchildren's RESPs. As you can see, the situation was on the upswing prior to October 31. As of November 1, a downward trend set in. Further on, there are signs of improvement, but only because additional investments were made in January. This chart reflects only to my grandchildren's RESPs.

The next chart shows my daughter's RRSPs. You can clearly see the impact of the November 1 decision and the subsequent stability. Clearly, there has been no real recovery.

The next page contains a chart showing my son-in-law's RRSP. There was a downturn, followed by a recovery because we reinvested funds from elsewhere. These funds were specifically reinvested in income trusts.

The next page shows my spouse's RRSP. I don't think any comments are necessary.

The same applies to the page showing my own RRSP.

The last page shows the situation of one of my sisters.

Obviously, these are personal and private documents. I'd like to ask a lawyer who is here today, namely Ms. Diane Ablonczy, to collect these documents after the meeting or after your in camera session. These are personal documents and I don't intend to bemoan my fate any longer.

My file also contains long-term planning and information about RRIFs. According to my projections, retirees won't be able to get by with a 4.5% rate of return. They may be able to hold on a little longer with a 6% rate of return, but if they are to truly survive, ideally their RRSPs needs to generate a return of about 8%. In this case, the retiree will pay considerably more tax and when he dies, the government will obviously take its share before the children and grandchildren get theirs. It's not difficult to maintain an RRSP when you are healthy.

While the Minister of Finance may well say that he works to pay bills for the current year, we are all left to worry about the years ahead, and we do worry.

I won't bore you with any more figures or personal tales.

Let me relate a simple story to you. In the fall of 2004, I invested some money in a company in Saint-Léon, Manitoba, that produced wind energy. I was entitled to tax credits from the federal and Quebec governments.

No doubt Mr. Paquette will hate me for contributing to the fiscal imbalance.

Subsequently, Ontario's Algonquin Power took over this operation. This facility operated in Manitoba, while investors come from across Canada, including Quebec.

As a result of your plan, Algonquin Power will probably be privatized. The Government of Canada will lose its subsidy, as will the Government of Quebec. As a small investor, the decision represents for me a permanent loss of revenue. Algonquin Power is no Ponzi scheme. However, it generates a 10% rate of return on my initial investment.

Therefore, I have a good question—

[The Chair, Conservative, Brian Pallister]

That's all. Thank you.

[Jean-Marie Lapointe]

Thank you, Mr. Chairman.

[The Chair, Conservative, Brian Pallister]

Merci. There'll be time for questions, of course, Monsieur Lapointe.

We continue with William Barrowclough.

Welcome, sir. You have five minutes.

[William Barrowclough, As an Individual]

Thank you, Mr. Chairman.

First, I would like to congratulate the committee for finally inviting some real investors to tell their stories. By the end of today's session, you will have heard four such people. That's four over three full days of hearings. It's high time you encountered some real people. I only wish Mr. Flaherty had given us some thought.

Seven years ago, my wife died as the result of a traffic accident. Our car was demolished by a reckless speeder who ignored a red light. The insurance settlement formed a large part of a portfolio that I invested to make a better life for our children and for the grandchildren she hadn't lived to see. Three and a half months ago, a large portion of that portfolio was erased, this time by the rash and reckless action of our finance minister. That's two major assaults on my family, both with reckless indifference. The first took my wife, and the second stole part of her legacy to her children and her grandchildren. You can't know the depths of my anger.

I had invested a large part of my portfolio in income trusts because Mr. Harper gave such solid assurances that one couldn't possibly doubt him. After all, Mr. Harper had gone to great lengths to differentiate his and his party's integrity from the perfidious Liberals. That should have tipped me off: beware the man who parades his own virtue.

My family and I have suffered gravely at Mr. Flaherty's hands, but others have suffered more, even though the actual dollar amounts may have been smaller. A loss of $25,000 or $50,000 might be more devastating than a numerically larger sum. If, like so many middle-class Canadians, one had retirement savings that provided an income barely adequate to meet expenses, then a few thousand less in capital would make a tremendous difference in monthly cashflow. And make no mistake; it's regular cashflow that is of primary importance to retirees. That's why seniors loaded their RRSPs and RRIFs with income trusts in the first place.

The Halloween massacre not only caused the evaporation of billions of dollars of our capital, but thanks to the impending death sentence hanging over income trusts, there isn't likely to be much of a rebound in valuations. That means our capital isn't coming back.

So what's an income trust investor to do?

Well, he can sell all of his trusts at fire-sale prices and use his reduced pile of capital to buy more expensive securities that pay far less in income. That's not very satisfactory for those who were just getting by before the bombshell attack.

Or, of course, he could just sell everything up and buy GICs and stick his hand out for every government program available, and I think then you'll see some tax leakage.

Or perhaps he could hang on and hope that his trusts would be among those to survive and that they would be able to continue paying their normal monthly distributions. That would require both faith and a deal of luck—far more luck than we had last Halloween.

Either way, the retiree would be facing a much reduced stream of income. Under the Flaherty scheme, taxable accounts would eventually see some relief through the dividend tax credit, but there is no such relief in registered accounts from the rapacious 31.5% proposed tax.

In sad fact, the brunt of the Flaherty tax plan, whether planned or accidental, is borne by foreign investors and Canadians with registered accounts. We're either collateral damage or the victims of a brutal mugging. Is it reckless indifference or a vicious attack on retirement plans? I must say, neither is a very comforting conclusion.

In my brief, which I assume was distributed to you, I have suggested a range of options that would go some way to ameliorate this ghastly situation. Naturally, grandfathering would be ideal, but at the very least I implore you to adopt a 10-year tax phase-in, as did the Americans at a time when trusts were a minuscule part of their economy—nothing like the over 20% they composed of our index—and to put in place the plan described to you previously by Mr. Dirk Lever for a refundable tax credit, so that seniors with registered accounts wouldn't bear the entire brunt of what Mr. Flaherty, in his best Orwellian doublespeak, calls a “tax fairness plan”. War is peace, freedom is slavery, ignorance is strength, double taxation is tax fairness—George Orwell would have been proud.

Mr. Chairman, two days ago I received a telephone call from another person on the witness list for today's hearings. I had never before had communication with this person, who proceeded to preach an hour-long sermon on the evils of trusts and then attempted to get contact information for the other individual investors. While at no time did this witness directly counsel me to change my testimony, what I heard was a diatribe that through its content, tone, and timing—two days before our appearance here—was clearly an attempt to influence my testimony before this committee. That fits my definition of witness tampering, Mr. Chairman, and I hope it fits yours.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you, sir.

We move to questions. Mr. McCallum, five minutes.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you, Mr. Chair.

Thank you very much to all of the witnesses.

I'd like to begin with Mr. Bruce. I think your testimony is significant in the sense that I believe you are one of approximately four people who have severely questioned the government's tax leakage conclusions. There has been no witness that I can think of who has defended the government's estimates. At the same time, the government has refused to release its numbers. I want to make sure the committee is clear in their minds of your conclusions.

If we go through your four points, your first point is that they've excluded already legislated corporate income tax changes, and the only way that could be rationalized is if you assumed substantial growth in the income trusts over the next six years, which is a crazy idea when income trusts are essentially being taken out of business. Is that a fair summary?

[Dennis Bruce]

Yes, the income trust market would have to grow significantly over the next 10 years in order for that to occur and offset the legislative changes.

[John McCallum, Liberal, Markham—Unionville, ON]

On the third point, the overestimation of tax-exempt unit holders, you have in the past been the source for the Department of Finance, and now you have more recent numbers, which they have not adopted. Is that right?

[Dennis Bruce]

That's correct. In the consultation paper our estimates for tax-exempt unit holders were utilized. We shared data. Obviously we had done a lot of discussion with industry, etc., and that information was used. We updated our data last year, and then our report of November 23, 2005.