Finance Committee on Jan. 30th, 2007

[The Chair, Conservative, Brian Pallister]

Ladies and gentlemen of the finance committee and guests, welcome. Pursuant to Standing Order 108(2), a study on income trusts will commence. Appearing this morning is the Honourable Jim Flaherty, Minister of Finance.

Welcome again, sir, to our committee. I understand you have some opening comments that you would like to make, and I invite you to do so now.

[Jim Flaherty, Conservative, Minister of Finance]

Thank you, Chair. I'm pleased to be here this morning and I'm pleased to be the first witness at the hearings you're having on the tax fairness plan.

I'm accompanied this morning by Robert Wright, the deputy minister; by Mark Carney, the senior associate deputy minister and G-7 deputy for Canada; by Bob Hamilton, senior assistant deputy minister, Tax Policy Branch; by Brian Ernewein, general director of the tax legislation division, Tax Policy Branch; and Denis Normand, senior chief of payments, financial sector division, Financial Sector Policy Branch.

We'll hear from all of those folks, certainly from Mr. Hamilton, about the analysis done by the department, after I have an opportunity to make some opening remarks. You'll also see the charts around the room, which we produced in order to try to demonstrate, in an easily readable manner, some of the major issues that are involved in the tax fairness plan.

Mr. Chairman, members of the committee, I want to thank you for the opportunity to be here today.

You have received a briefing book, members of the committee, with a copy of my statement, which is more or less what I'll follow; a document prepared by the Department of Finance outlining our revenue estimates and calculations; and a series of charts illustrating the growing trend toward trust conversions in foreign ownership of energy trust units.

I'm pleased to be the first witness, as I said. Make no mistake, the decision that was taken on October 31 is all about fairness for Canadian taxpayers: in the first instance, fairness for Canadian taxpayers and their families, who would be asked to pay more and more if we did not implement the tax fairness plan; fairness within the corporate sector, where the current rules give income trusts a tax advantage and distort investment decisions to give income trusts better access to capital than entities that are organized in the corporate form—that is, levelling the playing field between corporations—and fairness for Canadian taxpayers who are seeing tax dollars sent out of the country to foreign investors.

As you can see from the chart over there, in the large energy trusts, 50% of the ownership—

[The Chair, Conservative, Brian Pallister]

I'm sorry, Mr. Minister. We have a point of order.

Mr. Pacetti.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

I'm sorry to interrupt, but we have a copy of the speech. It seems to be ten pages long. How long can we expect to have Mr. Flaherty speaking for?

[The Chair, Conservative, Brian Pallister]

I think we'll let him use his discretion. We have him for an hour.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

So he can speak for up to an hour?

[The Chair, Conservative, Brian Pallister]

We'll use our discretion. The fewer interruptions, I expect, the more time available for questions.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

I thought we had limited it to ten minutes. I think ten minutes would be more reasonable.

[The Chair, Conservative, Brian Pallister]

Please proceed, Mr. Minister. Thank you.

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

The point I was trying to make before the Liberal member interrupted me was that the large energy trusts, as shown on the chart behind the member, are 50% owned by foreigners, largely Americans, who are only paying a 15% withholding tax. I'm sure the member will want to look at that chart. He will realize that a tremendous tax burden is being shifted to Canadian individuals and their families in that sector.

The other aspect of fairness, of course, is for Canadians vis-à-vis their governments, and I include not only the Government of Canada but the governments of Quebec and the other provinces in Canada. There are letters before you from nine of the provinces. Eight of them specifically support the four-year limitation, as you'll see from the letters. Two of them specifically comment on the tax losses to their governments of $450 million. In Budget 2006 we showed it was $400 million in Alberta. The minister has now written to me saying it's $450 million. There's also $150 million in the province of Quebec, which you can add to the federal $500 million, giving you a total in excess of $1 billion.

I want to take the next few minutes to quickly outline the tax fairness plan and walk the committee through the numbers and our methodology.

As I indicated in the fall, we estimate the federal revenue loss was about $500 million in 2006. I emphasize to you that this will be a growing figure if we do not act, and this is a conservative estimate.

I'll also point out the hundreds of millions of dollars in tax losses to the provinces, and I'll talk about the fact that the landscape had changed dramatically, with almost $70 billion in trust conversions taking place in the first 10 months of 2006 before we took action.

I'll also explain why it would be a serious mistake to carve out the energy sector and provide them with a permanent tax holiday. In that regard, I encourage members to read the letters from the Ministers of Finance of Newfoundland and Labrador and Nova Scotia with respect to their offshore interests and what it would mean to them if the income trust sector were to be active in those developments.

Finally, I want to touch on the need to maintain a four-year transition period in order to avoid billions more in revenue loss, about $3 billion to the Government of Canada, that is the taxpayers of Canada, and at least $2 billion to the provinces of Canada, again the taxpayers of Canada who pay taxes to the provinces.

I want to say from the outset that it is regrettable that some investors suffered financial losses. Although it was a very difficult decision, it was an absolutely necessary decision for our country and for future generations of Canadians, our children and our grandchildren, and for our prosperity in the future.

Our Tax Fairness Plan achieves two critically important goals. It restores balance and fairness in the tax system and strengthens the Canadian economy, now and into the future.

The tax fairness plan achieves these goals through a distribution tax on distributions from publicly traded income trusts, with a four-year transition period for existing trusts; an additional reduction in the general corporate income tax rate of 0.5% in 2011; an increase in the age credit amount by $1,000 to benefit low- and middle-income seniors; and the ability for pensioners to split income beginning January 1, 2007.

Pension income-splitting is a major positive change in tax policy for pensioners and seniors. It significantly enhances the incentives to save and invest for family retirement security.

I want to be clear with the members of the committee and with all Canadians that I have no intention of altering the government's decision, including the four-year transition period for existing trusts.

I want to be clear with the members of this committee and with all Canadians. I have no intention of altering the substance of the government's decision, including the four-year transition period for existing trusts.

Canadians are looking for fairness and for certainty, and our tax fairness plan provides both. I've said it repeatedly as finance minister: Canadians pay too much tax, and this government has already taken steps to reduce their tax burden. Simply ignoring this issue would have resulted in Canadians paying more tax--not less--today and for years to come.

Why? Because as more and more companies converted to income trusts, they were shifting their corporate tax responsibilities onto the backs of individual taxpayers and their families. There was a growing trend toward corporate tax avoidance. In fact, in a news release on September 11, 2006, Robert McFarlane, who was the executive vice-president and chief financial officer of Telus, said this:

TELUS is pursuing a trust conversion at this time since it has recently utilized all of its tax assets and a conversion early in 2007 will optimize its future taxable position.

This wasn't an isolated case, but rather a disturbing trend that was moving into the core of our industrial and knowledge-based economy.

Since we took office, the landscape began to change significantly. In the first 10 months of 2006, almost $70 billion in new income trust conversions took place or were announced. Chart A shows clearly this trend in income trust conversions and the path we were all on. You can see on the chart trends from 2003 to 2006 and the huge increase in 2006 in the first 10 months alone. This represented a clear and present danger to our tax system and our economic structure. Evidence was mounting that we were running a real risk of turning into an income trust economy, an economy where tax avoidance drove business investment decisions and foreign investors stood to make significant gains at the expense of Canadian taxpayers.

No responsible government could stand by and let this happen. I wasn't fair and it wasn't right. Regardless of the political consequences, we had to act. And we did, accepting our responsibility and acting in the best interest of Canada.

As I stated on numerous occasions, we estimate that the federal revenue loss was about $500 million in 2006, as chart B and the supporting material you have received clearly demonstrate. The chart shows the various calculations and the assumptions used to make those calculations, showing the net loss to the Government of Canada of about $500 million in 2006.

This is a conservative estimate. Now consider what these calculations don't include. They don't include any further conversions by any other companies. We estimate that TELUS and BCE alone would have added substantially more to this total. Widely reported estimates from financial experts, based on information from these two companies themselves, indicated that corporate tax savings over the next two years would have been about $1.3 billion for TELUS and about $1 billion for BCE.

Just imagine what the total would have been had other large corporations like EnCana or large financial institutions that currently pay billions in corporate income tax followed suit. The numbers also don't include provincial tax impacts. During my meeting with provincial finance ministers on December 15, 2006, in Vancouver, they expressed serious concerns about the loss of tax revenue and endorsed our tax fairness plan. Letters from most of the provincial ministers are included in your package.

Here are a few examples of what we received. Carole Taylor, the Minister of Finance of British Columbia, wrote:

I believe the measures you propose are necessary to address the policy and revenue impacts of converting corporations to income trusts.... I believe that without action the continued conversions to income trusts would have led to a serious disruption of the tax system.

The Honourable Greg Selinger, Manitoba's Minister of Finance, wrote:

Corporations were increasingly under pressure to convert to income trusts solely as a result of tax considerations, even in instances where trusts were not otherwise the most appropriate form of organization.

Michel Audet, the Minister of Finance for Quebec, said it was clear that the advantages enjoyed by income trusts had gone on too long and that action was called for.

Now, some critics have questioned these figures. In fact, these estimates are very similar to those made by Jack Mintz of the Rotman School of Business at the University of Toronto and former president of the C.D. Howe Institute.

On October 19, 2006, Mr. Mintz said:

It is silly to argue that there isn't any tax loss. Everyone knows the reason people go into income trusts is because there are tax benefits.... That's the way the law is.

The methodology used to determine federal revenue loss should also be familiar to the Liberal committee members of this finance committee. That's because it's the very same or identical methodology their own government used in preparing its 2005 consultation report. The revenue loss estimates are based on a sound methodology, and we stand by them. These are conservative estimates. The tax loss number could actually be higher, as chart C demonstrates; by increasing the effective tax rate by one percentage point, from 6.6% to 7.6%, the annual revenue impact would jump by over $200 million to $710 million per year.

You will no doubt hear from some witnesses that there is no real tax loss, and that if there were, it would be more than made up in the future through personal income taxes or withholding taxes on foreign investors, or taxes on deferred pension plans or RRSP withdrawals. Think about what you are being told: give income trusts an indefinite tax break now, but get it back some time in the future.

Well, as Minister of Finance, I have a fiduciary obligation to the taxpayers of Canada today, not tomorrow. I have an obligation to pay for needed social, environmental, and economic programs today, not tomorrow. I cannot, and I will not, fund today's programs from tomorrow's revenues.

Clearly, income trusts had a special tax advantage that regular business corporations did not enjoy. You know it, they know it, and the market knows it.

The market reaction to a policy that levels the playing field between income trusts and corporations, that makes them equal, not worse, shows that a built-in tax advantage existed, otherwise the investors would not have reacted the way they did. There would have been no market correction.

For those who, faced with all of this evidence, still claim that we don't know whether there will be a loss of government revenue from income trusts, all I can say to you is this. We have federal and provincial government estimates clearly demonstrating tax losses. Income trust distributions are being sent out of the country to a large number of foreign investors who are reaping a financial windfall at the expense of Canadian taxpayers. The only Canadian tax they are required to pay—that is, the foreigners are required to pay—is a 15% withholding tax. That's 15%, far less than the taxes paid by trust holders here in Canada. We have had two of Canada's biggest companies explicitly citing tax considerations as the reasons for announcing plans to convert last year. We know that these same two companies have since renounced their conversion plans since our announcement that any new trusts would be taxed as corporations. We know that other large firms that were actively planning to convert to trusts have abandoned their plans, and we know that groups such as the Coalition of Canadian Energy Trusts must realize that there is a tax loss, otherwise they wouldn't argue that the trust structure gives them a lower cost of capital than the corporate model does.

Faced with these tax losses, the natural question should be, who will pay for all of this lost revenue? Well, your constituents will, of course—the people of Markham—Unionville, the people of Joliette, the people of Winnipeg North, and the people of my riding of Whitby—Oshawa. By failing to implement the tax fairness plan, we would harm our government's books and affect the budgets of every single province in this country, these funds that belong to the people of Canada.

As I pointed out earlier, the provinces are quite concerned about this issue, because ongoing trust conversions were costing them millions of dollars. They understand that converting our businesses into income trusts is not the way to build a dynamic, competitive economy, the kind of economy that we described in our economic plan for Canada, Advantage Canada.

The Province of Alberta, for example, estimated in its 2006 budget that it would lose $400 million a year, before we introduced our tax fairness plan. Their minister now has told me, and put it in writing—you have the letter—that it's actually $450 million, according to their current estimates in Alberta.

The Atlantic provinces lost one of their biggest corporate taxpayers when BCE converted Aliant into an income trust. This conversion had a significant impact on their corporate tax revenues, and that's referred to specifically by the Honourable Mitch Murphy, the finance minister for the Province of Prince Edward Island, in the letter that you have from him.

And Quebec has estimated that the province would have lost $150 million annually if the conversions of certain large corporations had proceeded as announced.

How would it be fair that foreigners would reduce their tax bills through this structure, but hardworking Canadians, who pay to keep our schools, hospitals, and emergency services running, would not?

As you can see, the costs of indecision would have been substantial and unfair, not only for our government but for all governments in Canada.

Our tax fairness plan recognizes that investors, many of whom were seniors, have been affected. We are taking steps to protect investors in four key ways.

First of all, we are providing a fair and reasonable four-year transition period before the new distribution tax will apply to existing income trusts.

Secondly, we are providing generous growth guidelines during this transition period, allowing existing income trusts to actually double in size during the four years.

Thirdly, we are putting in place this year pension income splitting for seniors and pensioners, a significant improvement to our tax system, worth approximately $700 million per year.

Fourthly, we are increasing the age credit amount by $1,000, from $4,066 to $5,066, effective back on January 1, 2006. This measure will provide tax relief for low- and middle-income seniors.

This committee will be urged to make a recommendation to extend the transition period from four to six to eight or even ten years. I want you to consider, on behalf of all Canadians, the ramifications of that move. A transition extension is actually a policy reversal. It gets through the back door a policy change you can't get through the front door.

A longer tax holiday period for trusts would only mean tax unfairness for a longer period of time. It would do nothing for some investors who decided to sell their units between November 1 and today. Most of all, it would create a greater financial burden on Canadian taxpayers.

Extending the transition period from four to ten years would cost the federal treasury approximately $3 billion. It would also cost provincial treasuries. Alberta would lose over $2 billion, and Quebec would lose hundreds of millions of dollars.

So, I would say to the Member for Joliette, are you in favour of a wealth transfer of hundreds of millions of dollars from the pockets of Quebec taxpayers by extending the transition period to 10 years?

This isn't how you build a 21st century economy. This isn't how you build a productive future and a better quality of life for all Canadians, the ultimate goal of our economic plan, Advantage Canada. It certainly isn't how our competitors are doing it—not the United States, not Australia, not the United Kingdom. As Peter Godsoe, the former chair and CEO of the Bank of Nova Scotia, said on October 23:

We are using a structure that the Americans looked at, and shut down. The Australians had trusts, they shut them down. The British looked at this, and decided not to allow it. What do we know that everyone else doesn't?

Canada's new government agrees. Watching the world go by will do nothing to help future generations, whose standard of living will be determined by the investments we make today. Delaying, in other words, only puts off the ultimate goal of this decision, which is an economy driven by sound business and economic decisions, not by the kind of tax planning and tax avoidance our major competitors have clearly rejected.

Let me deal with one final issue, if I may, before I have an opportunity to take your questions—that is, the effect of our decision on energy trusts in particular.

Some in the energy sector have called for special rules based on that sector's history with these tax vehicles. I don't agree, and I don't believe most Canadians do either. I believe it's reasonable to expect that all sectors of the Canadian economy pay their fair share of taxes. Critics have often pointed to the U.S. energy sector and called on our government to treat energy income trusts the same way the United States does with master limited partnerships, or MLPs.

Well, first of all, Canada has no intention of mimicking the United States tax code.

Secondly, United States MLPs are almost exclusively owned by domestic investors in the United States. In Canada, energy income trusts are to a considerable extent foreign-owned—50% of the large energy trusts, as you can see on this chart.

Thirdly, structural impediments under U.S. law have the practical effect of limiting the investment of U.S. mutual funds and tax-exempts in MLPs.

Fourthly, we do not accept that the United States MLP rules will provide a tax advantage as compared to Canadian energy trusts, as the tax treatment of taxable investors under both regimes is effectively the same.

Finally, it's important to understand how much more significant the issue with energy trusts is here in Canada, and that is the size of the markets and the percentage of the markets. The value of Canadian publicly traded energy trusts represents roughly 4% of the TSX market cap. Income trusts alone comprise over 15% of Canadian oil and gas production. In comparison, the total value of U.S. MLPs amounts to less than a third of one percent of the market capitalization of the New York Stock Exchange and NASDAQ.

Had we not acted, the energy trust share of the marketplace in Canada would have risen even further. More and more businesses would have asked, why should that company benefit and not mine? Then that $500 million revenue loss would grow, because if a company like EnCana opted to become a trust, you can be certain that they would not be alone.

Talk to Newfoundland and Labrador, a province with a historic opportunity before it to build prosperity and lift its citizens out of debt, and see what they would think about Hibernia, for example, becoming an income trust. This is not a hypothetical illustration. In the case of Hibernia, the federal government has received several proposals to do just that, with respect to Hibernia becoming an income trust. As Mr. Marshall, the province's finance minister wrote to me:

The potential erosion of this revenue source resulting from the proliferation of Income Trusts had been of grave concern prior to your announcement.

Newfoundland and Labrador, Nova Scotia, and the federal government all believe very strongly that energy projects should pay their fair share of tax. Our government remains committed to tax fairness and fulfilling our commitment in Advantage Canada by lowering taxes further as we prepare our next budget.

Our last budget reduced taxes in 29 different areas. While not giving anything away, I can tell you that, had this government not acted on income trusts, any plans for future tax reductions in the next budget would be at risk.

I have a few final thoughts to conclude. In the end, our government was faced with a hard choice, and now this Parliament is faced with a big decision: to make the tax fairness plan a reality. We chose not only to recognize a growing problem occurring in Canada's tax system, but to fix that problem. We made that decision based not on political calculations, as did the previous government, but on principles of tax fairness--balancing the needs of individual investors with the interests of taxpayers and their families. We acted responsibly and decisively. It is not tax fairness if it is only for a few. And it is not strengthening the economy if the playing field is not level for all businesses in Canada.

Committee members should recognize that they can't turn back the clock. There has been a substantial change of ownership in trust since October 31, 2006--for a number of trusts, up to one-quarter of the shares have changed hands. Where there was once speculation as more and more large corporations opted to become income trusts, today there is certainty. Businesses are making their own choices to grow this economy. They're moving on.

It's time we all move on, in the interests of all Canadians. The result of our decision is clear: a tax system that is fairer for Canadians and that will help make our economy more productive, efficient, and dynamic, today and for years to come.

The result of our decision is clear: a tax system that is fairer for Canadians and that will help make our economy more productive, efficient and dynamic today and for years to come.

Thank you for your kind attention.

I would, if I may, Chair, ask Bob Hamilton, the senior assistant deputy minister of tax policy at the Department of Finance, to go over the paper that the department has prepared, and which members of the committee have, with respect to the revenue losses to the Government of Canada, the methodology and so on.

[The Chair, Conservative, Brian Pallister]

Thank you, Minister, for your presentation.

Gentlemen, I appreciate your attendance here.

I think we'll move to questions. We only have a half hour remaining and I do want to include the committee members in the exchange today, so we'll move immediately to questions.

Mr. McCallum, you'll begin, for six minutes.

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

Thank you, Mr. Chair.

I think we have good news and bad news today. The good news is that at least these hearings have demonstrated their value by forcing the Department of Finance to produce numbers instead of these blacked-out, highly censored documents that we have had to date. So congratulations on that.

The bad news is that these numbers from Finance have been all over the map. There have been four sets of numbers. These are hugely complex issues. We can't respond immediately when we're presented with numbers on the spur of the moment, so it will be my proposition that after we have heard from the witnesses.... Some of these experts will question Finance. Finance now says “900 million”; some of our witnesses say “zero”. This is an important subject. We will hear the witnesses, and then after we have heard from the experts, in light of the expert testimony we will propose to invite the minister back to revisit his estimates.

But I might just say off the top of my head, looking at two charts, I can think of two good reasons why right away I'm skeptical. He puts a lot of emphasis on BCE and TELUS, and at the time he said that if BCE and TELUS had converted there would be $300 million of lost revenue. But since that time, BCE and TELUS have both revealed they will be paying essentially no corporate income tax. As one of our experts will testify, in fact by not converting to an income trust, BCE and TELUS will be paying less tax, because they will be paying essentially no corporate tax over the coming years.

With respect to the second example, his other chart here, about the foreign energy trusts and the 15% withholding tax, if those companies were corporations they'd presumably be paying the average effective corporate tax rate in the energy sector, which is approximately 7%--7% is less than 15%.

Those are just two examples, which I won't elaborate on further, as to potential flaws. We have to hear the witnesses at this point. After we have had time to digest all these numbers, we will seek to call the minister back.

This is my question for the minister. Before your announcement, did you receive studies on the impact of your announcement on investors? If so, what did those studies tell you?

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

As you know, your government put out a consultation paper in 2005, and there were a large number of responses to that.

I'm pleased, Mr. McCallum, that you have said what we did was “absolutely the right thing, and we had started on this track to protect the tax base—”

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

Mr. Minister, my time is limited. Excuse me—

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

“—to ensure tax fairness and to work for the productivity of the nation.” I am glad you approve of the policy decision I made.

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

Mr. Minister, as a humble member of Parliament, I only have five minutes, but I think they are my five minutes, so I would ask you to answer the question.

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

I was going to answer your question.

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

And my question has nothing to do with that out-of-context statement of mine. My question is a very simple one. Before you made your announcement—

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

Was it the right policy or not? You said it was.

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

Mr. Minister, I am asking a very straightforward question. Before you made your announcement, did you receive studies on the impact on investors? For example, did you have any estimates or information or studies from your department as to the likely impact on the stock market in terms of the market value of income trusts? Did you have any studies or reports on that subject?

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

Obviously, Mr. McCallum, as I said in my opening remarks, the reason the income trust sector, particularly the energy trust sector, argued so vociferously for the maintenance of the status quo—

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

Mr. Minister, did you or did you not have any such reports?

[Jim Flaherty, Conservative, Whitby—Oshawa, ON]

The reason the income—

[An hon. member]

Come on!

[Mike Wallace, Conservative, Burlington, ON]

Let him answer.