Evidence of meeting #59 for Finance in the 39th Parliament, 1st session. (The original version is on Parliament’s site, as are the minutes.) The winning word was trust.
A recording is available from Parliament.
Liberal
John McCallum Liberal Markham—Unionville, ON
Thank you, Mr. Chair, and I'd like to thank all of the witnesses.
I'd like to focus principally on the tax leakage issue and the witnesses who have dealt with that question. I notice Mr. Kesteven referred to TELUS and BCE. I made the point earlier that because TELUS and BCE are saying they're not paying essentially any corporate taxes going forward, if they had become trusts, it would not indeed have cost the government tax revenue. I believe you agreed with that statement. Is that right?
President, Canadian Association of Income Funds
Absolutely.
Basically, the calculations I've seen indicate that the government has foregone somewhere between $1.7 billion and $2.2 billion of tax revenue that they would have otherwise received from unitholders of those two companies if they had been converted into trusts.
Liberal
John McCallum Liberal Markham—Unionville, ON
Thank you. That was my understanding as well.
Mr. Renkas, maybe I can refer briefly to my second comment when the minister was here in terms of this chart, that is, the reference to the fact that the effective corporate tax rate on oil and gas is in the order of 7% or so. Can you comment on that and the implications for tax leakage?
Royalty and Income Trust Analyst, BMO Capital Markets
I would agree with that. I believe the withholding tax is sufficient where it is. I don't believe there is a leakage to the U.S. investors. The other thing to consider is this. You're talking about effective tax rates of equivalent numbers using 7%. If you look at the average effective tax rate that corporations pay—this is on a broader sense, looking at business trusts—it's effectively 22%, on average, but that's off income.
We've looked at 83 business trusts that we cover at BMO Capital Markets, and on average distributions are 1.5 times the size of taxable earnings. It's a bigger number. You're collecting 15% off a bigger number. In fact, if you work through the math, it works out to about 23% that they collect today on withholding taxes off earnings going to the U.S., on average, versus an effective 22% rate.
I don't believe the withholding tax to the U.S. non-residents is a big issue at this point. I think it's something we could review. In my research I have also found that the withholding tax on U.S. flowthrough entities is specifically exempted from the tax treaties. In fact, they're collecting anywhere from 30% to 35%, depending on the entity you're dealing with. The U.S. is withholding more tax from non-residents. It's certainly an area I would think could be revisited on Canada's behalf.
Liberal
John McCallum Liberal Markham—Unionville, ON
I believe you said the tax system in the U.S. for energy or natural resources is effectively similar to that for real estate.
Royalty and Income Trust Analyst, BMO Capital Markets
I'm sorry, can you repeat that?
Liberal
John McCallum Liberal Markham—Unionville, ON
It is effectively similar to that for real estate in terms of flowthrough, the way it is in Canada.
Royalty and Income Trust Analyst, BMO Capital Markets
Yes. The exemptions provided to master limited partnerships, and REITS would be included in that calculation. The exemptions provided were to the energy space, which includes pipelines, exploration and production, transportation of energy, and mining. There's a very wide range of industries that are exempt.
Liberal
John McCallum Liberal Markham—Unionville, ON
Does that imply that the minister's statement and his comments are simply wrong when he seemed to question that? Is there some nuance there? How would you reconcile what you regard as a reality and what the minister said?
Royalty and Income Trust Analyst, BMO Capital Markets
I can't reconcile his statements. From what I have found, the minister is wrong. There is an active, growing market. With respect to limited liability corporations, since October there have actually been four IPOs of limited liability corporations that effectively operate like trusts and shift taxable income through to unitholders to pay their distribution tax, and those are active exploration and production companies. I do believe that those companies will start looking towards Canadian trust assets at some point. The U.S. energy basin is similar to the Canadian basin--it's a very mature basin. We're shifting to where it needs to be developed and exploited. It doesn't need to be explored any more.
Liberal
John McCallum Liberal Markham—Unionville, ON
We seem to say that the fact that the energy trust sector is a smaller percent of the TSX in Canada than it is of the U.S. equivalent stock market was relevant. I fail to see the relevance of that. Can you comment on that?
Royalty and Income Trust Analyst, BMO Capital Markets
Yes. I'm not certain how that is completely relevant.
The difference in the U.S., as I mentioned in my statements, was that they have a $6 trillion high yield market. Their flowthrough market is only $475 billion, approximately two and a half times what was our trust market of $220 billion before the announcement. Since that time, our market has shrunk. That $475 billion on a 10:1 population equivalent would seem smaller than our market, but they also have many other alternatives, such as tax-free municipal bonds, high yield junk bonds, and asset-backed securities, along with their flowthrough structures. There are many other alternatives for them, so they don't require their high yield alternatives to come strictly from the trust market.
Liberal
Liberal
Royalty and Income Trust Analyst, BMO Capital Markets
I believe it is, yes, in particular in our resource sector.
Royalty and Income Trust Analyst, BMO Capital Markets
It's because of the advantage the U.S. flowthrough entities have over...and because of private equity. There are many advantages that other non-Canadian entities have, which can hollow out our sector. I believe that's a risk we face now.
Conservative
Bloc
Pierre Paquette Bloc Joliette, QC
Thank you, Mr. Chairman.
I'd like to thank all of you for your presentations.
Ms. Urquhart, in your submission, you talked about a problem that is specific to income trusts, namely the fact that trusts often distribute more money than they effectively have. However, you did not comment on the decision taken by the Minister on October 31. Based on your analysis, do you agree, or disagree with the government's decision to block income trust conversions and to provide a four-year transition period for taxing income trust distributions?
Independent Consulting Analyst, As an Individual
My research has me conclude that I support the income trust tax plan and I do not support an extension of the grandfathering period. I believe there are permanent government tax losses as a result of permanent loss within tax-deferred accounts, both RRSPs and pension funds. I believe that the research indicating there would be more future taxes collected than foregone today is not credible. I believe that if you do a thorough analysis of the benefits of the tax structure of RRSPs, the upfront deduction and the deferral of taxes on investment income, the benefits of that structure will more than overwhelm any allegations of double taxation.
Consequently, there is not only a short-term loss, which I agree with the minister on, but also a long-term, permanent loss as well. The reason I further bring up the matter of malfeasance is that I think it's inappropriate for the Government of Canada to be spending government revenue, short-term and long-term, to promote seniors investing in a product for which there were criminal charges in the United States.
Prudential-Bache took the largest criminal settlement and securities offence settlement in American history--$2 billion in 1994. They were charged because in oral presentations and in marketing literature, Prudential Securities routinely used the terms “yield”, “return on investment”, and “income”, to describe the quarterly cash distribution received by investors in the energy income funds. Prudential Securities routinely used such terms in its marketing materials even though Prudential Securities knew, as evidence, in its disclosure in the prospectus, that the cash distributions did not constitute pure profit or interest but instead also contained a return of original investment capital. Twenty-seven state investigations, the National Association of Securities Dealers, the U.S. Securities and Exchange Commission, and the U.S. Department of Justice stopped the use of cash yields by this precedent decision, which was a deterrent to the rest of the American investment banking industry. There was a $2 billion settlement restitution to investors who lost on the limited partnerships as a result of the deceptive marketing. In addition, there was a $41 million fine and several terminations, but unfortunately, no one went to jail.
The RCMP, the municipal, and the provincial police forces have the jurisdiction to start investigations on the malfeasance in the income trust product under section 380 of the Criminal Code. Clearly, I support the income trust plan because it has stopped new conversions and it has stopped the prospects for more billion-dollar losses in the future.
Bloc
Pierre Paquette Bloc Joliette, QC
Thank you.
Would any of the other witnesses care to respond to Ms. Urquhart? I'd like to have some reactions to...
President and Chief Executive Officer, Canadian Association of Income Trust Investors
As distinct from Enron? Hello? This is endemic within the securities industry. If you want to think that's the high water mark, there are much higher water marks. In the case of Enron, I do recall that a couple did actually go to jail. To say that one form of model is better than the other would suggest that somehow one is subject to a different review process by the CICA or the OSC, which isn't the case. We don't have two parallel universes of securities regulations here. We do have two parallel universes of numbers produced by Finance insofar as tax leakage is concerned--and I'd love to spend some time demonstrating for you how in fact the numbers they attempted to conceal from us actually lay bare the very methodology that is at the heart of the falsehoods that are being asserted by our Minister of Finance, as it pertains to leakage, etc.
Thank you.
President, Canadian Association of Income Funds
I'd just like to address a couple of Ms. Urquhart's comments. One is the concentration on the focus on earnings. They key metric in a trust is not earnings, it is cashflow. Cashflow is the key metric, and that is one of the great aspects of the governance of an income trust. My management, which I deal with on a day-to-day basis, makes that point all the time, saying that the distribution of cash is either there every month to be paid or it's not.
There's no Nortel in the income trust sector because there's very little use of accrual accounting. It can't be concealed because it's all cash-related. So when she talks of earnings and excessive payments against earnings, that is not really relevant. What we want to talk about here is payments in excess of cashflow, and cashflow is the critical measure.
The other point is around return of capital. The term “return of capital” is admittedly a misnomer. The accounting profession has made that quite clear. CAIF, in its involvement with the CICA, has had those discussions. What it infers is that people are getting back their own money. That is not correct. What it is in fact is the tax deferral of that particular corporate entity being flowed through into the hands of the unitholder. Remember that this is a flowthrough entity. Therefore, all the tax consequences flow through benefits and taxes to the unitholder.
