Finance Committee on Jan. 30th, 2007

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

No, you're right. As you can see on chart A, Mr. Paquette, what happened in 2006 was very dramatic.

[Pierre Paquette, Bloc, Joliette, QC]

Had we opposed this decision and there was no change to the income trusts in place in 2005, the Conservative Party would have been prepared to live with the situation, but now, it is singing a different tune. I'd like to know the reason for this change of heart.

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

I can't account for the failure of the Liberal government in 2005. What I can say is that in 2006 we were faced with dramatically different circumstances. Quite frankly, we could have chosen not to act and we could have waited. Where would we be today, at the end of January 2007? Where would we be three months from now? What kind of economy would we be leaving our children? Is that the kind of economy, the kind of country we want to have? The answer to all of that is no.

Was it politically a good idea? Probably not. There's the fallout you're describing, but sometimes you have to do the right thing.

[Pierre Paquette, Bloc, Joliette, QC]

This was a very courageous move on your part. However, it also means that the promise made by Mr. Harper in 2005 was irresponsible.

Why four years rather than three?

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

I understand your position on that, Mr. Paquette. I will try to deal with the second aspect, why we chose four years instead of two years, or six years, or eight years, or whatever.

The nearest comparable case we had internationally was that of Australia, which dealt with this issue some years ago. They chose a three-year transition. We are more generous than that in allowing four years. Not only is the transition period more generous, but we're allowing double growth, basically. We're allowing income trusts, pursuant to the rules that we released in December, to double in size over the course of the four years.

It could go longer than that. It could go another six years. It'll cost the taxpayers of Canada $3 billion federally and more than $2 billion provincially. So $5 billion will have to be paid by those of us sitting around this table and by people at home, hard-working Canadians. If you think that's the right thing to do, then that's your view. I don't share that view. I don't think it is your view, as a matter of fact. I think you think the four years is a reasonable period of time and that it's a question of fairness to Canadian taxpayers.

Why should one form of corporate entity have a tax advantage over another form of corporate entity in Canada?

[Pierre Paquette, Bloc, Joliette, QC]

With respect to property trusts...

[The Chair, Conservative, Brian Pallister]

I'm sorry, but I must turn the floor over now to Ms. Wasylycia-Leis.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Thank you, Mr. Chairperson.

Thank you, Minister, and all your staff for appearing before us today.

I think, Mr. Minister, if you would just simply say that your party made a stupid election promise in the last federal election, we'd be able to clear the air and get on with this.

[The Chair, Conservative, Brian Pallister]

Would you like to make a motion to that effect?

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

I might.

In fact, what seems to be the case is that the information from the department has been a constant. The same information that you are relying on today from your finance officials was available to the Liberal government. In fact, it was the Liberal government that initiated the study back in September 2005, which revealed very clearly the loss of tax revenue, even then significant, given that we hadn't seen the explosion in potential income trusts at the time.

My question relates to that, and perhaps to the officials.... I think by the fall of 2005, the department had already flagged the tax loss question in public documents, and there was also a clear indication that energy giant EnCana was looking at a conversion. There were rumours about other major corporations. We were hearing then about other energy corporations--the banks, you name it, the list just seemed to grow and grow. Yet the Liberal government chose not to act.

Did the department actually take seriously this issue at that time? If it did, what was the explanation from the Liberal Minister of Finance for not acting on it?

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

Do any of you want to touch that?

[The Chair, Conservative, Brian Pallister]

Mr. Carney.

[Mark Carney, Senior Associate Deputy Minister, G-7 Deputy for Canada, Department of Finance]

Thank you, Chair.

The department has analyzed this issue, as the member suggests, for a number of years. Since the beginning of 2005 we've received tens of thousands of individual submissions to the department; we've had over 100 expert and professional submissions and meetings since the beginning of 2005.

So the short answer to your question is that we have looked at it over a period of time.

I would add, though, if I could correct one aspect of your question, that you referenced the fall of 2005, a specific company, and potentially financial institutions. I would refer back to what the minister said. That was the fall of 2006, which is consistent with the change in the landscape that took place over the course of 2006.

Thank you.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

I appreciate that.

Just to clarify, it was the Liberal consultation paper of September 2005 that began to identify the significant impact on tax revenue. At that time—quoting from page 5 of this Liberal document—it said it estimated that the federal tax revenues in 2004 were $300 million lower than they would have been if FTEs were structured as corporations. So I think that's a significant indication of the trend and the problem area.

Back on that fateful day, at least fateful for the Liberals, November 23, 2005—the same day, of course, that the Liberals announced their intentions for not taxing income trusts but for reducing the tax at the dividend-paying end—the parliamentary secretary at the time, John McKay, said in a media interview that there would be a tax on income trusts. He quickly withdrew that, but he certainly implied that the direction not to tax trusts at that time was a very last-minute one.

So I'm wondering if anyone has an explanation as to why the tax was pulled. What was it? Can you shed some light on this whole scenario?

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

You don't have to—

[Robert Wright, Deputy Minister, Department of Finance]

I just want to make it clear that as professional public servants we don't talk about the advice we gave to the current government or the previous government.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

Okay, fair enough.

Could I ask you, when you briefed the new Minister of Finance at the very outset, did you reference this issue of trust taxation as part of that briefing?

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

I can answer that if you want. My recollection is that the first time we had a serious discussion of review of the issue was in July 2006. It was a matter of quite serious concern in July, August, September, and October, before we made the announcement on October 31.

[Judy Wasylycia-Leis, NDP, Winnipeg North, MB]

I appreciate that.

Around the lead-up to the November 23 announcement, we had a clear indication from—

[The Vice-Chair, Liberal, Massimo Pacetti]

Ms. Wasylycia-Leis, sorry, I wasn't noticing the time. Your time is up.

I would ask Mr. Flaherty to just hang on, because we're going to try to go through a second round.

After Ms. Ablonczy I have Mr. McKay on the list.

Ms. Ablonczy, you have five minutes.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

Thank you, Minister, for appearing, and your officials as well.

It has been instructive to watch the Liberals opposite, who said we had to have these witnesses appear because they wanted facts. But I notice that Mr. McCallum did everything he could to keep facts from going out.

I appreciate the fact that you have given the committee the numbers that the Liberals keep saying they don't have. I would appreciate it if you could take some time to go through these—you and your officials—to help Canadians understand a little bit more about what was at stake with this decision.

[Bob Hamilton, Senior Assistant Deputy Minister, Tax Policy Branch, Department of Finance]

Yes, Mr. Chairman, I'd be happy to take a couple of minutes, and I'll try to make it brief; I recognize the time.

I will just take a minute to explain a couple of the charts that go through the revenue estimates to make sure everything is clear. What we're trying to do in calculating this is to look at the taxes that would be paid under a corporate structure versus the taxes that would be paid by the same entity under a trust structure. So we try to look at those two things, build that up, and compare at the end what the differences are and how big the revenue loss is.

If we look at that chart over there, the federal government loss, it takes you through those components, and it's in the background documents you have as well. If you look at the first panel, and I won't go through it in gory detail, we first look at the taxes under the FTE or the trust structure, and that includes taxes paid by the unitholders of the trust--there's no entity-level tax paid there by the trust itself, that's one of the issues--and taxes that are paid in other distributions, for example, to third-party lenders. If you look at the total of that--this is data that's based on 2005 built up to 2006--it's $1.6 billion.

If you look at the second panel, it says what that same operation would pay under a corporate structure. And there you have the corporate income tax that would be paid and you have taxes that would be paid by the shareholders on distributions and, again, the third-party lenders, and that comes up to roughly $2.2 billion or $2.3 billion.

In a sense, that's your ongoing difference. You take that $2.275 billion, subtract $1.675 billion and you get a $600 million difference. As I said, that's your ongoing loss that's there every year. But there's also another effect, and that's the one-time capital gains. When a corporation converts into a trust, there can be a capital gain arising from the increase in the share prices, and that happens in the year of conversion. That gives us capital gains revenue in that year, or some of it accrues that year and some of it accrues later. We factored that into the calculation as well, and that reduces the revenue loss. Here you see it's by $100 million, and it takes you down to a net loss for 2006 of $500 million.

As the minister indicated earlier, this is the federal revenue loss. There would be provincial revenue losses as well, and you've heard some of the numbers that have been played out.

First, the important thing in this calculation is to look at the taxes that are paid at the different stages under the two different structures and make sure you add them all up and compare them, and that's what we've done.

The other chart that's interesting in this context is over there, but it's also in your package, and it's the sensitivity chart. What we've done is said yes, $500 million is our best estimate of the cost. We think it's a conservative estimate, because some of the things we've seen since then suggest that some of the parameters might be understating it.

What this chart shows is if you adjust some of those key parameters, how much do the revenue estimates change? The two we've picked up here are the effective corporate tax rate, because in doing the calculation under the corporate structure you have to make an assumption about how much corporate taxes would have been paid, and the other parameter is the proportion of the entity that's held by tax-exempt investors. If it's held by taxable investors, it has one tax effect; if it's held by tax exempts, we don't collect any tax, RRSPs, RRIFs, in the year.

[Paul Szabo, Liberal, Mississauga South, ON]

RRSPs are not exempt?

[Bob Hamilton]

They're exempt in that year and then the tax ultimately could get paid.

Perhaps I'll just finish this. If you look at the chart, it first expresses the effective federal corporate tax rate as a percentage of earnings before interest, taxes, depreciation, and amortization, and you can see that runs from 6.6%, which is the average we've assumed in the paper, and if you run that across the road to see the column that's headed 38%, which is the percentage of tax-exempt investors we've assumed, that's your $500 million.

If you adjust those parameters, for example, if you increase the tax rate by one percentage point on the left column, which I should say is not a statutory corporate tax rate--that's the effective rate and it would translate to an effective corporate tax rate on pretax profits of 16.4%--then you can see that the revenue estimate would increase to about $700 million, and similarly, you can walk down the column.

Alternatively, if you were to--

[The Chair, Conservative, Brian Pallister]

I'll cut you off right there, as riveting as this is, but I have to move on now to the second round of questioning.

To accommodate two to three more questions, we'll make it three-minute rounds. Mr. McKay, we'll start with you.