Finance Committee on Feb. 1st, 2007

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. Dykstra, and thank you all for your participation today. It's much appreciated.

We'll take a couple of minutes to ask the second panel to move in.

I have a notice of motion from Mr. McCallum for a motion he wants to bring forward following the second panel. We'll deal with that at that time.

[The Chair, Conservative, Brian Pallister]

I welcome our second panel. Thank you very much for being here.

You're probably aware of the format already, but I'll review it. You've been told to keep your presentations to five minutes. Obviously that's to allow for an exchange with committee members. I will give you an indication, if you wish, when you have a minute remaining, and I would invite you to wind up your presentations before I have to unceremoniously cut you off, which I must do.

We appreciate your time, and we appreciate your being here. The panels have been most interesting.

We'll begin with Mr. Dirk Lever, from RBC Capital Markets. Welcome. Five minutes is yours.

[Dirk Lever, Managing Director, Global Equity Research, Chief Income Trust Strategist, RBC Capital Markets]

Thank you very much for the opportunity to present today.

I'm a chartered accountant and have been a research analyst in the trust sector for over seven years. My work is focused on trust structure, taxation issues, and evaluations. Like Gordon Tait, I am a research analyst, and my comments will represent my own views and not necessarily the views of the Royal Bank of Canada.

We have looked at the trust proposals put forth by the federal government and analyzed the expected financial impact of the proposals in the hands of investors, primarily Canadian investors. We've compared the trust proposals against current corporate tax legislation.

During 2006 the federal government took a step in the right direction when it eliminated double taxation of Canadian corporate dividends received by Canadian individuals. Unfortunately, double taxation of Canadian corporate dividends still exists in Canada today, and with the federal government's proposed trust taxation, a second instance of double taxation of Canadians will be introduced. We think the double taxation of Canadians should be eliminated because it is unfair.

Double taxation exists when an investor receives less income after tax than if the income had been received directly and then taxed. For example, if you receive a dollar of income and your tax rate is 30%, something is wrong with the system if you end up with less than 70¢. When that happens, rational investors look for ways to ensure they get their 70¢, and not less. Forget everything else you've heard today about the trust and alleged loopholes; trusts exist today because Canadians were fed up with receiving less than their fair share.

How does double taxation still crop up today? Quite simply, a Canadian corporation paying a dividend pays that dividend after corporate income taxes. Canadian shareholders receiving that dividend expect to be given a dividend tax credit for the corporate taxes paid on their behalf by the corporation.

Today, Canadian individuals are given a tax credit to ensure double taxation is eliminated. However, Canadian pension funds are not given a dividend tax credit. As well, although the Canadian pension fund makes distributions to the Canadian pension beneficiaries with after-tax dollars, that same Canadian pension recipient is subject to full taxes on the pension benefit; no tax credit is passed along to the Canadian pensioner, and taxes are paid a second time on that same income.

The problem of double taxation does not exist with interest income, so why should it with dividend income? Consider that interest paid by a Canadian corporation or government is paid without first being subject to tax. A Canadian pension fund can then distribute the pre-tax income to Canadian pension beneficiaries, who will then pay tax on the interest income for the first time.

From this example, you can understand that from the perspective of the Canadian pension beneficiary, the dollar is worth less if it starts off as Canadian corporate income rather than if it starts off as interest from a Canadian corporation or government. In this instance, a dollar is not a dollar because it's subject to double taxation.

The proposed trust taxation will do the same thing to trust distributions. The distributions will be subject to double taxation in the hands of Canadian pension beneficiaries. We typically refer to Canadian pension beneficiaries as pensioners.

What's the solution? It is simple--and we have to thank Professor Jack Mintz and Price Waterhouse Coopers for their collective work on this: it is to provide all Canadians with a full tax credit for taxes collected from a Canadian corporation on dividends paid, and a full tax credit for taxes collected from Canadian trusts on distributions paid. For some low-tax-rate Canadians, this will mean an actual tax refund; for Canadian registered pension plans, this will mean a full tax refund. In this way Canadians can be assured they will not be taxed twice on income received from their retirement funds and plans. We believe our amendment will help make the current proposal fair.

Canada, like other countries, has underlying problems with underfunded pension plans, and we can not understand how policies that effectively tax Canadian pension plans can possibly solve this problem. The Minister of Finance talked about having cash today to pay for the bills today, but we also must keep an eye to the future so that we do not saddle our children with financial problems we know of today. That is not fair.

The trust market has been a viable source of capital for many small and medium-sized Canadian businesses. Trusts are part of our everyday life, and Canadians buy goods and services from them daily. Trusts employ thousands of hardworking Canadians who take pride in their work and in their businesses. Trusts can live alongside corporations. Our amendments will put trusts and corporations, as well as Canadian investors, on equal footing. We believe trusts can and will succeed if they're given a fair chance to prove themselves. Let us not let Canadian businesses fall prey to those who conceive the values.

We believe our amendments are simple and fair. We have other recommendations we believe will help amend the current trust proposals on technical issues, and we'd be pleased to provide the information to the committee for consideration.

Thank you.

[The Chair, Conservative, Brian Pallister]

Well done, Mr. Lever. Thank you.

We move to the National Pensioners and Senior Citizens Federation, and Art Field. Nice to see you again, Mr. Field. Welcome.

[Art Field, President, National Pensioners and Senior Citizens Federation]

Thank you, Mr. Chairman.

I just want to make a couple of comments before I get started. I was here in November with the National Pensioners. I got a letter from the chairman, thanking me for coming, so I appreciate that. I have a handout, but we don't have it translated, so we'll give it to the clerk to be done afterwards.

I'll give a history of our association and what we're trying to do. We're a national association where membership is by clubs, chapters, or provincial bodies. We consider that we probably represent a million people, but we don't have a million-person membership list. It's by the association you belong to. For example, suppose a seniors club in Lindsay has a thousand members in it. If you're a member, then you're part of our federation.

We're cross-country. I myself work out of Ontario. The first vice-president and a past president are out of Newfoundland. The second vice-president, who is also the secretary of a federation of Nova Scotia seniors, is out of Nova Scotia. The third vice-president is also out of Newfoundland, and is also secretary of a Newfoundland 50-plus seniors' group. The treasurer is in Ontario, and the secretary is in Saskatchewan, and she's also president of the SSAI in Saskatchewan. The treasurer is the second vice of the USCO in Ontario. So we're all very integrated, and our main goal is looking after seniors.

We've been working with the SIPA, the Small Investor Protection Association, and they had hundreds of horror stories from before this. Our agenda was set before what happened on October 31. There was some misrepresentation and people have been losing money because their broker or whoever told them it was great, it was great this year, but then it was not great two years from then. Obviously, I didn't bring them, and you're not here to hear that.

We also are working with the FADOQ in Quebec. Our past president from a few years back is working with them. The FADOQ, as you know, has a 400,000-person membership in Quebec, with 15 or 20 vice-presidents, but theirs are individual memberships. Individuals pay a membership fee in FADOQ. They have big numbers. Obviously they're a big organization, they have resources, and they work with the government. We're working with them on some of the while-collar crime, as you may want to call it.

We are wishing for a regulator, because there isn't one. You have regulations if you buy a fridge and you have regulations if you buy a furnace or whatever, but nobody answers to anybody or any regulation when you're buying shares or income trusts or whatever. Seniors—and most of us think this way—are reluctant to speak out if they lose their money. It ends up being “their fault” even though they were given bad advice. You complain about your car that doesn't work and you get mad at the dealer and you complain about something else, but you don't tell your neighbour that you lost $50,000 because you made a bad investment or you think you made a bad investment. You invested with cooperation from a broker and maybe he advised you badly. There are no rules to combat that, so we need those.

We welcome the income splitting, plus a higher deduction for the age credit. The government, on income trusts and what was going on, needs a good tax base to supply the needs of all Canadians, but not just seniors.

Where I live in Ontario we have the highest density of seniors. We're an hour and a half out of Toronto, but we're also in cottage country. The cottage that you got 30 or 40 or 50 years ago is now your house. Obviously most cottages aren't cottages any more, but they're worth a fair amount of money. But we also have a lot of seniors who are on the edge and don't have a whole pile of money, and they're living in our area.

We have a good hospital there that is very busy, but there's a shortage of doctors, like everywhere else in Canada.

I just want to give one credit on the thing we're handing out. Fred Silk, chartered accountant, did it for us, and we have others.

Thank you, Mr. Chair.

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. Field. We'll look forward to reviewing your presentation as well, once it's translated.

From the University of Toronto, Ramy Elitzur is here. Welcome, sir.

[Ramy Elitzur, The Edward Kernaghan Professor, Financial Analysis, Rotman School of Management, University of Toronto]

Thank you for inviting me. It's a great honour and a privilege to be here, and it's a great privilege to see democracy in action.

Before I start, I want to point out that as opposed to some of the people who came here, I don't represent any interest group. I don't have any financial interest whatsoever in income trusts. I don't get commissions from them. I'm just an academic. As you probably know, I have a professorship in financial analysis, and I've been following the trusts since their inception, as well as other things.

My angle is not taxation. Taxation is very important—my good friend and colleague Jack Mintz made very good comments—and of course tax leakage is a serious issue. My angle is the perverse incentives that existed prior to the legislation. I think the tax change is actually a step in the right direction, but let me make my points very briefly.

If you take a look, many of the income trusts that we have out there have no business being income trusts. In order to be an income trust—a company that distributes most of its cashflow—distributions have to meet certain conditions. As condition number one, a company has to be a mature company. That means it has large operational cashflows and small capital investment. Condition number two is that it still has lots of time remaining in this stage. Condition number three is stability. It has to have stable income—in other words, stable revenues and stable expenses—and less or almost no uncertainty.

If you take a look at some of the recent companies that registered as income trusts, they violate every one of the conditions, or most of them. As such, I think what we have now is a bubble. If we hadn't stopped it now, in the long run more investors would lose their money.

I hope I'm wrong in many respects, but I think you are going to meet me again in the future, talking about the income trust debacle and why so many companies registered. If people ask me, I'll be more than happy to answer about the perverse incentives of the financial institutions and management and so on.

Thank you very much.

[The Chair, Conservative, Brian Pallister]

Thank you very much, sir.

Gordon Kerr will continue. He is from the Coalition of Canadian Energy Trusts.

Welcome, sir. It's over to you.

[Gordon Kerr, Co-Chair, Coalition of Canadian Energy Trusts]

Thank you for this opportunity to speak to the committee. My name is Gord Kerr, and I am here on behalf of the Coalition of Canadian Energy Trusts.

On October 31, 2006, Canada's new government broke a key election promise not to tax income trusts. This has cost energy trust investors billions of dollars. Investors relied on the government's good word, and the subsequent devastation was unnecessary. We believe the government broke its promise to Canadians in its rush to stop trust conversions.

We're not here to dispute the government's decision to stop conversions, but we do believe this decision should have been followed by consultation regarding the role trusts should play in specific sectors of the Canadian economy. With a more complete analysis of our sector, we believe the government would have recognized that energy trusts are different and ought to have been exempted from any new policy, just as real estate investment trusts were.

We are not suggesting that the entire oil and gas industry should be structured as trusts, nor do we believe that would happen. As my comments will show, this structure is the right business model for a significant component of the western Canadian sedimentary basin.

Our coalition has produced a detailed document that justifies the continued existence of trusts in the energy sector. Our report concluded that energy trusts do not cause tax leakage; that energy trusts enhance productivity; that contrary to the government's assertion, U.S. energy trusts continue to thrive; and that millions of Canadians, including retirees, have suffered enormous financial losses as a result of the government's broken promise.

With regard to trust-like entities in other jurisdictions, this committee has already heard from others that the Minister of Finance is wrong. Comparable structures do exist in other countries and are in fact expanding, potentially increasing foreign control over Canada's energy sector. I won't revisit that territory. What I want to address is the issue of tax leakage and the important role of energy trusts in Canada's energy future.

On the matter of tax leakage, we heard a lot about tax leakage in the previous session. Our research shows that government revenues are actually enhanced by the energy trust structure. During the past five years, energy trusts have generated greater taxes than they would have as corporations. For 2006, we estimate that our $8 billion in distributions will generate in the order of $2.4 billion in taxes. Moreover, for 2005, our data shows that our sector will have generated an estimated 30% of the tax revenue collected from publicly traded Canadian entities in the oil and gas sector, while representing only 16% of the revenue.

Regarding our contribution to productivity and sustainability, since 1986 the energy trust structure has evolved as an ideal model for Canada's maturing hydrocarbon basin, through our focus on maximizing recoveries from mature oil and gas pools. Our report clearly shows that members of our coalition have substantially increased capital spending on these assets, resulting in significant reserve and production additions. We have also repatriated approximately $10 billion worth of assets from foreign control over the past ten years.

Despite record levels of drilling, Canadian conventional oil production is falling and natural gas production has plateaued. The traditional corporate growth model is not sustainable for all entities operating in a declining producing region.

Finally, Canadians deserve to have the decisions that impact their economic future made with proper care and all of the facts. We want the government to take the time and do the consultations required to get this decision right. We believe such consultations and this committee's work this week will show that energy trusts are unique and should be exempt from the proposed tax changes. We want to get it right for ordinary Canadians who believed the Prime Minister's promise not to tax trusts, and for Canada's producing regions so that we can maximize ultimate recovery of our scarce resources for the benefit of all Canadians.

We have produced a report supporting our position in this regard. We welcome critical review and debate on this issue and we invite the government to do so, rather than continually stating that they will not change their decision. It is never too late to get it right.

Thank you, Mr. Chairman.

[The Chair, Conservative, Brian Pallister]

Thank you very much, Mr. Kerr, for your presentation.

We continue with Dennis Bruce, of HDR|HLB Decision Economics. Welcome to you. Five minutes are yours.

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

Thank you, Mr. Chair.

Good afternoon. Thank you for inviting me to appear before the committee today. It's a great honour.

I'll be presenting evidence on tax leakage, and I'll submit it after my testimony today.

I'm vice-president of the firm HDR|HLB Decision Economics. For the sake of time, I'll refer to it as HLB going forward.

Our firm specializes in the provision of impartial and objective third-party economic analysis. Since the fall of 2003, we have been working on behalf of the trust sector to ascertain whether taxes generated under the income trust structure are less than tax revenues generated under the corporate form.

We also have met and collaborated with the Department of Finance in developing our methods and models. In the period during which the Department of Finance prepared the government's 2005 consultation paper on the tax effects of income trusts, HLB was asked by the department to work with them to help come up with a common methodology and assumptions for deriving tax leakage estimates.

HLB and the Department of Finance achieved a consensus on general methodology, with one key exception. We did agree to disagree with respect to whether or not to include the value of deferred taxes. While not immediately taxable, distributions received in tax-exempt accounts are taxable upon withdrawal from such accounts, and they do therefore have economic value.

The discussions that you're hearing about deferred taxes reflect confusion about budgeting convention versus policy analysis. While budgeting is done on a current basis, policy analysis should be done on a life-cycle basis. Accounting for the life-cycle effects of tax changes, namely deferred taxes, is appropriate in consideration of tax policy.

With the release of the new data from the Department of Finance on Tuesday, HLB has updated its analysis. The results are summarized in exhibits that I'll provide to the committee after I testify.

We can confirm that the general methodology employed by the department remains the same as that which we had previously discussed with them. In fact, given the department's assumptions, we've managed to replicate their numbers based on their assumptions. There remain, however, important differences in the way the methodology has been applied, leading HLB to conclude that the department is sharply overstating tax leakage.

The difference between HLB's analysis and that of the department stems from four key factors. First, the department's assumed effective corporate tax rate for energy trusts fails to reflect the reductions in the tax rate for resource corporations from 2004 through 2006. This results in an overstatement of tax leakage of approximately $84 million per year.

Second, the department's figure for income trust units held in tax-exempt accounts is overstated. Derived from data from surveys, interviews, and Scotia Capital Markets data, the percentage of units held in tax-exempt accounts is approximately 31%, which is less than the department's estimate. This results in an overstatement of tax leakage by approximately $125 million per year.

Third, the value of deferred taxes, as I discussed earlier, is excluded from the Department of Finance's analysis. This results in an overstatement of tax leakage of $80 million per year.

Fourth, the impact of future legislated tax changes through 2010 has not been accounted for. Doing so reduces the ongoing federal tax leakage by $232 million per year, and this excludes planned corporate tax cuts that have been announced for 2011.

In addition, in our analysis, we looked at the income trust sector only, and not limited partnerships, which have a small impact. Based on our overall analysis, we conclude the following.

Federal tax leakage for income trusts for 2006 was $164 million, not the almost half-billion dollars stated by the department. Ongoing tax leakage for income trusts post-2010, after taking into account the legislated tax changes, is approximately $32 million a year, or about 5% of the department's estimate.

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

Thank you very much.

[The Chair, Conservative, Brian Pallister]

Mr. Bruce, I didn't want to indicate you were done your time. You do have 45 seconds left if you wish to use them.

[Dennis Bruce]

I'm quite good. Thank you.

[The Chair, Conservative, Brian Pallister]

Very good. Well done. Thank you, sir.

We're here to listen.

We're pleased to have the Honourable Mitchell Murphy with us today. He is Provincial Treasurer for the Government of Prince Edward Island.

Welcome to you, sir. It's your option to use the five minutes as you wish.

[Mitchell Murphy, Provincial Treasurer, Department of Provincial Treasury, Government of Prince Edward Island]

Thank you very much, Mr. Chairman, and my thanks to the committee members for inviting me here today to provide my province's views on income trusts, as part of your current examination of the issue.

I will begin by saying that I have written the federal Minister of Finance, expressing my support for the proposed tax fairness plans as announced on October 31, 2006. This letter is the latest in a series of correspondence we've been having regarding the income trust issue. As early as March 2006, I wrote to the federal minister, expressing Prince Edward Island's concerns. The letter reiterates my government's support for Minister Flaherty's proposed tax treatment of income trusts, including the four-year transition period for current income trusts. A copy of this letter, as well as those of similar letters from other provincial governments, were provided to the committee members by the federal minister on Tuesday.

I'm here today to further lend my support for the measures proposed in the new tax fairness plan of October 31, and I urge this committee to endorse this plan as it is currently proposed.

As Provincial Treasurer for Prince Edward Island, I have a responsibility to manage and protect the public finances as well as the economy of our province. We, like you, also have an obligation to provide public services, especially in the areas of health care, education, and infrastructure. It became abundantly clear in 2006 that the sudden increase in income trust conversions was becoming a threat to both.

In Canada, the income trust structure has been permitted for the last few decades, but their impact on Canada's corporate structure, the economy, and government tax revenues was relatively modest for that period. Until relatively recently, companies that converted to income trusts did so because that corporate structure fit their business model. However, in 2006, the number, size, and, importantly, the types of companies that were either becoming or were proposing to convert their operations to an income trust structure began to increase significantly. This was in large part due to significant tax advantages that income trusts had over traditional corporate organization. It was becoming increasingly evident that something had to be done.

I have personally seen and heard the pressures that corporate managers were under to convert their businesses to income trusts even when the income trust corporate structure did not make sense for their business model. My colleagues across Canada heard of similar pressures.

Minister Flaherty spoke Tuesday as well about the damaging effect that income trust conversions have had on the balance of the tax burden between both corporations and individuals. The rising popularity of the income trust structure and subsequent conversions was beginning to significantly shift the tax burden in this country toward the average Canadian. This situation needed to be rectified, and the tax fairness plan achieves that. We cannot have a sustainable economy in which corporations do not pay tax, and this situation would also not be socially just.

There is another very important issue relating to the distortional tax effects of income trusts at the provincial level that I would like to raise with the committee. This issue was less of a concern at the federal level, but very relevant to most provinces. It has been one of the primary concerns of my government with the income trust model.

When a company converts to an income trust, it no longer pays provincial corporate income tax to the province or provinces in which it operates. The resulting increased payments to trust unit holders are taxed provincially through the personal income tax system of the province in which the unit holder resides as long as they reside in Canada. If a company operated in one province and all of its unit holders lived in the same province, this would not be a significant issue. However, this is not the typical scenario for large companies in Canada. Many of the companies that have converted to trusts, or were planning to, typically operate in many provinces, but their unit holders, for the most part, reside in the larger provinces, as well as outside of the country altogether. When a unit holder resides in another country, federal non-resident tax applies to the income a foreign investor earns from a trust, but that same income is not subject to tax in any province. In contrast, the dividends that a foreign shareholder of a Canadian corporation receives are paid out of corporate income that has already been taxed federally and provincially.

This situation has had a severe detrimental effect on smaller provinces in particular, as they have seen the corporate tax revenues from some of their largest corporate taxpayers dry up, while the personal provincial income tax receipts are being collected by the larger provinces. This is less of an issue for the federal government, as a Canadian unit-holder will pay federal personal income tax regardless of which province they reside in, and non-resident unit-holders also pay their federal tax.

My case in point is a conversion of Aliant by Bell Canada Enterprises during the first half of 2006. Aliant was one of Prince Edward Island's largest corporate taxpayers, as well as a very significant one for all of Atlantic Canada. However, a vast majority of shareholders in the company do not reside in the region, so relatively little provincial personal income tax was recovered to offset the loss of provincial corporate tax.

[The Chair, Conservative, Brian Pallister]

Mr. Murphy, I'm going to have to cut you off there. I'm sure there will be questions pertaining to the issue you're speaking about.

Thank you all for your presentations. Well done.

We move now to questions. We begin with John McCallum. You have five minutes, sir.

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

Thank you, and my thanks to all of the witnesses.

I'm going to use my limited time to focus on Mr. Bruce, because I think it's highly significant that someone using precisely the same methodology as the Ministry of Finance could have such very different results, as shown in this chart.

I wonder if there's a finance department official in the room. I'd like to begin—

[The Chair, Conservative, Brian Pallister]

Would you like them to come to the table, John?

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

Yes, please.

[The Chair, Conservative, Brian Pallister]

I'll invite the finance department officials who are with us today to come forward to assume a seat at the table, just in case there are some questions directed your way.

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

I'd like to start with the largest item.

Mr. Bruce has worked with the finance department officials. They use the same plumbing or model, yet Mr. Bruce says the finance department should have taken account of legislated tax changes that change the result by $232 million. I wonder if the finance department would agree with Mr. Bruce on that point or not. I'd be grateful if you were succinct in your answers, given the time limitation.

[The Chair, Conservative, Brian Pallister]

Who would like to take that? Mr. Ernewein, would you like to, or Mr. Normand?

[Brian Ernewein, General Director, Tax Legislation Division, Tax Policy Branch, Department of Finance]

Mr. Chairman, first of all, as a lawyer, I'm presumed to be innumerate. I must confess to approaching these more intuitively, as some of the previous witnesses did, in suggesting that a revenue loss must exist or else the markets wouldn't have reacted the way they did, or else, as one of the previous witnesses said—

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

No, please. I have very little time.

[Brian Ernewein]

I'm sorry.