Finance Committee on Feb. 1st, 2007

[Jeffrey Olin]

Thank you very much.

[The Chair, Conservative, Brian Pallister]

Thank you, sir, for your presentation.

Kevin Dancey is with us, on behalf of the Canadian Institute of Chartered Accountants. He is no stranger to this committee.

Welcome to you, sir. Over to you.

[Kevin Dancey, President and Chief Executive Officer, Canadian Institute of Chartered Accountants]

Thank you.

Mr. Chair and members of the committee, on behalf of Canada's 71,000 chartered accountants, thank you for the opportunity to speak to you today on the issue of income trusts.

One of the goals of Canada's chartered accountants is to enhance the quality of financial information that is used in the private and public sectors to measure and enhance organizational performance. We do this through our support of the setting of both accounting and auditing standards, as well as providing guidance on a range of financial reporting issues.

In this context, last fall we issued guidance for income trusts that recommended standardized reporting for the term “distributable cash”. This guidance calls for enhanced disclosure of the strategies used by management to determine what percentage of a trust's cash is distributable to investors. The focus is on two specific questions: where did the cash come from, and is the cashflow sustainable? The guidance addresses the concerns of regulators, analysts, and rating agencies that there was no consistency in this reporting and is important for the millions of Canadians who own or acquire trust units.

While our focus in the income trust area has been on financial reporting, I will focus today on the tax issue. In my brief remarks, I will set up my perspective on the key points in this debate. So let me begin.

First, some key principles are that the tax system should promote the growth and competitiveness of our economy, generally through the broadest base possible and lowest possible rates; second, the tax system should be neutral; and third, the tax system should be fair.

The tax system, as it related to income trusts before October 31, did not meet these criteria. Why? There are two reasons. First, the tax system was not neutral, as there was a significant incentive to use a trust, rather than a corporation, for tax purposes, and business structure should be created and selected for good business reasons, not for tax reasons. Second, there was tax leakage with respect to both the units held by tax-exempts and non-residents, and this leakage was growing.

The most important of these two points is that the tax system was not neutral. There was a strong incentive—i.e., a tax saving—for businesses to convert into trusts. This tax saving was not available to corporations. This was neither a stable nor neutral tax system. Accordingly, action had to be taken, and the government should be commended for taking action. The status quo was not an option.

The next issue is whether the solution proposed on October 31 was the right one. In my view, it was an important step in the right direction that had to be done now. Why? First, it levelled the playing field between corporations and trusts; and second, it addressed the tax leakage issue.

That said, I believe there's one additional change that could be considered and should be studied by the Department of Finance in the future to make the system even more neutral and more fair, because improving the tax system is always a journey.

Let me explain. I believe trusts have a role to play in rounding out Canada's capital markets. Trusts are appropriate for some businesses. Trusts offer a source of financing that might not otherwise be available, especially for smaller and mid-sized companies.

I also believe it is important to put the growth of income trusts into context. They were arrangements to avoid the double taxation that still exists in Canada's tax system.

By double tax, I mean the fact that corporate and personal taxes are not fully integrated in Canada. The ultimate tax burden is different, depending on which business structure is chosen. Our tax system is partially integrated, for example, for individual Canadian investors in higher tax brackets, but not for all Canadian investors and certainly not for tax exempts like pension plans and RRSPs.

A solution that would make our system fully integrated so there's no discrimination among different Canadian investors would be to make the government's proposed tax on trust distributions, as well as the dividend tax credit, fully refundable to all Canadian investors, including RRSPs and pension plans.

There are a number of issues the Department of Finance would have to consider in studying this issue. These include the fiscal and interprovincial implications; whether there would be the same need for sector-specific exemptions like REITs; and ensuring mid-sized and small businesses that want to go public still have adequate sources of financing.

We believe this option should be considered in the future, along with other options, to make our tax system even more effective in supporting the growth of Canadian businesses.

In conclusion, the government needed to take action on the income trust file. Secondly, the government's proposal is a significant step in the right direction. These changes need to be implemented now. These proposals level the playing field between trusts and corporations and address the tax leakage issue.

Finally, to make Canada's tax system even more competitive, the Department of Finance should study in the future the option of making the proposed tax on distributions, as well as the dividend tax credit, fully refundable to all Canadian investors, including RRSPs and pension plans.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you very much, Mr. Dancey.

Thank you all for your fine presentations; we appreciate them.

We move now to questions, beginning with Mr. McCallum. You have five minutes, sir.

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

Thank you, Mr. Chair.

Thank you to all of the witnesses.

I would like to focus on the issue of the manner in which the government acted, and I direct my question first to Mr. Tait.

Let us take as a working hypothesis, as Monsieur Fortin said, that it was appropriate to take some action in view of the conversions of Telus, BCE, etc. The actions that the government actually took undoubtedly destroyed $25 billion of Canadians' savings—an average of perhaps $25,000 per Canadian holder of income trusts. It's arguable that the actions will also destroy the income trust sector in the longer term, thereby depriving the Canadian economy of some of the diversification benefits and improved access to financing that were mentioned by the Governor of the Bank of Canada.

Mr. Tait, given the premise that it was appropriate for some action to be taken, what other options could the government have taken, and would have been aware of, that did not have these two very negative effects I just mentioned?

[Gordon Tait]

To be honest, I don't think there was an easy way to do it.

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

I'm sorry. First of all, do you agree with my suggestion that in the longer term the actions taken by the government will effectively eliminate, or destroy, or...?

[Gordon Tait]

I think they would, and as I say, it only eliminates it in the public markets. Non-public players can use this, in fact, and that's going to be a problem, which we can touch on later.

To be honest, I don't think there was an easy way to do it, because even a hint that you're going to change tax rules has an impact. But partly there was no guidance; people had no clear direction on this.

Maybe going forward, what they could look at doing—and what they might have thought about—is clearly saying what sectors they think would be inappropriate for trust structures. Maybe there would be a certain size of corporation that they think would have to be reviewed before they could convert.

There are a lot of things you could do to make sure that if you're going to use this structure, it isn't in key sectors of the economy—the way they handle foreign investment—or somehow limit it. But the point is that probably it should have been studied, and probably there should have been some guidelines before.

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

What about the possibility of a longer transition period or a greater degree of grandfathering that might have substantially mitigated the losses that people suffered?

[Gordon Tait]

It certainly would. By simply extending the time period, the present value of that tax would be minimized. I think what it would do is buy more time. It would mitigate the impact of the current proposal that still has some problems in it. Also, it would provide more time for people to study this and maybe come up with a solution that would work better and wouldn't discriminate against small, ordinary Canadians, versus big institutions.

So I think that would at least minimize the impact, while this issue was being discussed further.

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

Mr. Fortin did you have anything to add with respect to policies the government could have adopted which would have been less costly for Canada?

[Yves Fortin]

Yes, I think I do. The governor referred to inefficiency issues, however he also said that benefits could be derived from trusts. A series of criteria and regulations should of been developed, in my opinion, to prevent what I referred to as undesirable conversions. This would have averted the complete demise of the sector, and at the same time forestalled the damage and ramifications which result from such conversions.

Should the government decide to go ahead despite everything that has been heard, especially when it comes to the eligible lost of tax revenue, it should at least have the decency to somehow clean up the mess. Mr. Dancey referred a couple of times to the importance of stopping double taxation, should the bill go ahead. As things currently stand, if trusts were taxed in addition to taxing RRSP withdrawals, we would end up with incredibly high tax rates in the realm of 57 to 63%.

[The Chair, Conservative, Brian Pallister]

Thank you very much, sir.

Mr. Paquette now has the floor. You have five minutes.

[Pierre Paquette, Bloc, Joliette, QC]

Thank you, Mr. Chair.

Thank you very much for your presentations. It has become clear from the testimonies that this subject is not as straight forward as the rather simplistic presentation made on October 31 would have led us to believe.

Mr. Fortin et Mr. Tait, you argued that converting income trusts into publically traded companies may have an adverse effect on the government's tax revenue.

Does the $500 million amount quoted by the minister last Tuesday seem exaggerated or inflated in your opinion? Is the current income trust structure resulting in tax revenue losses? If you were indeed right—and I have no doubt about the legitimacy of your arguments—, why would the government and the department have chosen to go down this path knowing full well that, at the end of the day, they would collect less revenue than they currently collect under the existing income trust structure?

[Yves Fortin]

The $500 million amount is continuously changing. It is based on a terribly flawed methodology and a number of slightly far-fetched hypothesis. It is also based on the premise that cooperations pay the normal tax rate of 35%. Reference was also made to RRSPs, RRIFs, and pension funds. Quite frankly, this whole business of lost tax revenue is a great political tactics which goes over well with the print media and the public. It is not an easy argument to resist because the public... One of my neighbours told me that it was incredible that trusts generated losses and that you had to pay taxes because of that. So I then ask him if he knew what a trust was, and he admitted that he did not know.

[Pierre Paquette, Bloc, Joliette, QC]

But why did the government chose to go down this path if it is so obvious that...?

[Yves Fortin]

I think that the underline reasons are quite different. The lost of tax revenue is not an issue here. The document I prepared, “or how to generate loss of tax revenue ”, gives you an idea of how tax rates will change under such legislation.

Why is the government doing this? Perhaps we can ask the gentleman who represents the interests of business which feel threatened by the presence of trusts. Business does not like that sort of competition. How do you expect to sell an annuity at 4% when people can get 8 to 10% on trusts under their RRIFs?

There is competition, and investors opt for the highest return as Mr. Tait pointed out. Don't kid yourself by thinking that people buy units in a trust because it is cheaper or more beneficial tax wise. That is not why they invest in them. They do so because income trusts give them the kind of return they need for their retirement. Most people out there buying income trusts don't give a dam about all this tax stuff we are being told.

[Pierre Paquette, Bloc, Joliette, QC]

Thank you, Mr. Fortin.

My next question is directed to Mr. Dodge. He said that the income trust structure may be economically disadvantageous for developing sectors seeking investors. Mr. Fortin has suggested criteria be established so that only certain sectors can convert into income trusts.

Is that a possible action in your opinion? Which sectors could take advantage of such an income trust structure, in your opinion, beside from the real estate sector, which is already excluded?

[The Chair, Conservative, Brian Pallister]

Mr. Dodge, you have about 45 seconds to undertake an answer.

[David Dodge]

It is hard to give you an answer which would apply to businesses in each and every sector, because circumstances differ from one industry to another. A decision may benefit one given sector or company, and, yet hurt another. The problem to date is being that inappropriate business decisions have been made in an effort to save on taxes.

[The Chair, Conservative, Brian Pallister]

Merci, monsieur.

We continue with my Manitoba colleague, Madam Wasylycia-Leis.

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

Thank you, Mr. Chairperson, and thanks to all of you for your time today.

Let me start with Mr. Dodge.

Thank you for your presentation today. It helps clear up some of the headlines that happened around November of last year, with things like “Income trusts a good thing, Dodge says”, and “Dodge touts trusts' benefits”. I think, as you've pointed out today, you were taken out of context.

So I would like you to take a minute to further clear up the record and give your feelings about the government's decision on this file, given the attack that has been made against closing the loophole, given the questionings around the tax leakage, which we're hearing from in terms of finance officials, provincial governments, reputable folks out in the field, yet all of that is being questioned by some lobbyists today. I need you to address that for the record.

[David Dodge]

Thank you.

I tried to clear up that misleading headline after the hearing in front of the Senate. I did issue a press release, and I'll just very quickly read the critical line:

We've looked at it from the point of view of the efficiency of capital markets. The work we have done in terms of capital markets per se is that probably, on balance, income trusts make markets somewhat more complete and hence somewhat more efficient, but that has nothing to do with the tax treatment and that it is appropriate that businesses face a level playing field in choosing the form of corporate organization that allows capital to be allocated to its most efficient use.

I have repeated that today.

Going beyond that, we're not in the tax game, as you will well imagine, but we do look at capital markets, and what has happened since the October 31 announcement is that we've seen something like a $20-billion or $25-billion reduction in the market value of these trusts. It has not been even, of course, across all trusts.

So what does that represent? Well, it represents two things. It can only represent two things: number one, the present value of all the future taxes that the government would have lost; and number two, the inefficiencies that were there by organizing some businesses in the form of trusts that should have been organized in the form of corporate businesses.

I can't separate between the two, but I do have faith, reasonable faith, that market evaluation of what has gone on is right and a big chunk of that $20 billion or $25 billion has to be the present value of tax losses to governments, federal and provincial.

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

Thank you. I think clarification is important, since in fact a lot of people hang on to every one of your words, and it needs to be considered in this debate. I think we need to consider also what many have said—that is, that income trusts exist for one reason only. I'm not saying these are your words, but my perception of the experts' advice on this is that they offer a tax benefit to investors in trust that was not available to corporations, which I think has been stated clearly to try to refute what Mr. Tait and Mr. Fortin have tried to say to us.

I'd like to go to them, but just before I do, Mr. Hibbert, you have over the years made important assessments of existing trusts and concluded that there was significant overvaluing and that there are serious problems for people who hold trusts in terms of getting value for their investment. Could you elaborate just a bit on the problems that exist and what would happen in the absence of any government action putting a lid on trusts?

[The Chair, Conservative, Brian Pallister]

Mr. Hibbert, you'll only be able to elaborate a little bit, because you'll have only 30 seconds for your response, unfortunately.