Finance Committee on Feb. 13th, 2007

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

Thank you, Mr. Chairman.

Mr. Rosen, I just want to ask you a couple of questions

Just quickly, we're here for tax leakage, and I think we're getting away from the subject. But I think the points you bring up are quite important, and it probably means that we have to spend a little bit of time on this. I think your points were mainly on governance and regulation and on how that's interlinked when investors are putting money into these vehicles, whether it be trust or even shares of companies.

First of all, you have a problem with trust funds, income trusts, but what about the real estate tax sector? The government decided to keep the real estate tax sector going. They're going to have the same problems.

Secondly, for corporate structures, you can't tell me that junior mining companies out there have not undergone significant scrutiny, or non-scrutiny, if you wish, where they state that they've discovered minerals, diamonds, or gold—you name it—and meanwhile they're not worth anything. The marketing or the underwriters, or whoever you want to blame it on, have brought the stock prices up to the sky, and then all of a sudden they've dropped overnight.

So you can't tell me it's just in the trust sector. I'm not sure how you can correlate the two, where you can say it's fine that the corporate sector remains alive, and that the real estate sector and the income trust sector remain alive. You can't have it both ways.

This is not the issue of the hearings, but we're here to find out what the actual tax leakage is and why Canadians suffered all these losses. Again, I agree with your last comment, which was that the actions of the previous government are not necessarily what caused Canadians to lose all their money. But I think the Finance officials say that nothing happened between October 31 and November 1 outside of the government announcement, so I think today's new government has to take part of the blame.

[Al Rosen]

As for your comment about comparing to mining and other industries, I don't know how anybody can look at the figures that I gave you today, plus all the updates we've done since then, and come to any other conclusion than that these were quick disasters. They dropped very quickly. So the whole model, to start with, stunk, and there's no question about that. The winners out of it were the underwriters and brokers.

So if you're saying real estate and other corporate...people are quite well aware of the problems, and you are following along on a particular level. Once you decide that 90% or 80%—whatever the number is—of trusts go down the drain so quickly, I don't know what alarm bells one needs. This was a bad model.

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. Rosen and Mr. Pacetti.

And thanks to you all. We appreciate the time you've taken to be here with us today. You are dismissed, and we'll invite the next panel to come forward.

Committee members, I have a brief statement to make to you, so I'd ask for your indulgence.

Mr. Thibault.

[Robert Thibault, Liberal, West Nova, NS]

On a point of order, Mr. Barrowclough referred to some recommendations that he had available for circulation to the committee members. I haven't seen them. Will they be distributed?

[The Chair, Conservative, Brian Pallister]

I'm not aware of what recommendations you're referring to, frankly.

[Robert Thibault, Liberal, West Nova, NS]

In his discussion, he recommended—

[William Barrowclough]

I said a brief would be translated and distributed.

[The Chair, Conservative, Brian Pallister]

When it's translated it will be distributed, yes.

Thank you, sir.

You're dismissed, panel. Thank you.

To the committee members, I'd ask you to remain for a moment.

First of all, on a housekeeping item, we'll have lunch available at 12:30 for committee members and staff. I would encourage those who are not committee members and staff to make sure they wait until the former have had their lunch, because we're going to endeavour to deal with the report following the second panel's presentations.

To committee members, this Thursday the House of Commons finance committee will begin its review of the Bank Act. This is an important undertaking, and it's my sincere hope that the work of the committee in this, as in all of its undertakings, be given the serious consideration it merits.

As your chair, it is my wish to maximize both the efficiency and the effectiveness of your work. I know that none of us would wish to call into question the integrity of the work we do here. For that reason, I will be removing myself as your chair for the duration of the consideration of Bill C-7.

As I have previously disclosed to you and to the clerk, my family has a controlling interest in two companies that place insurance contracts of various types. I have consulted with the Ethics Commissioner's office. I have consulted with you, and I thank you for your input. I appreciate it very much.

The contentious topic of banks marketing insurance products will most certainly be raised at some point during your deliberations. This issue relates directly to companies in which I and my spouse have controlling interests. Although the impact of such changes as proposed is uncertain, there is no doubt that my participation in the discussions could potentially lead to accusations of conflict of interest and therefore have the effect of discrediting the work that we as a committee must undertake to do. As your chair, I cannot allow that to happen.

I thank the committee members for their support and their encouragement and advice during the difficult period of considering this issue. I believe this course of action is the correct one, and I believe this decision has come about because of your input to me and to my family.

I also want to thank Massimo, our vice-chair, for agreeing to take on the chairmanship during the committee's deliberation of the Bank Act.

I wish the committee great success in this important review, and I look forward to resuming our work together following the completion of your report.

We will recess for two minutes while the second panel comes forward.

[The Chair, Conservative, Brian Pallister]

We recommence immédiatement, s'il vous plaît, with our second panel.

Panellists, we thank you very much for being here today and look forward to your comments.

Witnesses, I'll give you an indication that you have a minute remaining, and then I must cut you off at five minutes to allow time for questions. Some of you know this drill already.

We begin with Dave Marshall. You have five minutes, sir.

[Dave Marshall, As an Individual]

Thank you, Mr. Chairman.

My name is David Marshall and I'm from Cornwall, Ontario. Thank you for inviting me to share with you the impact that the government's decision regarding income trusts has had on our lives.

Let me tell you a bit about myself and my wife, who is with me today. When I got out of high school, my first job was as a telegraph messenger boy for Canadian Pacific at $24 a week. For many years I worked as a truck driver and a chemical plant worker, and then I retired five years ago at the age of 65. My wife retired last August from an auto parts warehouse at the age of 60.

During our working days, my wife and I raised two daughters, and I had to diligently save for our children's education and our eventual retirement. We realized that the income from GICs, T-bills, CPP, OAS, and my company pension was not going to support our modest lifestyle. My wife has never had the opportunity to participate in a company pension plan. After studying the income trust sector and the risks that were involved in all types of investments, we cashed in our GICs and T-bills and invested in income trusts. We were very satisfied with the results. Our portfolios were diversified and consisted of both growth and income.

So why are we here today? Because Mr. Harper and his finance minister took a sledge hammer to our savings and income. Overnight we lost over 20% of our retirement savings and big chunk of our future income. During the last election campaign Mr. Harper said—and this is important—that a Conservative government would protect seniors and not tax income trusts. You can't get any plainer than that.

Because of that very statement, I took him at his word and decided to vote for his party. As it turns out, one of the biggest mistakes of our lives was believing in Stephen Harper. What is amazing to me is how this government can flip-flop 180 degrees on something that is so important to the welfare of ordinary Canadians such as us.

To top it off, it appears that the government made its decision with very little study or understanding of the impact of their action. Many credible, knowledgeable people and institutions have come to the defence of the income trust structure.

Based on what I read from various sources, it is obvious that the government had alternatives. If in fact the government had become a threat to the Canadian economy, they could have taken action to limit the creation of new trusts and reform the reporting standards of the existing ones, without causing any financial hardship to pensioners such as us.

I must say it is very disturbing when a Canadian citizen applies for documentation through the Access to Information Act and all he gets back are blanked-out sheets. We have to wonder what this finance minister has to hide. My guess is nothing.

It should make all of us very sad. What has this great country of ours come to? My father and father-in-law fought in the First World War and Second World War, during which many men and women died. Presently our Canadian soldiers are fighting in Afghanistan. All this is to protect the rights and freedoms that each and every one of us enjoys today. So why the secrecy? The citizens of this country deserve an open and honest government—the kind that Stephen Harper promised us. We deserve full disclosure, because this is important to us whether we are young or old.

I have written to Mr. Harper concerning my concerns about the way his finance minister is treating us seniors, who were once the foundation of this country and now are the vulnerable within our society. No reply.

I'm nearly finished, but I want to say I believe that as members of Parliament, it is your duty to support a full public review of this matter before the members of the House vote on this legislation. I urge you to vote on this.

One last thing is that I do not want Mr. Rosen looking after my interests.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. Marshall.

We'll continue with Dianne Urquhart, an independent consulting analyst. We'll provide five minutes to you, madam.

[Dianne Urquhart, Independent Consulting Analyst, As an Individual]

Thank you.

The income trust tax plan removes tax advantages, and where there are tax advantages there is by definition government revenue leakage. If there were no tax advantages, there would not be this aggressive income trust lobby to reverse the income trust tax plan. If corporations had less combined business and personal taxes, then income trusts would be rushing to convert back to corporations to achieve these relative tax advantages. If there were no tax advantages, there would not have been a drop of about $20 billion in the market capitalization of business and energy trusts after the October 31 announcement.

I'd like to speak about the tax-deferred plans. It's my opinion, as a financial analyst with numerous years of experience both conducting financial analyses and supervising the work of up to 60 analysts and associates within the CFA Institute, of which I am presently still a member, that in the RRSPs and the pension funds there is permanent government revenue leakage. There is a tax-deferred loss. As a consequence, I do not agree with the witness testimony of Dennis Bruce, who indicates that there is a tax-deferred gain—and I believe it was on the order of $125 million—offsetting the estimates of the finance department.

I'm not going to attempt to redo the budgetary estimates; there isn't the time here. I want to use my expertise with respect to the tax-deferred loss from income trusts versus corporations in tax-deferred accounts.

There was a research report tabled by Mr. Art Field, president of the National Pensioners and Senior Citizens Federation, on February 1, 2007. From that report I determined that the present value of the tax-deferred loss from ownership of income trusts within tax-deferred plans is $98 for every $1,000 invested within income trusts. The loss occurs because you have to compare investing in income trusts in tax-deferred plans with investing in corporations in tax-deferred plans. Clearly there was a tax advantage, because the income trusts in the tax-deferred plans didn't have their business taxes collected; corporations in tax-deferred plans did.

When you take the present value of all of the aspects of the tax-deferred plan and do the proper questioning and comparison, there is in my mind an indisputable tax-deferred loss. As for the $500 million estimate, or whatever number this committee seizes on as the right one—I'm prepared to accept the Department of Finance and its expertise—the actual total loss, bringing into account the tax-deferred accounts, would in my opinion be substantially more than $500 million.

I want to turn now to the related issue noted by the various experts, including Kevin Dancey of the CICA and Dirk Lever of RBC Dominion. It has been said that there is double taxation in the ownership of income trusts, post-2011 and currently for corporations, because corporations owned within income trusts do not have the preferential tax treatment of the dividends.

It is categorically incorrect to say that within the RRSP plan and pension funds there is net double taxation, because of the structural benefits within the RRSP and the pension funds themselves.

When you calculate the investment value of corporations owned within RRSPs, you will find that the net present value and the future value of corporations owned in RRSPs will be more than that of corporations owned outside of RRSPs, and that's because, with the benefit of the upfront tax deduction, if you put $1,000 in you're going to get approximately $380 of tax savings to put to work. In addition, you have your investment income earning on a tax-deferred base and accumulating on a compounded basis over a very long period of time.

Now I'd like to turn to another matter that was of significance, which the income trust industry and others have indicated as the reason we have to reverse the income trust tax plan, and that is the reason we have to reverse the income tax plan, and that is the U.S. master limited partnerships.

The U.S. master limited partnerships are for the most part taxed identically to the Canadian income trusts following the income trust tax plan. Americans who invest in master limited partnerships in taxable accounts pay full personal taxes. Most notable, in the tax-deferred plan in the United States within master limited partnerships, individuals who own these within their IRAs must pay a special shareholder tax that is equivalent to the business taxes that would otherwise have been paid, and the purpose of that tax is to make sure that master limited partnerships within IRAs do not have an unfair tax advantage relative to corporations.

In conclusion, the master limited partnerships are not giving American retirees opportunities that Canadian retirees are allegedly going to be denied post-plan. More importantly, it is incorrect to argue that the master limited partnerships, because of their competitive advantages, are going to buy out the Canadian oil and gas industry. It is the reverse. The current Canadian income trust situation, with the Americans being able to buy them through such a strong incentive, is why the majority of our Canadian energy trusts are owned by Americans.

[The Chair, Conservative, Brian Pallister]

Madam, I'm sorry, your five minutes has passed. Thank you very much.

Mr. Don Francis is with us. Mr. Francis, it's over to you, sir.

[Don Francis, As an Individual]

Thank you.

I'd love to debate that, but I'll give my presentation.

I'm a 63-year-old retired scientist and small businessman. We lost $70,000 on November 1. We had $7,000 less income this year. Even worse, double taxation at lower yields will plunge our retirement income from $60,000 to $30,000 a year. Like millions of Canadians caught in this mess, we'll not be spending our golden years in the lap of luxury.

Tax policy decisions must be based on numbers, not on lies or personal or political gain. I'm a numbers guy, and I decide using logic and verified facts. Given new information, I'm open to changing my mind.

I'm upset by the lack of logic and honesty that the Tories and the NDP have displayed on this issue. We all know the Tory objective is to double-tax income trust distributions in retirement accounts in order to kill income trusts. Their justification is contrived and wrong.

Is there tax leakage? There is none. Is there reduced productivity and competitiveness? No. If other business structures can't compete, boo hoo. Is there unfair tax collection from citizens? No way. Is trust accounting worse than corporate accounting? No way. Do these answers logically justify this proposal? No. Are those even the right questions? No.

The right question that you should be debating is this: does killing income trusts benefit Canada? The clear answer is no.

Why this proposal, and who benefits? That answer is easy. It's thoughtless, unethical, power-seeking politicians and those who serve as the messengers, the fat cats. You know where I'm going. It's corporate executives at the top of the greed chain, the uber-rich and their private equity, those with fat defined benefit pensions, including politicized bureaucrats, and, of course, the self-promoters who we've heard far too much from already.

Who loses? It's the 70% of Canadians responsible for their own retirement, those with thinly defined benefit pensions and small businesses, the source of most Canadian jobs and productivity. Ultimately 95% of us will lose, as our wealth continues its shift to the uber-rich and to the south.

A wrong decision here mimics the Avro Arrow fiasco, which threw away an innovative Canadian product. Facts were deliberately destroyed, along with that superb machine. Political lies don't stand the test of time. Politicians again satisfied a greedy military industrial complex through the death of a strong Canadian aerospace industry. The Arrow died. Was it good for Canada? Hardly.

Canada has evolved an innovative business structure that democratizes our capital markets and helps citizens like me ensure their own retirement. I have seen no facts that show a need to kill income trusts. I see private equity already picking at the meat of our income trust bones.

To Jack Layton and Judy, my family helped found the CCF and supported the NDP for 67 years.

Judy, we met on January 29, and you'd shown me some courtesy and quit playing with your BlackBerry. You agreed to convince me of the logic of the current NDP position. I received nothing, nothing but babble about bank machines, and Ponzi schemes, and little Miss Urquhart all in a row.

Judy, Canadians think for themselves. You should try it. The NDP needs to rethink its position. This proposal targets hard-working Canadians for the benefit of all those fat cats. This is as clear a case of those fat cats eating the mice as this country has ever seen. Tommy Douglas is spinning in his grave to see NDPers like you acting like fat cats.

Don't listen to Manulife's Dominic D'Alessandro. His $75 million in stock and options gained $3.5 million on November 1. He'd personally pay millions more in taxes if Manulife was a trust. Mr. D is no mouse. He's about as concerned about Canadians as I am concerned about how he's going to manage to live on his obscene retirement pile.

Jack and Judy, are you worried about corporate accountability? I am too. I support a full public inquiry into this smelly proposal and into accounting, or I fully support grandfathering all existing trusts, without growth constraints, until the issue is honestly and fully studied.

Judy, you're running up the hill against the principles our party was based on. Get out of bed with the mouthpiece and give us back our party. The NDP does not have a choice.

Jack Layton, tear down the bill or the NDP will come tumbling down.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you, sir.

We continue with Jim Kinnear of Pengrowth Corporation. Welcome, sir.

[Jim Kinnear, President and Chief Executive Officer, Pengrowth Corporation]

Thank you, Mr. Chairman.

Indeed, I'm the chair of Pengrowth Energy Trust and, as many of you know, one of the founders of this whole energy trust sector some 18 years ago. We're here this morning to explain why we believe the energy trusts are different.

Mr. Chairman, the energy royalty trust is fundamentally different from REITs and from existing businesses that may have restructured themselves as income trusts, perhaps to obtain premium market valuations. The differences include a long history, the substantial ongoing capital requirements of the sector, and an active business model that is of strategic importance to all Canadians, including significant new capital fundraising within the sector. It has promoted growth, efficiency, innovation, productivity, and minimal environmental impact.

In fact, the royalty trust industry in Canada has become a pivotal part of the Canadian oil and gas industry over the past two decades. Our business model was only undertaken after careful consultations with the Department of Finance, supported by a series of tax rulings that have provided the discipline and framework for our industry over the past 20 years.

Mr. Chairman, energy royalty trusts are highly efficient facilitators of the movement of capital within the oil and gas industry, enhancing productivity and the ultimate recovery of our mature fields. We reward the exploration success of our junior oil and gas companies—as a matter of fact, we've even spawned new exploration companies—and have acquired mature assets from the majors and super-majors. That has freed up capital for other large infrastructure projects, such as the oil sands and the Mackenzie Valley Pipeline, among others.

Trusts are in the forefront of CO2 injection and other technologies that will not only increase the recovery and productivity, but also minimize the environmental impact of the energy industry and the substantial capital requirements for Canada's mature oil and gas industry, including the pipeline and the oil sands, going forward.

The vast amount of capital required for the development of our oil and gas industry is generally not available in the Canadian marketplace, and we must compete for that capital in the U.S. and elsewhere. Capital will seek the highest return at the lowest risk. It doesn't have to come to Canada.

The playing field will not be levelled by the government's proposals. The information that has been presented to this committee is clear, conclusive, and compelling. There is no tax leakage associated with energy royalty trusts compared with traditional Canadian oil and gas companies. Royalty trust unitholders will pay approximately $1.8 billion in current income and withholding taxes on $8 billion of cash distributions in 2006, generating more than 30% of the tax revenue collected from Canadian public oil and gas entities while representing only 16% of the revenue. Indeed, we estimate that the government will lose approximately $1 billion a year in tax revenues if energy royalty trusts are forced to convert back to a corporate structure.

Why is this? The application of a 31.5% tax at the trust level in four years, with no deductions available, is inconsistent with the taxation of oil and gas corporations that are based on net earnings. They have significant deductions, and we all know they pay very low levels of cash taxes. Combined federal and provincial taxes on corporations last year were at 32.1%; the net effective marginal tax rate in the oil and gas industry is only 6.7%. Now, the companies can declare dividends, but as you know, in the oil and gas industry they do not pay significant amounts of dividends.

Taxes imposed upon energy royalty trust distributions are based on cashflow, and cashflow is approximately twice the level of earnings. Distributions are now about 80% of cashflow, relative to a very low level of payout of earnings as corporations.

So cash taxes for the major independents in Canada average about 5% of EBITDA, compared with 18% for the trust industry, and substantially more taxes are paid on a proportionate basis by investors in the royalty trust industry.

We talked earlier about the MLP example in the United States. In 1986 and 1987, considerable review was conducted by the House of Representatives and the Senate in the United States. They found that they exempted REITs and energy trusts, and they exempted energy royalty vehicles because of the security of supply issue and because they were an established vehicle for raising capital in a capital-intensive business. Mr. Chairman, I would submit the same applies here in Canada. Energy-related vehicles were exempted and allowed to pass through income.

We believe there's a clear and compelling case for grandfathering Canadian energy royalty trusts, and we encourage you to make that recommendation to the government.

I hope my presentation today opens the door to work together on this very important issue. Thanks for your attention. I look forward to any questions the committee might have.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. Kinnear.

We will continue with the C.D. Howe Institute representative, Finn Poschmann.

Welcome, Mr. Poschmann, over to you.

[Finn Poschmann, Director of Research, C.D. Howe Institute]

Thank you, Mr. Chairman. Thanks to the committee for inviting me back. It is always a pleasure to be here.

Today's topic is a fraught one, so it is important, as always, to mention that although I am working in my capacity as research director of the C.D. Howe Institute, I am speaking for myself and not necessarily the institute or its board of directors or its members, many of whom may have quite different views on income trusts.

The trust issue is a fraud. It is a little problem that grew. It was a problem that was flagged in the report of the Technical Committee on Business Taxation, a committee that reported nine years ago, having been struck by a previous finance minister and chaired by Jack Mintz.

The issue, as everyone knows, is that investors, especially tax-exempt such as pension funds and individuals through other RRSP holdings and non-resident investors, are attracted to income trusts because of their ability to use debt, or leverage, to eliminate Canadian income tax liability at the corporate level.

The technical committee highlighted potential problems with the growth of trusts and partnerships model and went on to discuss solutions employed elsewhere. The technical committee's central recommendation was a neutral tax policy toward corporate capital structures, as would be possible through a corporate distributions tax, not very different with respect to trusts from the mechanism put forward recently by the current government.

Clearly the government's decision was ultimately the right one, if late in coming and not revamping the system as much as circumstances might warrant, but it was generally the right choice. Here is why.

The impetus to choose a particular capital structure is a market distortion, and that means costs as well as benefits. Some benefits accrue to income trust unitholders, especially non-residents and tax exempts whose investments are exposed to less corporate income tax than others. The costs, however, are more diffuse and arise from the constraints the trust model imposes on a business of capital structure.

An income trust cannot grow organically through retained earnings; it can only grow by going back to capital markets, reissuing new trust units, or by borrowing. These are legitimate options, and trusts use them. However, those options are also costly. They have constraints such as that issue in new units is diluted to existing holders. Issuing new debt is costly because it raises the business's total carrying costs by raising total risk, and that also limits payouts to all unitholders. Again, those are costs that may have offsetting benefits, but do they?

For instance, do income trusts have special governance features that make them more responsive to unitholders' interests? No. Unlike common shareholders, unitholders' rights are defined only within a trust indenture, which may be written by the trustees themselves and exist entirely outside the corporate law framework.

Do income trusts, which are generally thought to be bound to a fixed stream of distributions to unitholders, do a better job of holding managers to account for financial performance? No. The board of directors of a common-share corporation could just as easily instruct management to implement a fixed, high-dividend payout policy or to leverage the business to ensure management did not overbuild in its own interests. The trust model is unnecessary for exerting that sort of management discipline.

Do income trusts bring special characteristics to capital markets, so the overall market performs better? Now, that is interesting. Real estate investment trusts, for example, make it possible for retail investors to round out their portfolios with diversified investments in commercial real estate that would not otherwise be available to them. The trust, of course, or the business benefits from its ability to attract retail investors who would not otherwise be investing in those companies.

When it comes to ordinary business income trusts, matters are different. The risks and assets they bring to the retail marketplace are no different from those available through ordinary corporate structures. Their governance does not offer an improvement over corporations. The constraints imposed by required distributions do not improve management performance in any way that could not be generated or achieved in a common-share corporation. Yet, as I explained, the trust model imposes constraints on capital structure.

The constraints imply clear costs but do not deliver clear benefits. That is why, on balance, a neutral tax policy with respect to corporate form is the right policy. The reason is that there is nothing special about trusts that would warrant tax favouritism. As l've suggested and written elsewhere, more business tax policy changes are warranted. For example, upstream taxes paid on distributions to pensions and RRSPs should be refunded to unitholders and shareholders, so that pensioners do not end up bearing more than their fair share of corporate tax. That would be an extension of current policy, not a reversal of it.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you, sir.

Thank you all for your presentations.

We will now move to questions. Due to the constraints of time, we will do four-minute rounds.

We will begin with Mr. Thibault.

[Robert Thibault, Liberal, West Nova, NS]

Merci, monsieur le président.

Thank you all for coming.

I'd like to start with Mr. Marshall. Mr. Marshall, did you receive investment advice prior to making the decision to go into income trusts?

[Dave Marshall]

No, sir.

[Robert Thibault, Liberal, West Nova, NS]

You didn't work with a broker?

[Dave Marshall]

No, sir.

[Robert Thibault, Liberal, West Nova, NS]

Did you increase your position in income trusts after the promise of the Prime Minister?

[Dave Marshall]

No, I didn't.