Finance Committee on May 29th, 2007

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

Good afternoon.

There is no need to alter the income trust tax amendment in Bill C-52 based on any developments that have occurred since October 31, 2006, when the new income trust tax was announced. The only action that's now required is for the Canada Revenue Agency to make an announcement that it plans to use the general anti-avoidance rule and the thin capitalization rules in the current Income Tax Act to ensure that all acquirers of income trusts will be forced to pay Canadian business taxes. This must done so that individual investors are treated fairly compared to pension funds, private equity funds, corporations, and U.S. master limited partnerships. I'll speak on that in a moment. I want to review some of the developments since I was last here.

First of all, the income trust tax damage was relatively small upon announcement. The average capital loss in the 14 days post-announcement was 14%, or $24 billion. The capital loss as of last night is now negative 3%, or $5 billion. While income trusts have rallied from their worst prices, they have, as indicated earlier this morning, underperformed the common stock market, which rallied 15% since October 31.

Income trusts are underperforming corporations in the market because they're bringing out the overvaluation that was contained in the market prior to the announcement of the tax. Without access to the new financings, distributions have become less sustainable. The Ponzi structure of paying the excess distribution is not working anymore. Income trusts are now brought to a level playing field with corporations. That was the objective of the tax and that is what the impact is in the marketplace.

Another development since I was last here is that on April 26, 2007, the National Pensioners and Senior Citizens Federation, the United Senior Citizens of Ontario, and the Small Investor Protection Association made a joint call for a criminal investigation by the Royal Canadian Mounted Police and the Ontario Provincial Police on the deceptive cash yields in the marketing materials used by the investment banks to sell income trusts to seniors. I'm here also as a spokesperson today on behalf of those three associations that supported the income trust tax. We have one million senior members throughout all the provinces of Canada.

While there has been some recovery of income trusts in the market as a result of extremely buoyant stock market conditions, there are still 50 business income trusts that are down more than 20% from their public offering prices in the last six and a half years. This group has had an average loss of 50%, representing $8 billion of capital losses for seniors and other retail investors.

The income trust tax was not responsible for the cause of this decline. It was due to the deceptive cash yields that proved not to be sustainable. We now have close to one-third of the business income trust market that has suspended its distributions or has made significant cuts. The latest ones—XS Cargo, Drive Products, Precision Drilling, Primary Energy Recycling—slashed distributions in the past couple of months. It's when these distributions get suspended and slashed that we get the catastrophic losses for seniors that are the subject of the call for the criminal investigation.

Now I'd like to turn back to taxes. There have been 25 acquisitions of business income trusts. Most of those have indeed occurred since October 31, but acquisitions were clearly anticipated since the new income trust tax would result in the phase-out of most income trusts by 2011. There are only two ways to phase out income trusts: you either get acquired or you decide to convert back to corporations.

The Canadian Association of Income Trust Investors, the federal Liberal Party, and several tax lawyers and financial analysts are saying that the acquired income trusts will not be paying Canada any taxes. This clearly cannot be the case. U.S. master limited partnerships are said to be the most promising acquirers of the Canadian energy trusts, with the intent again not to pay any Canadian taxes.

The objective of the vocal income trusters is to have us rescind the income trust tax that is before this committee today. This is not the answer for fair treatment of individual investors who've just had a tax advantage removed. We can't turn around and give that tax advantage to foreigners and to pension funds. The answer is fair treatment—for Revenue Canada to announce that it will enforce the general anti-avoidance rule in section 245 of the Income Tax Act and the thin capitalization rule in subsection 18(4) of the Income Tax Act.

The fair tax policy is that Canadian business is not to be permitted to operate with artificially high debt loads and interest rates for the purpose of stripping profits and paying no business taxes. Similarly, the energy trusts cannot be permitted to use artificially structured royalty agreements for the purpose of stripping profits and paying no business taxes. All Canadian businesses must pay business taxes, regardless of who owns them: public investors, pension funds, or any foreigners in the market.

[The Chair, Conservative, Brian Pallister]

Thank you for your presentation.

We continue with James Morand, as an individual. Welcome, sir. It's over to you. Five minutes is yours.

[James G. Morand, Partner, McCarthy Tétrault, As an Individual]

Thank you.

Just by way of background, I'm a tax lawyer with McCarthy Tétrault, and I practise quite a bit in this area of income funds.

I am here to talk about some technical deficiencies in the current draft legislation. I'm here not to debate whether or not it should go ahead but to instead point out some deficiencies on the assumption that it is going ahead. These deficiencies have been raised with officials in the Department of Finance in detailed submissions, but we thought it worthwhile to bring them to your attention also.

The first relates to the fact that the way the draft legislation is crafted, although it's ostensibly aimed at publicly traded partnerships or trusts, it will similarly apply to trusts or partnerships whose equity is not publicly traded but that have debt that is publicly traded. The reason is that the definition of security and investment in the draft legislation causes the scope of the legislation to be so broad as to capture those types of trusts. That seems to be at odds with the announcements of the minister in the backgrounder when the legislation was released, because the minister indicated then that the legislation was aimed at large public trusts and he talked about the equity being publicly traded.

We think a legislative amendment is necessary in order to carve out debt that is publicly traded where it's not convertible to equity and where the trust or the partnership is not a publicly listed trust or partnership.

A similar problem exists where, in the context of a partnership, you have a partner who has a greater than 50% interest in the partnership, or, in the context of a trust, you have a beneficiary who has a greater than 50% interest. If either of those entities has debt that is publicly traded, you run into the same problem. The underlying partnership or trust is considered to be a SIF and is subject to these rules, although, again, that wasn't the announced scope of the rules. It was aimed at trusts or partnerships whose equity was publicly traded. So we think the rules need to be carved back so they don't capture these types of situations.

It is quite common to have private partnerships or trusts that have parent entities, parent corporations, for example, that carry on business through the partnership in conjunction with a third party. That corporation would go into the public market and issue debt. Because it has issued debt, although it has a private partnership underneath, that partnership gets caught in these rules. Whether it is intended or not, I don't know, but that is the scope of the rules as drafted, and we think they need to be amended.

The next theory I'd like to turn to relates to the normal growth guidelines that were issued on December 15. Those guidelines allow new issues of equity to be made and not considered normal growth if they're used to replace debt that was existing on October 31. But the rules, as contemplated, seem to require a tracing. At least, this is the interpretation being offered by officials in the Department of Finance in discussions we've had with them. The actual guidelines don't say anything about the tracing, but that's the interpretation. They force greater costs and inefficiencies by requiring a SIF that has a debt outstanding on October 31 to use new equity to replace that debt, because it could then turn around and issue new debt, and that wouldn't cause it to be offside. So you could circumvent that restriction by doing a series of transactions. It seems that instead of requiring this tracing concept, it would make more sense to eliminate the tracing concept and just allow a new issue of equity that was equal to the amount of debt outstanding on October 31.

The last couple of points I want to raise are these.

The normal growth guidelines are incorporated by reference into the draft legislation. They're not drafted with the precision of legislation at all; they're very broadly drafted. If they're going to exist in this form, I suggest they be drafted with much more detail so that people will know what's intended. Right now there's no precision to the rules.

On a related point, in the first session, Mr. Chair, you indicated that someone had requested a rollover for subsequent conversions. We endorse that. The existing tax rules don't provide for it, and should provide for it, if these rules are going to be implemented.

[The Chair, Conservative, Brian Pallister]

Thank you very much for your presentation.

We conclude now with Armine Yalnizyan.

There are five minutes to you, Madam.

[Armine Yalnizyan, Director of Research, Community Social Planning Council of Toronto , As an Individual]

Thank you, Mr. Chair.

Yes, context is everything, so I want to talk about my context. I come from the Social Planning Council of Toronto. It serves the residents of the sixth biggest governmental jurisdiction in the country: 2.5 million people. We deal with about 1,400 agencies that provide human services to residents, that cover hundreds of thousands of residents every day, and that touch literally the lives of all citizens in Toronto.

We're funded by the City of Toronto and the United Way, if you're wondering where our money comes from.

Context is everything for you. You folks are dealing with the daily cut and thrust of politics. The two big contextual issues in which you discuss Bill C-52 are these.

In the last few days there is the remarkable development in Quebec, where a minority government might fall because it's promising to deliver on its promise to cut taxes, because members of Quebec society feel the need for that money to be used to provide health and education is perhaps the more important imperative. That's quite a remarkable development in our political discourse of the last few years.

The second very important political moment for you is this discussion of mergers and acquisitions and foreign takeovers, which is not just an issue of foreign ownership but more an issue of increasing concentration of our corporate resources. This is a theme I'll touch on in a moment.

Our context for discussing Bill C-52 has several features. First of all, the economy is hotter than it's been in 40 years. All the fundamentals are right. Our government at the federal level has run 10 back-to-back fiscal surpluses, a feat that has not been paralleled by any other nation on the surface of the planet. We are literally rolling in money. That's quite a remarkable contextual moment.

Secondly, we are facing the biggest retirement of the labour force of any industrialized nation on the planet. No other nation had as big a baby boom as Canada had. We have been sleepwalking towards this event with no national training strategy. Whereas our governments mandate access to health and education, there is no national strategy to deal with what is about to hit those services, which are considered basic by every Canadian who lives here.

Thirdly, inequality is a growing issue globally: between nations, within nations, within your ridings. There's not one of you who sits here who doesn't know of stories of how inequality—not just growing poverty, but growing prosperity—happens cheek by jowl in your riding, rural or urban, and what the impact of that is on your constituencies and between households.

I would love the opportunity to address any one of your caucuses about the issue of inequality as the other inconvenient truth of our era: that it is unsustainable in Canada. It is growing at a faster rate than it has in the 30 years we have data for it, at a time when precisely economic conditions are ripe for its reversal. And it is happening with a face, a place, and a race—some of those comments that Mr. Jock has referred to. This is completely unacceptable for a country with our prosperity.

We have just returned to the rate of child poverty that unanimously your colleagues in 1989 stood up in Parliament and said was unacceptable. Child poverty had to be eliminated when it was at the 11.7% mark in 1989, and now we should be cheering that it has returned to that after 10 years of economic prosperity.

I would say to you this is not about just poverty, and it's also not about just income, when the rich set the markets for housing, and when we are dealing with a global diaspora because we're not dealing with training but are importing our solution. We're welcoming people into the three major immigrant basements, plus Calgary and Edmonton, where there are housing shortages already, where the rich set the prices for housing markets, where our bankers and our economists tell us that over the course of the next 20 years housing prices are going to double. There's not one economist or banker who will tell you that incomes are going to double.

This is not a poverty issue, though poverty is the worst part of it. We are sitting on a potentially huge problem, when the majority of Canadians are feeling increasingly economically insecure at a time of huge prosperity.

I won't go into the other parts I wanted to touch on. But I want to say that I think you have three revenue-neutral options for adjusting your budget to address some of these realities.

First, you should reconsider the tax cuts promised last year. The second 1% of GST reduction—that one point of GST reduction—should go to where the real fiscal imbalance now lies.

You've done an amazing job of starting the discussion on where the fiscal imbalances are and how to redress them. I think it's very important for you to recognize that the real vertical fiscal imbalance is with the cities: $60 billion to $120 billion of infrastructure deficit that we know of, which is hard infrastructure deficit, primarily occurs in the cities, and they have no capacity to raise the funds for this. The federal government should be playing a role there.

Secondly, you have introduced significant changes to the CST. We are repeating exactly what we did with the CHST and the separation of the CHT, and so on. It's time to separate out those elements of the CST and introduce clear objectives as to what these pots of money are for. This government is the value-for-money government. It's the accountability government. Show us where the money is going and what we're getting for it.

I think we have some precedents in the way we got the four pillars of child care negotiated prior to that. We can separate out the CST so we are clear on what we are sending money to the provinces to achieve, and it surely can't be just to produce tax cuts for their citizens.

Thirdly—can I just make one more point?

[The Chair, Conservative, Brian Pallister]

No, but you can work it into a response to one of the questions, and I invite you to do that.

Thank you for your presentation. You crammed a lot of very good points into a brief time.

[Armine Yalnizyan]

Thank you very much.

[The Chair, Conservative, Brian Pallister]

Mr. McCallum, we'll begin with you. You have six minutes, sir.

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

Thank you, Mr. Chair, and thank you very much to all the witnesses.

I'd like to begin with Ms. Urquhart and make a couple of comments and then ask a question.

First of all, I can't really understand why the government measures created a level playing field. I would say it tilted the playing field deliberately in such a way as to destroy income trusts, and witness after witness has confirmed that point. While it's true that a 31.5% tax rate equalizes statutory rates, the critical point is that the average corporation pays far less than that, so it's not truly equalizing.

Secondly, you seem to criticize the argument that you specifically connect to the Liberal Party that the acquired entities won't pay much tax when they're acquired by a combination of public pension plans and private equity outfits that load up on private debt. I don't think you deny that they won't pay much tax under existing rules, but you're proposing to change the rules, to change to the thin capitalization rules so that they won't be allowed to load up on debt anymore. But under existing rules, we are claiming that in many cases they'll pay little tax, partly because public pension plans pay no tax in the immediate and partly because there are these devices, by loading up on debt, so that private equity firms of the kind that are likely to acquire BCE will pay little tax.

I don't disagree with you that maybe CCRA should alter the rules to limit the degree to which they can load up on debt, but that's kind of a separate issue. I agree with you on that.

I guess that brings me to my question, because this is reminiscent of our discussion of that old issue on which the government has backed down: interest deductibility. The experts who came to talk to us a few weeks ago were unanimously of the view that the real source of abuse in the interest deductibility issue had nothing to do with double dipping and had everything to do with so-called debt dumping, where corporations load up on debt, deduct the interest on that debt, and thereby avoid taxes.

Would you agree with me, first, that this thin capitalization is also applicable to the interest deductibility issue, and secondly, that in the absence of such changes we are right that, in many cases, little tax will be received by the government by these acquisitions?

[Dianne Urquhart]

No, I do not agree.

First of all, just to review income trusts, the way in which no business taxes were paid was primarily through each of the income trusts, which is itself a legal structure, having a corporate subsidiary. In the corporate subsidiary, that is where you have virtually—

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

I'm asking you about the—

[Dianne Urquhart]

No, I have to answer the question. Do I have time?

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

I don't have much time.

I want to ask the question about these new acquisitions. Our contention is that in many cases little tax will be paid. My question is whether you agree with that or not.

[Dianne Urquhart]

No, I do not agree with that.

The current thin capitalization rules apply to non-arm's-length debt, so the master limited partnerships and the U.S. foreign equity who come in to buy an income trust and who do not raise additional debt from third-party lenders expect to pay no business taxes because they expect the treatment of that corporate, non-arm's-length debt in the subsidiary not to be subject to thin capitalization rules.

If the federal government announces that it intends to apply the thin capitalization rules, then that debt, artificially high, non-arm's-length debt, will not be permitted to exist, and if it does, it will be ignored and it will be treated as not interest that is deductible.

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

Thank you. So basically we agree—

[Dianne Urquhart]

No.

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

—because you're saying that if they don't change these rules, they won't—

[Dianne Urquhart]

No, I disagree. They have the rules today to stop the acquirers of income trusts from having interest deductibility for the purpose of stripping out profits from the underlying—

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

But they're not enforcing the rules.

[Dianne Urquhart]

Well, they have the means to do so, and my demand today is to have an announcement from Carol Skelton, the Minister of National Revenue, of her intent to use the rules.

Germany just did a study and they found that the German multinationals—

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

Okay, I'll have to stop you there. Thank you.

I want to turn to another witness, because we agree. It doesn't sound as if we do, but the problem, you're saying, is that they're not enforcing existing rules and that these companies are getting away without paying much in taxes, and if we did enforce the rules, they would pay some taxes and that would be a good idea. But I'm not asking you to answer that.

Ms. Yalnizyan, I want to turn to cities. I like what you said about cities and agree with you that they tend to be the neglected level of government. I think that under the Paul Martin government we started to move towards a gas tax and other revenue sources being transferred to cities. It's my opinion that the current government is not enamoured of this; it's of the view that cities are basically the creatures of the provinces.

So I'd like to ask you to comment on what you think would be the next step in terms of helping the fiscal situation of municipalities, not just cities, I should say.

[The Chair, Conservative, Brian Pallister]

Unfortunately, you only have a very brief time to give a response.

[Armine Yalnizyan]

May I just say that what cities need—and you all probably know this story—is money for capital costs to maintain existing public infrastructure, as well as to expand it, in jurisdictions that are growing. So capital costs are distinctive from operating costs. And cities also require some growth source of revenue. They do not have any growth source of revenue, and it is incumbent upon senior levels of government to negotiate something, because most Canadians live in municipalities, not in rural settings, and 50% of Canadians live in the biggest urban centres.

If we're going to continue with our immigration policy, we have to have a system of financing the way people live in this country, a system that responds—

[The Chair, Conservative, Brian Pallister]

Ms. Yalnizyan, your time is well past.

Just for clarification, you said they don't have a growth source of revenue, yet I understand that local municipalities essentially receive a share of the growth in tax revenues coming from property taxation in their region, or some percentage of that from the provincial level.

And you alluded in your presentation to the prospective doubling of real estate values, so wouldn't that in a sense be a growth form of revenue that would be available to cities?

[Armine Yalnizyan]

Indeed, it would, sir, if market value assessment had no problems with income affordability. You've probably heard of people in your own riding who are elderly and house rich and cash poor, who are very, very concerned—