Canadian Politics from Canada's Centre

Tuesday, November 07, 2006

Understanding the Income Trust Move

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In the wake of Finance Minister Flaherty's income trusts move and also as a result hearing about real estate income trusts, I decided to get a professional's appraisal of what just happened on the federal financial scene. Here's another fine piece by Concordia University and Dawson College Economics professor Phil Ghayad. Prof Ghayad addresses which income trusts are really affected and why Flaherty had to move. This is an excerpt of an email he authorized me to publish here.

The move last week by Flaherty was quite reasonable and predictable. Income Trusts are mostly mature firms that pay practically no tax on their profits, contrary to other firms that also have shareholders. This permits the Income Trusts to give higher dividends to their shareholders (by the way I was one of them!). The shareholders will of course have to be taxed on these dividends. These large dividends, however, make the Trusts more interesting than regular firms to potential investors.

What the government realized was that these Trusts created a loss in terms of Government revenue. Mainly for two reasons: 1) there was a loss that stemmed from the non-taxation of profits, and 2) investors receiving these large dividends were not necessarily in Canada (e.g. international investors who obviously do not have pay Canadian taxes). These losses for the Government were assumed to be between 500-1000 million a year.

In the end, this was a good decision because it creates greater taxation equity between firms that have shareholders. This might even be a good thing for the Trusts since instead of passing their profits to shareholders they might decide to reinvest part of them in capital or research and development. The Trusts were simply too focused on short term gains, attracting investors with their large dividends, and sacrificing long run profits, by reinvesting part of their profits in projects that would make them more productive.

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At 7:02 p.m., Canadian Politico Anonymous Brian C. said:

Hi, I'm not clear on the foreign investors problem. I hear that this will cause them to bail on income trusts to the point where the C$ will drop so obviously a fundamental problem was resolved.

When I receive a US dividend, I get charged a foreign owner tax as I'm getting the dividend. Isn't this done on Canadian income trusts so that taxes aren't lost on foreign investors.
Great move, I think but I only had less than 5% of my portfolio in trusts.

At 4:08 p.m., Canadian Politico Anonymous Rick Drysdale said:

How on earth does taxing Canadians the way they are going to , maybe, stop the tax leakeage to foriegners? The better solution would have been to stop new conversions. BTW oil and gas trusts spend billions of dollars on research and developing new sources of oil and gas and enhancing old fields. Maybe we can stop the generalizations The pizza trust is not like Harvest energy.There are just too many half truths and outright lies going around in this tax grab by the feds.


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