Income Trusts

Remember them.



The October surprise after the election of the first Harper Minority government in 2006, andthe first big lie by the Harpercrite government. It closed down Income Trusts after having promised not to. By forcing them to change to corporations they initially harmed seniors who had invested in the Trusts for their dividend pay outs. So how come the Harpercrites can count on seniors for their vote?

And when Income Trusts dissolved, some into corporations, others bought out by hedge funds how did that help Canadian small businesses relying on them for their capital investment? Well it didn't help them.

Those Trusts that became corporations benefited from tax breaks, tax cuts and or course deferred taxes, which have contributed to the current Harper Deficit.

Ms. Lefebvre said that some companies have benefited from converting to corporate status because they can use other exemptions to offset entity taxes, which income trusts will soon have to pay.

“Although the rate might be roughly the same in theory, if you're a corporation, you have access to various ways to defer tax or shelter tax, none of which are available to an income trust.”

However, she added, smaller trusts are simply disappearing because they cannot continue to attract investors when they switch to corporate mode because they are no longer able to pay high-yield dividends.

“Many of those have been taken out of circulation by being bought out by private equity, or being bought out by pension funds,” she said, adding that the government wrongly assumed most funds would keep their status and begin paying entity tax.

“The biggest change for the Canadian economy is that small- and medium-sized companies will not have the access to capital that they would before.”

“[The income trust] was a creation of the Canadian economy,” she said. “It was particularly suited to an economy where small- and medium-sized companies had very difficult access to capital, where the capital market is small.”

The demise of the trusts began four years ago, on Halloweeen, 2006 when Finance Minister Jim Flaherty did a flip-flop on a Conservative campaign promise and announced that trusts would be taxed starting in 2011.

Investors were shocked and angry. Many dumped their trust holdings in the big market sell-off that followed the announcement. To this day, a few diehards continue to fight a rear-guard action in the hope that the government might have a last-minute change of heart. It won’t.

The disappearance of the trusts couldn’t have come at a worse time for income-oriented investors. With interest rates near historic lows, traditional safe haven securities like GICs and government bonds are offering pitifully low returns. As of the time of writing, five-year federal government bonds were yielding only 2.22 per cent. Five-year non-redeemable GICs from major institutions like Royal Bank were even lower, at 2.1 per cent (posted rate). That means anyone investing in these securities isn’t even keeping up with inflation, which was running at an annualized rate of 2.4 per centin October according to Statistics Canada.

The Conservatives propose new rules for income trusts

Following announcements by telecommunications giants Telus and Bell Canada Enterprises of their intentions to convert to income trusts, on October 31, 2006, Finance Minister Jim Flaherty proposed new rules that will effectively end the tax benefits of the income trust structure for most trusts. Brent Fullard of the Canadian Association of Income Trust Investors points out that at the time of the announcement Telus and Bell Canada Enterprises did not pay any corporate taxes nor would they for several years. According to his analysis, had Bell Canada Enterprises converted to a trust it would have paid $2.6 to 3.17 billion in the next four years versus no taxes as a corporation.

Subsequent to the October 31 announcement by Flaherty, the TSX Capped Energy Trust Index lost 21.8% in market value and the TSX Capped Income Trust Index^[22] lost 17.6% in market value by mid November 2006. In contrast, the TSX Capped REIT Index,^[23] which is exempt from the 'Tax Fairness Plan', gained 3.2% in market value. According to the Canadian Association of Income Funds, this translates into a permanent loss in savings of $30 billion to Canadian income trust investors.^[24]

In the month following the tax announcement, the unit price for all 250 income trusts and REITs on the TSX dropped by a median of almost 13% according to the iTrust Report published by TrustInvestor.com and its iTrust Index. Studies by Leslie Hayman, publisher of the Report, indicated that the tax news at the end of 2006 was the second most significant volatility event in the market following only the suspension of advance tax rulings by the Minister of Finance, Ralph Goodale in 2005.

Income trusts, other than real estate income trusts, and mutual fund investment trusts, that are formed after that date will be taxed in the same way as corporations:

• income flowed out to investors will be subject to a new 34% tax as of 2007 (which falls to 31.5% in 2011),^[25] which approximates the average corporate income tax paid by corporations—this is equivalent to the current prohibition against deducting dividends paid to investors in determining corporate taxable income; and
• income flowed out to investors will be eligible for the dividend tax credit to provide equivalent treatment to dividends paid by corporations.

Income trusts formed on or before that date will not be subject to the new rules until 2011 to allow a period of transition. Real estate income trusts will not be subject to the new rules on real estate income derived in Canada (the non-Canadian real estate operations of existing REITs will be subject to the same taxation as business trusts). The new rules were completely contrary to the Conservative Party's election promise to avoid taxing income trusts.

Flaherty proposes to reduce the federal corporate income tax rate from 19% to 18.5% in 2011. The 34% tax on distributions will be split between the federal and provincial governments—the federal government will consult with the provincial governments on an appropriate mechanism for allocating 13 percentage points of the new tax between the provincial governments.

Flaherty also proposed a $1000 increase to the amount on which the tax credit for those over 65 (the "age amount") is based, and new rules to allow senior couples to split pension income in order to reduce the income tax they pay. Although these proposals were said to be designed to mitigate the impact on seniors of the new income trust rules, there have been widespread calls for such changes in previous years.

Legislative amendments to implement these proposals must be passed by the Parliament of Canada and receive Royal Assent before they become law. The legislation to implement these proposals was included in the 2007 federal budget, which was presented to Parliament by Jim Flaherty on March 19, 2007.