Income trust risk

[Shakespeare]

Income trust conversions bleeding Ottawa, expert warns

''The minister of finance has a big problem on his hands,'' Mintz, a business professor at the University of Toronto and former president of the C.D. Howe Institute, said.

''There is going to be tremendous pressure on the government to act EThis has been going on for too long as it is.

''There are huge conversions down the road that could easily happen. We have to ask ourselves if this is how we want to allow corporate Canada to organize itself.''

[sydney2]

Please correct me if I am wrong, but when the Corporations that convert to a trust reduce their tax base, yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov.

[pitz]

Please correct me if I am wrong, but when the Corporations that convert to a trust reduce their tax base, yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov.

Good point, and if the government is managing their finances and is able to post large surpluses without Telus/BCE paying taxes (right now, they are using up tax losses), does the Government really need the extra money?

Think of the windfall of riches the government will have next year, when Telus/BCE start paying taxes, or alternatively, their unitholders pay taxes on the cash 'income' distributions.

In fact, the government benefits significantly today because of the capital gains realization. They don't have to wait for the widows and orphans who own those stocks to die or sell. They get their CG tax money right now, up-front.

In short, I'm not convinced that the Government will seriously suffer any loss of revenues that cannot be easily compensated for. They really need to get their own financial house in order first before they start complaining about Corporate (or Trust) Canada.

p.s. sydney2, in case you're wondering, I don't mind my stuff being converted to trusts, but I am very annoyed when the market places irrationally high bids on my stocks/trusts, because it makes it very expensive for me to re-invest my dividends into quality companies.

[yielder]

Please correct me if I am wrong, but when the Corporations that convert to a trust reduce their tax base, yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov.

It's about a business model that is based on distributing all earnings beyond those needed for maintainance capital (and there are questions about whether enough is being retained even for that purpose). Growth and expansion is thus funded by a debt/equity/debt/equity/etc. (the old Loewen Group model) rather than from internal cash flow.

[sydney2]

Thank you both for your input and any further input that is forthcoming. I agree this business model is not an equal playing field for all business converts, some conversions are really a way for the business management group to get very rich and I wouldn't touch them with a ten foot pole.

I don't mind paying taxes on my distributions when I am receiving a relative 6 to 13% on some of these that I consider good or excellent companies that have good management teams in place and they are working very diligently to increase the overall success of their companies.
However diversification is everything in todays marketplace....

[Shakespeare]

yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov

However, many trusts are held in tax-exempt or tax-deferred entities, which represents a real current revenue loss. In addition, foreigners that hold royalty trusts pay federal tax but not provincial tax, so there is provincial revenue loss, mainly from Alberta.

The revenue loss, though, is likely less worrisome than the potential business model problem.

[twocentsworth]

Another point of view: If the trust market overall does tank and drop 25%, some of us won't lose a lot of sleep because we're UP over 50% from our entry point. We bought the darn things for future income, not capital gains. Didn't you?

[yielder]

Another point of view: If the trust market overall does tank and drop 25%, some of us won't lose a lot of sleep because we're UP over 50% from our entry point. We bought the darn things for future income, not capital gains. Didn't you?

Think about what might make prices drop 25%. Ottawa changing tax rules so that net after-tax yield drops? Distribution cuts? Higher interest rates?

Price declines AND lower gross income/net income. 50% gains can lull you to sleep/blind you to risk.

[scomac]

[url=http://www.globeinvestor.com/servlet/story/GAM.20061013.RMINTZ13/GIStory/]Analysts expect other firms to flock to the trust model now that it's been embraced by the likes of BCE, meaning Ottawa's corporate tax base is likely to continue eroding.

National Bank Financial chief economist Clément Gignac predicts it's only a matter of time now before Ottawa imposes a tax on income trusts. "Before the end of this decade, you will see income trust taxes because otherwise the federal government [finances] will go into the red," he says.[/url]

[kcowan]

Maybe they can shift their revenue burden to consumption taxes rather than the regressive income taxes.

[Shakespeare]

revenue burden to consumption taxes rather than the regressive income taxes

So which party just cut the GST?

[twocentsworth]

Point taken, yielder...BUT if my capital gains are all lost -- say a 50% drop which is likely -- and my yield drops from 9% to 7% (or 12% to 10% etc) is that going to drive me out of the trust market? Nope. What else is paying me 7% or more per year. The long strip bonds in my RRSP are close to that but they were bought ages ago. I bought the income trusts for income and plan on holding them long term. Should I sell everything now and guess what the future holds. I suppose I could. My crystal ball, however, is just as foggy as everyone else's. I'm currently stocking up on cash, including the rewards reaped from that sweet SMU deal, and awaiting some juicy negative news.

I currently have my full trust alotment and need to concentrate on dividend yielders next. Let the doom and gloom begin. The folks who are going to suffer in the coming (?) trust collapse are those who are playing them like stocks -- ie for capital gains, not income.

[kcowan]

revenue burden to consumption taxes rather than the regressive income taxes

So which party just cut the GST?

Yea I was hoping that was purely political (like when the Liberals promised to abolish it to get elected) to atone for Mulroney implementing it. There are lots of consumption taxes on alcohol, tobacco, autos, gasoline, maybe fast food...

[AltaRed]

revenue burden to consumption taxes rather than the regressive income taxes

So which party just cut the GST?

Yea I was hoping that was purely political (like when the Liberals promised to abolish it to get elected) to atone for Mulroney implementing it. There are lots of consumption taxes on alcohol, tobacco, autos, gasoline, maybe fast food...

And given the size of the surplus this year, there is speculation of another 1% cut announcement in the Feb 07 budget. I suspect that perhaps softening tax revenue increases over the next 3 months might put that on hold.

[lystgl]

Putting the U.S. deficit / debt aside for the moment, do you think they might be on to something? Reduce taxes to increase tax revenue? Reaganomics / Bushnomics? They apparently just set a tax collection record last month as it was the most tax ever collected in a period. Stephen Harper doesn't seem to think like previous politicians (that he has to reinvent the wheel) and has no qualms about taking something that works from someone or somewhere else and applying it here. Ain't common sense a wonderful thing?

[AltaRed]

Putting the U.S. deficit / debt aside for the moment, do you think they might be on to something? Reduce taxes to increase tax revenue? Reaganomics / Bushnomics? They apparently just set a tax collection record last month as it was the most tax ever collected in a period. Stephen Harper doesn't seem to think like previous politicians (that he has to reinvent the wheel) and has no qualms about taking something that works from someone or somewhere else and applying it here. Ain't common sense a wonderful thing?

I believe it is too early to tell whether this year's tax cuts have a Reaganomics impact on tax revenues this year. What is more likely is the huge step increase in federal tax revenues being generated out of Western Canada and primarily Alberta. Wages, employment and consumer spending is way up and O&G companies' tax bills are increasing by orders of magnitude (notwithstanding higher expenses). Most O&G companies have exhausted their tax pools in the pricing environment of the last 1-2 years.

[kcowan]

All of the tax windfall in BC this year was applied to the debt as that was the only legal action. They are conducting a survey this year so that they can arrange to spend it next year. Harper will not have the luxury of paying down that debt as long as he has to buy the votes from the opposition members.

[George$]

An interesting read on trusts in the G&M this morning
No zeal like the converted: The rise of the income trust
In part ...

Indeed, one of the reasons shareholders have gravitated toward trusts is that they function as a kind of a leash on executives bent on sacrificing upfront, predictable profits in their core business in favour of empire-building or diversification. Because trusts pay out the bulk of their cash to unitholders, they are forced, in essence, to ask permission from investors every time they want to raise money for a large acquisition.

"This is why I've owned trusts for 10 years," explained Sandy McIntyre, a trust proponent who is a senior vice-president at Sentry Select Capital Corp. "I lost faith in the capability of Canadian management to allocate the capital trapped in Canadian companies half a generation ago. They've done a truly pathetic job."
Since 1980, Mr. McIntyre pointed out, the reported profit from Toronto Stock Exchange-listed companies has increased just 5.7 per cent, while the growth among Standard & Poor's 500-stock index companies is only marginally better, at 6.2 per cent: not exactly stellar returns. One of the main reasons for these meagre returns, he suggests, is executives misspending capital.

"The amount of savings of the Canadian population that has been destroyed in ill-advised investment and M&A activity by Canadian management is criminal."

Of course, not everyone is sold on this line of thinking. Detractors argue that these structures deprive the government of corporate tax revenue, and that by imposing a "leash" on executives, Canada could be headed for a massive productivity problem. Economic nationalists also worry that stricter controls on deal making could deprive the country of the chance to create global champions.

Brian Gibson, a senior vice-president at the $96-billion Ontario Teachers Pension Plan, insists that capital allocation is a bigger concern than the perceived threat to productivity. Indeed, sources said Teachers, one of Canada's most powerful investors, had been quietly persuading BCE to consider the trust model for the past year.

"The biggest problem we have is poor reinvestment of capital," he said. "And there are a lot of businesses that are in a corporate structure that have not done well, and it has to do with the management not being very good at reinvesting the capital in new things. The advantage of a trust structure is that the bulk of the earnings and cash flow are paid out, and if management wants to seek an acquisition or something like that, they in effect have to ask the shareholders for the capital."

Leslie Lundquist, a trust expert and portfolio manager at Bissett Investment Management in Calgary, said she has faith in Canadian executives and is sympathetic to their plight. Yet she also understands why so many investors would prefer to have management under a firmer rein.

Company CEOs mispending assets? Heaven forbid. Not possible if they truly warrant those huge compensation packages.

[Oliver]

yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov

However, many trusts are held in tax-exempt or tax-deferred entities, which represents a real current revenue loss. In addition, foreigners that hold royalty trusts pay federal tax but not provincial tax, so there is provincial revenue loss, mainly from Alberta.

The revenue loss, though, is likely less worrisome than the potential business model problem.

US tax payers are subject to a 15% tax on the total distribution, including any return of capital. As you pointed out there is a provincial revenue loss.

Oliver

[YogiBear]

yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov

However, many trusts are held in tax-exempt or tax-deferred entities, which represents a real current revenue loss. In addition, foreigners that hold royalty trusts pay federal tax but not provincial tax, so there is provincial revenue loss, mainly from Alberta.

The revenue loss, though, is likely less worrisome than the potential business model problem.

US tax payers are subject to a 15% tax on the total distribution, including any return of capital. As you pointed out there is a provincial revenue loss. [emphasis added by Yogi]

Only if the trusts are not held by US tax payers in US tax deferred/ exempt registered retirement accounts. If they are, then according to the Canada - US Tax Treaty there is no withholding tax applied to their distributions (just as Canadian taxpayers are exempt from US withholding tax on dividends from US corporations if the shares are held in an RRSP, for example).

To the extent, therefore, that many US investors do hold trusts in their registered retirement accounts, that could result in substantial tax leakage, since there is no current revenue loss- the revenue is lost for good: unlike Canadian holders, the income from those US registered accounts will not be subject to Canadian tax when it is withdrawn.

[Oliver]

yours and mine increases as we pay tax on the distributions, so it is either them or us, the tax is still getting paid to the Gov

However, many trusts are held in tax-exempt or tax-deferred entities, which represents a real current revenue loss. In addition, foreigners that hold royalty trusts pay federal tax but not provincial tax, so there is provincial revenue loss, mainly from Alberta.

The revenue loss, though, is likely less worrisome than the potential business model problem.

US tax payers are subject to a 15% tax on the total distribution, including any return of capital. As you pointed out there is a provincial revenue loss. [emphasis added by Yogi]

Only if the trusts are not held by US tax payers in US tax deferred/ exempt registered retirement accounts. If they are, then according to the Canada - US Tax Treaty there is no withholding tax applied to their distributions (just as Canadian taxpayers are exempt from US withholding tax on dividends from US corporations if the shares are held in an RRSP, for example).

To the extent, therefore, that many US investors do hold trusts in their registered retirement accounts, that could result in substantial tax leakage, since there is no current revenue loss- the revenue is lost for good: unlike Canadian holders, the income from those US registered accounts will not be subject to Canadian tax when it is withdrawn.

What you describe was true, but the rules have changed. The 15% tax/withholding now applies to trust distributions in an Individual Retirement Account (IRA). I know TD Waterhouse USA/ TD Ameritrade takes out the 15%. A quick google search did not reveal give me an authoritative source for this treatment. However, I did run across the info below.

http://www.providentenergy.com/company/about/faqs.html
2. Why is the 15 percent Canadian withholding tax being applied to the distributions I receive from units I hold within my Individual Retirement Account (IRA)?

The Government of Canada changed the rules pertaining to non-resident withholding taxes. Effective January 1, 2005, the entire amount of distributions paid to U.S. unitholders is subject to a non-refundable 15 percent withholding tax. This tax applies to units held in both taxable and tax-exempt accounts such as IRAs.

http://www.enerplus.com/investor_information/tax_info.shtml
Where units are held in an IRA, the same withholding taxes apply. In an IRA, the withholding tax is not creditable for U.S. tax purposes.

[YogiBear]

What you describe was true, but the rules have changed. The 15% tax/withholding now applies to trust distributions in an Individual Retirement Account (IRA). I know TD Waterhouse USA/ TD Ameritrade takes out the 15%. A quick google search did not reveal give me an authoritative source for this treatment.

Ruddy tax law- as soon as you think you understand a little how it works, they go and change it on you ...

Thank you for updating me on current practice!

I think- emphasis on "think", not "know"- that the recent change you note is due to CRA tightening up its application of Canada - US Tax Treaty derived rules- IOW, it reflects a policy decision to interpret and apply the Treaty-based exemptions literally, instead of more broadly, rather than a change in the legal rules as such:

Exempt Organizations

[snip]

2. Subject to the provisions of paragraph 3, income referred to in Articles X (Dividends) and XI (Interest) derived by:

(a) a trust, company, organization or other arrangement that is a resident of a Contracting State, generally exempt from income taxation in a taxable year in that State and operated exclusively to administer or provide pension, retirement or employee benefits; or

(b) a trust, company, organization or other arrangement that is a resident of a Contracting State, generally exempt from income taxation in a taxable year in that State and operated exclusively to earn income for the benefit of an organization referred to in subparagraph (a);

shall be exempt from income taxation in that taxable year in the other Contracting State. [emphasis added]

This is the RRSP/ IRA/ other tax-deferred retirement account exemption- note, however, that the exemption refers specifically to "income referred to in Articles X (Dividends) and XI (Interest)". The problem, I think, is that Canadian income trust distributions are now being characterized by CRA as "Other Income" referred to in Article XXII, and thus not falling within the tax exemption in Article XXI:

Other Income

1. Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State, except that if such income arises in the other Contracting State it may also be taxed in that other State.

2. To the extent that income distributed by an estate or trust is subject to the provisions of paragraph 1, then, notwithstanding such provisions, income distributed by an estate or trust which is a resident of a Contracting State to a resident of the other Contracting State who is a beneficiary of the estate or trust may be taxed in the first-mentioned State and according to the laws of that State, but the tax so charged shall not exceed 15 per cent of the gross amount of the income ... [emphasis added]

This policy change in application was no doubt driven precisely by the fear of foreseeable cross-border tax leakage as a result of the increasing amount of Canadian income trusts being held in US tax-deferred/ exempt retirement accounts.

(N.B.: I'm not a tax practitioner, and the above is not tax advice- consult a tax professional for your own situation ...)

[Shakespeare]

Seniors' group wants trust conversions halted

“A lot of seniors are being taken in on this because they are not getting the yields that they thought they were going to get,” Art Field, the organization's president, said in an interview from Ottawa. “We want regulations to police the income trust area, to police it if people are losing their money. There are regulators for all kind of things, but there don't seem to be any for income trusts.”

Uh, Art, that's why they sell GICs.

I'd quote more, but I want to have lunch in a little while....

[YogiBear]

Seniors' group wants trust conversions halted

... “There are regulators for all kind of things, but there don't seem to be any for income trusts.”

[emphasis added by Yogi]

Gee, that seems a bit of a rude way to refer to the XSCs in this country ...

[jiHymas]

Seniors' group wants trust conversions halted

“A lot of seniors are being taken in on this because they are not getting the yields that they thought they were going to get,” Art Field, the organization's president, said in an interview from Ottawa. “We want regulations to police the income trust area, to police it if people are losing their money. There are regulators for all kind of things, but there don't seem to be any for income trusts.”

I visited their website. It's a very polite website.

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