No doubt, trust conversions will remain popular among business owners including professional and hedge fund managers due to tax related interests. But analysis might best address real and compelling tax concerns.

As income trust structures provide business the legal means to transfer tax burdens to owners, a liability is taken from assets in the market so market prices naturally rise. As a result, professional outside money managers argue that trust agreements give company owners the control they deserve. Flow-through entities can focus public company managers on the most profitable, less speculative uses for cash while ensuring owners are paid returns.

Single taxation is more efficient than double taxation for both government administration of revenues and for efficient financial planning. The recent agreement by Ottawa with Ontario to reduce the filing of corporate tax returns to a single form submitted to Revenue Canada provides evidence that Federal and Provincial tax authorities recognize the means and merits of coordinated action and rational processes.

In the case of BCE taxation, the company faces a large tax “overhang” and has the prospect of paying tax for the first time in coming years. Conversion into a flow-through entity will have tax implications and trigger a large tax bill for investors. Some suggest that, especially because BCE is widely held with a wide range of investors involved, it can make greatest sense for the company to give owners an ability to manage their finances including the responsibility for handling emerging tax liabilities in the context of their own affairs.

What about the income “lost” due to delayed taxation as a result of registered retirement accounts? Studies that emerged during the 2005 Finance Consultation suggest that whatever corporate tax is missed by Revenue Canada when BCE becomes a trust, federal coffers may be more than made up for by personal income tax now and fully taxable retirement account withdrawals later if only the government allowed the market to grow in value as its participants expect that it can.

On average, approximately two-thirds of distributions generated by business trusts are considered fully taxable business or foreign income.  But it depends on the individual income trust. And when real estate trusts or energy producers are considered, then depreciation and other tax credits reduce the cost of capital for tax purposes.  Yet many investors hold income trusts of all kinds inside their registered retirement accounts to avoid tax on the cash yield. They too forget both the potential capital gain on growing units held and the looming full taxation of those gains upon withdrawal from their retirement account.

Whereas the government provides a 50% tax credit on capital gains for assets held outside a registered account, capital gains made on growing trusts are deemed fully taxable income when cashed out of an RRSP or RRIF. 

These factors must therefore be considered by individual investors when planning their financial affairs. But they also have implications related to tax risk and political policy.

In principal: By deferring trust taxes, the government is effectively reinvesting tax revenues, along with Canadians, in Canadian business during a period of Federal Budget surplus.  Some suggest that, in effect, the successful conversion of BCE into a trust provides the government with a relatively low cost social security net for the many people who invest in BCE. Yet, there is certainty about a pending revenue boon for federal coffers. As the adage goes, “you can only be sure of two things: death and taxes”.

Media hype about narrowly defined tax risk can spur price volatility for all kinds of flow-through entities.

Some suggest that the real risk of fast and coordinated federal and provincial action on tax concerns remains relatively small in the broader context of federal-provincial relations. The differentiation of one type of flow-through entity from another for purposes of adding tax would find little political favor in corporate circles.  The political risk of taxing income trusts may be too great for a minority government touting tax reductions to the Canadian population. As important, policy change remains difficult given the complexity of the environment while many appreciate the potential merits of a consistent and coherent tax system.

Meaningful tax reform is possible.  All that it would require is significant time, thoughtful and coordinated considerations beyond quick and narrow calculations associated with the purported risks in BCE conversion.

Call for Constructive Discussion

The health and credibility of local markets and the Canadian economy in a global market depends on fully informed policy-making and leadership in establishing integrated tax policy in, first and foremost, a stable policy regime.

Public desire for reasoned debate and a demonstration of leadership did not prevent a group from performing a very political stunt for the sake of media attention at the federal Liberal leadership convention. A bikini-clad woman walked through the crowd with a sign stating two opposing views. On one side it said “Income Trusts Bad”. And on the other it suggested participants not forget the interests of small investors.

So it is with continued intent to host meaningful discussion that iTrust Institute was established and brought to life in 2006.  Unlike trade associations or the companies involved, we can provide a non-partisan floor for open discussion and can truly welcome participants from all sides of the market. Please let us know your thoughts.

RE BCE situation, also see prior articles:

BCE Proposes Joining the Maturing Trust Market

Size Matters

Trust Market Stengthened

Learning in 2006 Since Department of Finance Consultation