With the Ontario Budget on the table, there may be motivation for some dividend-paying companies with public equities to convert their shares into income trust units...for the moment.

According to executives like Bill Holland at CI Financial, for example, it can all hinge on whether provincial governments coordinate tax policy with the federal government. And the Ontario government has delayed going along with the dividend tax policy proposal announced by the Liberal government.  Ontario officials want to wait to hear the budget from the new Conservative government.

So the situation on taxes and motivation to convert company to trust might change. Mr.Holland has provided numbers to reporters indicating that total tax on dividends from his company’s common shares (CIX on the TSX), would be 50% to if held in the hands of those in the highest tax brackets.  The total tax on distributions of an income trust would be 4% less according to such focused caclulations.  What is not shown is whether the base assumptions are correct, nor the full range of assumptions required to understand how much tax is paid on conversion.

Mr. Holland talks much like the owners of Precision Drilling before they converted from shares to trusts.  Many quotes from Holland sound like he is begrudging the “need” to convert in order to remain competitive in capital markets and save those few percentage points in tax for investors in his company, like him.  For years, Halland has been saying that every company should convert into an income trust if the government leaves the tax situation as it is.

If the reluctance for CI Financial is similar to the sentiment for Precision Drilling insiders then any move to convert will “force” insiders to revalue their bonus payment plan and cash out on conversion.  Shareholders will be asked to pay off the “reluctant” owners and managers for the right to cash distributions via an income trust.

In fact it is a significant issue for companies to convert into an income trust so managers are reluctant.  The trust structure itself reorients the business structure to put returns into the full ownership of unit holders.  Yes, there are ways for trusts to leave control and rights in the hands of insiders, like they exist within corporations. But trusts exist within a different set of laws than corporations so that unit holders are deemed owners of the returns for tax and other purposes.

There is mighty motivation for corporate leaders to avoid conversion.  So many more companies do not convert and have not converted.  That is despite Mr. Holland suggesting that every company should convert.  And most notably, he has avoided leading CI Financial through a conversion.  After all, conversion would change the reins and the way he could hold them.

If CI Financial was so concerned about delivering returns to unit holders other than insiders and concerned about adding 4% in returns to those high tax bracket individuals who might (not) miss that little difference, there is plent that CI Financial could do make it happen. If the company managed its internal finances and public communications differently, they could demonstrate more of a financial democracy for owners other than insiders. 

But why would these executives, bank or other highly rewarded executives really want to democratize their ownership?  When a company is closely held, there is no need to address the interests or concerns of outside owners.  There is not as much influence in these companies for private hedge funds or large fund holders.  So relatively closely held companies avoid the kind of trust conversion push given to Cinram, for example.

So much of the current rhetoric is a bit misleading for the general public.  According to statements like those from Mr. Holland, share holder rights are being damaged by poor tax policy.  And now that provincial governments are hesitating to complete the steps required to fulfill the dividend tax policy promise from the federal government, influential owners like Mr. Holland are protesting to the government.

What is being said now by company officials in the media and behind closed doors is exactly the same as what was said before the Department of Finance initiated a public consultation on flow through entities like income trusts.

But after threatening to put new taxes on income trusts, corporate interests were appeased without putting new taxes on millions of smaller owners holding income trust units.

In November 2005, the Federal Government proposed minimizing dual taxation on dividends, after considering whether new taxes should be added to income trusts.  As we recall, the issue was charactized to say that companies are taxed before paying dividends to shareholders.  And shareholders are provided some dividend tax credit.  But in the case of income trusts, income to the trust is flowed through to the unit holder who is responsible for paying the entire tax on that income.

There was great debate about the net tax effect of income trust taxes at personal rates from the perpsective of corporate taxes alone and with a more comprehensive assessment of overall tax revenues from corporate and individuals.

What was known for sure was that for the Federal tax policy to reduce taxes to taxable corporations, the federal government required coordinated income tax policy at the provincial level.  Whether that policy is a “no go” or just slow, it’s not happening with the recent budget from the Ontario government.

As a result, some companies seeking to simply cut the tax bill on their payouts, may consider conversion of their shares into the trust structure.  If the company is taxable, then that conversion will cost the company money in legal fees and accounting advisory services.

As important, the conversion of shares to trust units will given our tax collectors opportunity to tax the company on signficant gains held within the company, at the time of conversion.

It is no surprise that the tax policy debate is refuelled by corporate leaders who argue that there is no fair or balanced “playing field” for taxable corporations.  They’ll talk again about wanting “tax neutral” policies.  They’ll say they “don’t want to have to convert” to deliver value to their investors.

And they’ll beg the questions about why they, as corporate leaders, can not create corporate value for shareholders more than they are now able to do. It need not be a question of ability. It could be a question of self-motivation and willingness to “share” in new ways, in trust.

The iTrust Institute was intiated by investors and participants from all sides of the market to explore the relative net benefit that results from the trust structure and from equities. There is ongoing confirmation that much work remains.