Tax policy concerns persist for investors as provincial governments delay in supporting the Department of Finance proposition that dividend taxes be reduced on common equity issues. And the new Conservative government sees the federal coffers as draining with such tax reductions as GST.  The lines of contention go a step further than that, however, as pending trust conversions appear to hurt provincial tax revenues.

Business Trust Example

Case in point: Aliant telecommunications business will be merged into the looming Bell Canada income trust spin-off of land phone lines.

Bob Howse, editor-in-chief of The Chronicle Herald in Nova Scotia, notes that Aliant is a major phone operator in the Atlantic region and a “giant” cash generator. It’s CEO Jay Forbes says that the company is “ideally suited for an income trust...because it provides “stable and predictable cash flows.”

Income trusts don’t pay corporate income tax. Their cash distributions are only taxed in the hands of the unit holders.

The problem as Howse describes it is that Alliant paid $116 million in income tax in 2005. And that tax will, with trust conversion, be only be recouped by governments from individual trust owners.  So there is concern about how the breakdown of federal and provincial income taxes will appear after the trust conversion. 

Nova Scotia is losing corporate tax as Alliant becomes a trust.  And the province only regains personal income tax to the extent that unit holders of the new trust actually live in Nova Scotia. Given the population distribution across Canada, it is unlikely that provincial taxes in this relatively small provinces will remain as high as they are now as the local company becomes part of a Canadian income trust.  Most unit holders likely reside outside the province.

Mr. Howse also points out that there is consideration to be given to the growth trajectory of companies being merged into the pending new trust.  In the case of Aliant, it has a fast-growing business in Atlantic Canada which it is “giving up...in return for Bell’s much larger, but declining, wireline business in rural Quebec and Ontario.”

He asks, “Is this old-lamps-for-new good for Nova Scotia? The province should be trying to find out the impact on investment. If the logic of the trust is to pay out most of its cash (outside the region) and reinvest little here, how will this impact the local economy?”

To explore the tax questions, he goes deep into the numbers in an attempt to assess the specific damage being done on the regional economy and provincial tax revenues.  Howse speculates about the detailed results of the Aliant merger with Bell and the transformation of the tax base from partically corporate tax into fully taxable trust unit holders.

The real answers, however, more generally reside in consideration of the location of populations, the proportion who are investors and the differences in tax rates by province. 

On this we note that, if provincial tax authorities go along with the federal proposal to reduce corporate taxes on dividends then one wonders: Does the location and tax status of share holders will become as relevant a concern for provincial governments as those considerations appear now in regard to income trust owners?  Will provincial governments demand the same kind of restriction on security ownership that the federal government uses to limit the distribution “leak” to foreign investors?

The frontier for battle over taxes in Canada has been and will remain along the lines over which the interests of federal and provincial authorities conflict.

Matter of Location, Population, Growth and Energy

Many anticipate that, as growth of the Albertan economy exceeds that of other provinces, people—potential and likely trust owners—are moving to Alberta.  Attractive provinces like Alberta will make an increasing proportion of tax revenue from personal income taxes charged to unit holders of trusts that generate their cash flow from other regions.

If we consider this possibility in context of a global economy, we realize that oil is the driving factor.  As Alberta generates increasing royalties from energy production for distribution to a global market place, provincial government income is rising.  In fact, some analysts like Jeffrey Rubin at CIBC suggest that it is very likely that Alberta will cut personal income taxes to attract employees to fill jobs being created in the province. With rising energy prices, the provincial growth in royalty revenues year over year is enough to more than pay for all personal income taxes in the province.

Look back at the Aliant merger and trust conversion, we see that trust unit holders living in Alberta could become relative winners due to their savings on taxable income.  Theoretically, people will use their income to invest in that provincial economy, just as the growing economy needs them to invest.

But then we have to ask about the relative attractiveness of various investment options, including one trust versus another. How will the growth trajectory for cash flow from outdated telephone lines compare to the growth trajectory for oil and gas energy trusts?  Over the long run, investors—particularly in growing Alberta—might invest in staid telephone systems.  But that would be a minor diversification from their primary interest: Fast growing cash flow and a good life in Alberta.

To compete for taxable income, provinces will have to set tax rates to counterbalance economic growth requirements. The most attractive province will be the one with low tax rates or the offering of an effectively tax-free-zone.  The low cost provincial government (or high tax earner) will set the rules of competition through its tax policy as it affects income earners and population size and wealth across Canada. 

Provinces with a population and service overhead representing the greatest need for income will not survive in this national competition. But some would say that is what federalism is all about. Losing provinces will slip away unless the Federal government does something more to transfer from the wealthy individuals to give to the less fortunate.

This is an environment in which tax rates and policy will need to change.  It is not so much a problem with trusts themselves.  It is a problem that reflects the growing dominance of global markets and commodity pricing along with the connection of international financial markets. 

Corporate taxes in Canada will be earned by governments when they increase the tax on truly profitable and global companies, such as the banks with international operations.  But that’s not likely to happen anytime soon.  And with trade agreements and bank operations the way they are now, bank profits are being made specifically on services geared to helping major investors earn cash from Canadian business while avoiding Canadian and other taxes altogether.

Except for the wealthy few who might already have offshore tax avoidance schemes, the coming economic and tax turmoil will be painful.

What’s the Message in the Trusty Messenger

Trusts are not the problem.  Trusts are merely the tangible manifestation of an increasingly global and sophisticated securities market and increasingly international investment community.

One fun solution: Alberta could consider all members of global society to be its residential population, in theory.  Tax income could be passed back to everyone.  And if pipe dreams can come true in a land with cross-country gaslines, $10 million in tax rebates per year could be given to every individual in the free world along with free set-up of a Swiss bank account.

Or, people could be given the option of living off the land and sea while tending to a wheat farm or wind farm on some ocean shore somewhere, backed up with Canadian-class public health care.

Trusts are not the problem or solution for public officials who need to negotiate a very challenging environment to set tax policy, national and provincial rates and incentives.  Detailed financial calculations are useless in the context of the global economy.

Federal and provincial authorities as well as Canadians at all levels, need to combine their collective intelligence to consider how best to survive, if not thrive, while growing a healthy society for Canadians to live in the changing global economy.