A professional engineer working with a major gas producer writes: Imagine a nation whose citizens took pride in owning dynamic businesses that formed a significant part of its own economy - businesses dedicated to running efficiently and giving the resulting profits back to the people: A people who enjoyed a level of income from investment that afforded them a decent standard of living, replacing or supplementing their employment income, and topping up social security and pension income from their Government as they entered retirement. Until recently, Canada was this nation…

And he concludes a well-informed letter to suggest that the Canadian, ”government has just launched a devastating attack on the standard living and quality of life after retirement of most Canadians. The brunt of the attack is borne immediately by senior citizens, and those who for various and valid reasons cannot or choose not to enter the workforce. For the rest of us the effect will be delayed, but should start becoming apparent when the November financial statements arrive.

In summary, income trusts do not represent a significant tax issue to the government. More income generally means more income tax! More income in the hands of individual Canadians means a higher standard of living...and isn’t raising the standard of living of everyone really what it’s all about?

The minority Conservative government led by Stephen Harper has committed a major mistake with far reaching consequences for all of us by moving to tax income trusts. Our attention is being diverted from the faulty logic used to justify the action by a barrage of propaganda. The Harper government has not only declared war on income trusts, but on the concept of trust itself.

On Halloween night 2006, the Government suddenly broke a key promise from the last election campaign. Even though the promise never to tax income trusts was a significant reason for the Conservative victory in that election, it was broken. This was a stab in the back not only to voters, but to investors, retired people, and people outside the workforce that were depending on the regular distributions that income trusts provide.

No consultation was undertaken before wiping tens of billions from the pension plans, investment accounts, and retirement nest eggs of the people of Canada.  Apparently any action, no matter how ill informed, is justified as long as it is taken decisively. What is unfortunate is that Canadians have not been fully informed about the role that income trusts play in the economy, and the role they should have played in our collective financial future.

The Conservative party propaganda is that trusts are corporations that avoid paying taxes, and that the tax burden must be shifted from the individual onto the corporations.  This argument is likely music to the ears of many, but it is false.  The key point, rarely mentioned, is that trusts do not pay taxes because they literally pay their profits to their owners, the people who invest in trust units.  Trusts are similar to private companies where profits accrue to the owners, but in this case the owners are the Canadian public.  Tax on the income earned by trusts does get paid, but is paid by the trust unit owners, and at their personal marginal rate of taxes on income, usually a higher percentage than taxes on corporate dividend income.

The idea that tax revenue is somehow lost due to income trusts being owned by Canadians is a myth. Trust unit holders want the trusts to continue to provide them with income so they can pay the income tax, even at the marginal 39% to 46% rates.  We do not want to “shift the tax burden back to the corporations”, because in doing so our income is itself being shifted back to the corporations.

Anything that prevents income trusts from continuing their important role in the economy is rightly a serious concern for everyone, including the Government, but the full story of income trusts is not widely understood.  The remainder of this article is dedicated to presenting the full argument for income trusts to the Canadian public.

Most of us have probably wondered about the impact that the baby boom will have on the economy.  By one definition, the first boomer retired in 2002, that being 65 years after 1937, when the birth rate first began to exceed the death rate in Canada.  A prudent question for economists and business people alike to ask is: “What will the upcoming wave of retiring people need?” Will it be retirement residences or vacation condos, travel services or golf courses, hobby supplies or health care?  The answer is – yes! But first and foremost they will need to replace what they lose when they retire, a steady income. Income trusts could be considered an essential service to the public in that they efficiently provide that essential item. 

The wave of baby boomers requiring income will roll over us in the next ten to twenty years, and the demand for income producing investments will surge.  Conservatives, and their leaders in Government, are normally considered to be astute business people, but in this case they have completely missed this classic convergence of demand for, and supply of, income. The Government is now actively choking off the potential income supply by punitive measures against the income trust sector. From the economic perspective, the proposed actions of this Government could not be more ill timed, nor more oblivious to demographic realities.

Ordinary Canadians who purchased income trust units directly, and indirectly through pension funds and mutual funds that made the investments on our behalf by the financial industry, have now seen the rules changed arbitrarily, for reasons that do not make sense. Income trusts are nothing more or less than corporations that pay a large percentage of their profits to their owners, and trust units are nothing more or less than stocks that pay a high dividend.  High dividend stocks have historically enjoyed great popularity in the stock market, with good reason, as will next be explained.

If you want to own a business, buy an income trust.  They put the average investor in the closest position possible to actually owning a company, because the trust unit holder has discretionary use of most of the profit just like an owner of a private business.  Legendary investor Warren Buffett prefers to keep the cashflow from his companies for his own discretionary re-investment, rather than paying it out as dividends. Business ownership has its benefits, and these can accrue to anyone through income trust unit ownership.

If for example, you like A&W root beer, and perhaps would be interested in owning a franchise, the simplest approach is to buy units in A&W Royalties Income Fund on the stock exchange, in the same way you would by any listed security.  With the resulting distributions you can choose to pay your bills, re-invest anywhere in the economy, or go to A&W and enjoy a burger and a root beer.  In this way you actually get a sense that you are an owner in the business – a sense made tangible by the monthly cash distribution that you receive and may spend according to your own choices. Certainly shares in regular corporations provide a similar experience, but often not the income – for corporations dividends are optional, for trusts distributions are the reason for existence.

The portions of profit that are not paid out by trusts are re-invested in the underlying business, resulting in growth and an increased capacity to supply income.  An examination of the record on existing trusts shows that most are actively expanding their businesses, increasing their efficiency, and doing their utmost to provide stable distributions.  A small fraction of the existing trusts have failed to live up to investor expectations, but that is also true of corporations such as Nortel.

Income trusts are arguably better-run businesses than their corporate equivalents. One reason for this is that corporate dividends are optional. However, income trusts are accountable to produce distributions monthly, and stable distributions are essential. Unit holders scrutinize the performance of trusts regularly, and pressure to run the business in the most rigorously efficient manner is considerable. Well-run trusts are therefore extremely careful with their capital expenditure and operating decisions, a fact that can be confirmed by talking to the large number of Canadians currently employed in the income trust sector. Employees of income trusts take pride in the tangible benefits they generate for unit holders.

The idea that income trusts do not re-invest and grow their businesses is a myth.  Anyone living in Canada over the past few years should have noticed a lot of income trust companies in action.  The above-mentioned A&W Royalties Income Fund is a good example - new outlets have appeared across Canada, and distributions keep increasing. A&W is only one of hundreds of income trusts now contributing to the economy.  Most people would be surprised to learn that many businesses they are familiar with are income trusts. Companies such as Sleep Country Canada Income Fund, Boston Pizza Royalties Income Fund, Jazz Air Income Fund, Big Rock Brewery Income Trust, Canada Cartage Diversified Income Fund are but a few of the excellent businesses in the income trust spectrum that runs the gamut from restaurants, transportation, manufacturing, energy, real estate, and many services.

We are arguably losing our cultural identity and control of our economy, and income trusts could be one cornerstone of the solution. We should be concerned about the increasing levels of foreign ownership of the Canadian economy. The sale of the Hudson’s Bay Company has to be the cruelest blow to anyone with a sense of our history as a nation. Companies like Inco, La Senza, and many others have recently been sold. Arguably, people are less likely to sell an investment that provides consistent income.  Chances are that if HBC had been a trust, people would have had more pride of ownership, and it would not have been so easily sold. Most retirees want income without having to reduce their capital nest egg.

The United States and Australia have eliminated their trust sectors, and this is sometimes used to justify the Conservative position on the issue. I view this as meaning that Canada still has a unique advantage that those nations have foregone. Unfortunate for them, and since when do we make our decisions based on what other nations are doing versus what is best for Canada?

As a result of the Harper decision, retirement for all Canadians just got a lot more difficult. “Do the math”, as they say. Consider that income trusts yield 4% to 40%, with a median near 10%.  Thus an income of $20,000 per year can be obtained through income trusts by investing roughly $200,000. If the income trust structure is eliminated, the alternative will be to invest in GICs, bonds, or corporate stocks paying a dividend, however, the yield from these vehicles is typically in the 1% to 4% range. An income of $20,000 from investments yielding 3% requires $666,666 in capital invested.  Although $20,000 is a modest level of income, the average Canadian senior, single parent, disabled, or unemployed person is less likely to possess the investment capital required, even if they sell or mortgage their home.

Thus the Harper government has just launched a devastating attack on the standard living and quality of life after retirement of most Canadians. The brunt of the attack is borne immediately by senior citizens, and those who for various and valid reasons cannot or choose not to enter the workforce. For the rest of us the effect will be delayed, but should start becoming apparent when the November financial statements arrive.

In summary, income trusts do not represent a significant tax issue to the government. More income generally means more income tax! More income in the hands of individual Canadians means a higher standard of living...and isn’t raising the standard of living of everyone really what it’s all about?

Mr. Ron Forth, P.Eng.