Deloitte has written a newsletter to suggest that, “Since the fateful announcement on October 31, 2006, there have been 40 announced or completed trust buyouts versus 14 deals over the equivalent year-ago period. We have seen the trust population of 256 shrink by more than 15% to 215. Market conditions such as foreign exchange fluctuations and commodity prices also had an impact on this decline, but the trust tax announcement was certainly the catalyst for the sell-off.”

The report goes to show how policy objectives had opposite and negative effects on Canadians.

Deloitte had some expectation of this, as could have the government. The firm wrote on that, “In December 2006, Deloitte hosted an event for trustees and management of income trusts, and their investors, bankers and advisors. The participants were asked to estimate the number of trusts that would still exist at the end of 2010 – and 87% responded “fewer than 100.”

A decline of this magnitude is inline with reality and translates into almost 40 trusts per year.

“Of the 40 deals that originated since October 31, 2006, 31 have closed and 9 are pending completion. Many other trusts have been targeted (see the hit list of what’s left to buy) during this period, with at least one publicly disclosing a takeover attempt that was subsequently terminated. The figures are:
-- 25 business trusts have been taken over, 14 by foreigners and six by domestic private equity.
-- Six energy trusts have been taken over, three private equity (two foreigners).
-- Five REITs have been bought out, two foreign and one private equity.
-- Four power and pipelines trusts have been scooped up , two by foreign private equity.

In total 40 takeouts, 20 foreign and 24 private equity neither of which will pay taxes possibly ever.

“Energy trust activity remained consistent year over year, although there were two foreign buyouts as opposed to exclusively trust mergers prior to the announcement. The REIT and Power & pipelines sectors experienced an increase in interest by foreign buyers and Canadian pension funds. The characteristics of both of these sectors lend well to the infrastructure-based investing that many pension funds and foreign buyers are looking for, and should result in continued buyout activity.”

“Buyers in the 40 announced deals were equally split between strategic and private equity, as well as between domestic and foreign. But in terms of tax revenue for the Canadian government, the news was not so balanced: 70% of the purchasers are tax exempt pension/private equity funds or foreign buyers who pay little if any tax in this country.

“What structures were buyers using to acquire trusts? In 22 of the 40 transactions, trust units were acquired; in the other 18, the purchaser acquired shares of subsidiary corporations, trusts or partnerships. The method of acquisition has significant implications for the buyer, trustees and unitholders. The entity left “holding the bag” has to bear the cost and risk associated with the wind-up of the engineered trust. A caveat for future purchasers: all parties should consider the implications of a proposed structure when assessing the value and risk of an offer for a trust.

“Based on our involvement with over 20 income trust buyout transactions in the past year we believe that the buyout momentum will continue. The current M&A slowdown is primarily driven by “mega” transactions exceeding $1 billion in size. The income trust market, particularly the business trust segment, is comprised of medium-sized companies that are ideal for financial and strategic buyers. Clearly, volatility in the income trust sector is far from over.”

Not a single objective announced by Flaherty and Harper was achieved:

-- The tax burden has not been shifted off families. Some $1.372 billion in taxable distributions will now be used to make interest payments on loans to acquire these income trusts. No taxation as a result.

-- Bringing Canada’s approach to taxes in line with other countries. Wrong. This is now a made-in-Canada botch up. REITs have been hampered by new rules, unlike the U.S., and energy trusts have been severely wounded, unlike the U.S.

Deloitte’s report highlighted the renewed calls by upset income trust investors for an inquiry or—as Deloitte has already done—a panel of experts. The conclusion is that the income trust rules have hurt the market and tax base.

Diane Francis provided insight in here Finanical Post column, stating that, “Deputy Finance Minister Mark Carney, under questioning in Parliament last week on his “qualifications” to be the Bank of Canada’s Governor, said he convinced the Tories to destroy income trusts, costing two million investors $35 billion in one year. The policy’s purpose? To stop tax leakage...The policy’s result? It has done the opposite and created multi-billion dollar tax leakage.”

Francis suggested that, “So far, 40 of 259 income trusts have been taken out, permanently wiping away $1.372 billion in annual taxable distributions. Their new owners have spent $39 billion acquiring them and will divert the $1.372 billion to make interest payments on the loans raised to acquire the trusts. No tax on that. More will follow until none are left.

And furthermore, “The $39 billion has also contributed toward the over-priced Canadian dollar because most of the buyers were foreigners.”

She said, “Everybody knew this would happen except Carney, Flaherty and Harper who trotted out the tax leakage as an issue. A new Deloitte Canada report last week provides a depressing, predictable summary of events. Also see the numbers for yourself...But instead of a pink slip, Carney is promoted.”

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On Friday June 22, the Canadian Senate approved Bill C-52, which includes the trust tax rules that impose more than a 31% tax on distributions to unit holders effective in 2011. It fulfills the Conservative intentions to tax trust owners as announced on October 31, 2006 in a surprise reversal of Party policy and public promises.

Not all political parties are committed to letting the Bill stand as law.  But change will only come with new results in the next election.

Not all financial experts see a clear way to enact the law in 4 years time.  And many of the income trust executives in Canada, particularly in the energy sector, see need to lie down in their fight against the “Tax Fairness Rules”.

The tax has been described as onerous and blamed for hurting investors by destroying their sources of income, particularly important for retirees.  The tax has been blamed for the sell-off of public companies into the hands of private equity as well as the sell-off of Canadian based businesses into foreign hands.  More than two dozen income trusts have either been sold or have engaged in an exploration of sales opportunities.

Passage of C-52 is marked in time by the nearly simultaneous announcement that 182-year-old ED Smith, the jam maker in Ontario had been sold to an American pickle maker.  Bruce Smith, the company CFO is quoted by John Partridge in the Globe & Mail, as saying, “I would say it’s highly unlikely this process would have taken place without the change in the legislation. It created challenges for us to raise capital and was one of the leading reasons we got into this strategic review process.”

The Minister of Finance, Jim Flaherty, has repeatedly denied that he or his government should take blame for the perceived negative consequences of their legislation. 

Meantime, some Ottawa insiders report that further market-controlling legislation may be in the works to clamp down on foreign sell-offs. However, that is not saying much. As the trust tax news announcement came as such a surprise with such devastating effects on market prices, market participants are living in “disaster mode” so that nothing can really be a surprise. 

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Liberal Leader Stephane Dion has said that the changes to the tax system introduced by the Conservative government has threatened the competitive ability of Canadian businesses.  Specifically, new taxes on income trust distributions have resulted in more than a dozen foreign takeover attempts in less than half a year. The trust tax, along with other government policies could threaten Canada’s economic sovereignty, according to Mr. Dion.

He is proposing specific remedies to what he describes as mistakes.

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When the Minister of Finance announced a new form of tax on Canadian income trust owners, Jim Flaherty caused a stir as many finance professionals anticipated that a consequence of his policy would be the buyout of income trusts by foreign buyers. The implication of that occurrence was that Canadians federal tax revenues would shrink with loss of taxable Canadian ownership. 

They and others observed that if the intent of Mr. Flaherty’s policy was to end the income trust market, because he deemed trusts somehow “bad”, then his policy was not about making policy to protect Canadians from tax losses at all.  His policy was focused on “putting an end” to a growing public market and so was intended to destroy a tax once worth $200 billion with annual income streams of close to $20 billion that was ultimately taxable.

National newspapers are beginning to report on the current situation in the Canadian trust market to show that such anticipation of outcome has already been seen in measurable reality. This is news in so far as, with rare exception, the national newspapers have doggedly reported the Conservative Party line on the justification for tax policy and frustrated the interests of informed citizens and professionals in the process.

The tide may have turned towards factual reporting. And the news confirms the problem that Minister Flaherty has created for Canadians with his policies. For example, the Globe & Mail reporter, Steven Chase, has just reported that “Resulting takeovers could cost Ottawa as much as it hoped to recoup, critics say”.

He reported that, “Ottawa will see as much as $73.2-million in annual tax revenue drained from its coffers as a result of 11 trust takeovers since the trust levy was announced on Halloween last year, calculates Sandy McIntyre, a senior vice-president at Sentry Select Capital Corp.” And he goes on to show the basis for Mr. McIntyre’s observations which include trust buyouts announced only following the tax policy news as if a consequence of the policy:

TARGET - FOREIGN BUYER
Halterm Income Fund - Australian private equity
Lakeport Brewing Income Fund - foreign company
Norcast Income Fund - Swiss private equity
Entertainment One Income Fund - U.K. private equity firm
Amtelecom Income Fund - Canadian income trust
Great Lakes Carbon Income Fund - U.S. private equity
Associated Brands Income Fund - Canadian private equity
KCP Income Fund - U.S. private equity group
Gateway Casinos - Australian private equity firm
Calpine Power Income Fund - U.S. hedge fund

Mr. McIntyre is reported to estimate that the tax losses include both an explicit loss of $60-million in tax revenues and another $9.4-million in deferred taxes that remain “unpaid until some indefinite later date” so fall within Minister Flaherty’s definition of “tax leakage”.

The facts according to Mr. McIntyre suggest that an “additional 5 per cent of the existing income trust sector snapped up by such investors would cost Ottawa another $165-million in annual lost revenue” and take approximately “15 per cent of the trust sector to be bought out” by foreign firms “before Ottawa was losing annual tax revenue equivalent to what it said eluded its grasp before the trust tax.”

Numerous experts have been heard supporting Mr. McIntyre’s form of thinking.  And some suggested then and again now that his measures are still too conservative in favor of government tax policy working the way it was intended.

It is not news that many think that the 31.5% tax on income trust distributions and the stop to new equity issues will sap Canadian tax coffers rather than protect them as proposed as reason to add the new tax.

It is news that the proof of policy detractors’ arguments has now been reported in a clear way to the public.

Such useful measures of policy remains, however, in the business pages of major newspapers like the Globe & Mail. Members of the iTrust Institute suggest that Canadians might understand policy implications and be proud of their major news media at the point that such facts about tax losses caused by government policy are shown on the same front pages in which stories were placed to promote Conservative policy.

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Following its study of income trust taxes, the Finance Committee has released its report on findings and recommendations: “Taxing Income Trusts: Reconcilable or Irreconcilable Differences?” (PDF, 183 KB in printable format).  Two significant alternatives are offered to the pending 31.5% on distributions to income trust owners. The Committee is recommending in this report that change from the current tax scenario is essential.  The current policy was as “devastating” to Canadians as it was shocking in breaking a Conservative election promise.

Specifically, the paper proposes that either the 31.5% tax be reduced to 10% or the government should extend the tax-free period for trusts from 4 years to 10 years. These are two proposals previously announced as suggestions from the Opposition Liberal Party and Bloc Quebecois, respectively.

Overall, the report recognizes the Prime Minister Steven Harper’s Conservative government set tax policies hurt Canadians. In addition, the report calls for the government to release information to support its calculations of tax losses due to income trusts. During public hearings it became clear that Department of Finance officials may have made mistakes and that if they did then they “would not admit it”.  And public requests for background details garnered documents with blackened out statistics.

The report recognizes both direct testimony to the Committee through hearings, as well as written submissions including that from iTrust Institute.

While the report includes suggestion that remedies are required to reduce the impact of taxes on trusts, the report supports the notion of a moratorium on new trust issues.

Despite hearing the facts and concerns of Canadians and despite their participation in the Finance Committee, the Conservative Party and the NDP are rumoured to be making their own recommendations in a report.  The two parties are working together to suggest that trusts “are bad” and that tax on trusts is necessary and fair.  Neither group, however, seems able to follow-through on election promises and maintain economic protections for Canadians, let alone deliver policy that reduces tax on working or retired Canadians.

During public hearings on income trusts, the Finance Committee received testimony and submissions that suggested that the trusts tax was a tax on individual Canadians, despite Conservative suggestion that the tax was like a corporate tax on companies with trust issues.

The report says that, “It is imperative that a democratic government be as transparent as possible when levying a new tax so that it can be held to account by its citizens.”

The document further suggests that the members of parliament should be given opportunity to vote on the trust tax itself without mingling the vote with other proposed reductions in tax.