OPEN LETTER To Members and Clerk of the Finance Committee

Thank you for helping to make the preliminary study of income trusts happen and allow for public participation.  Canadians appreciate the process as some small way to rebuild trust in policy-makers in a situation where it has been terribly broken by tax and equity policy that defied past promises. 

We observe that your valiant actions to make public debate open for public observation continue to be seen by the public as you move behind closed doors on an issue critical to all Canadians: Stage three in preliminary consideration of income trust taxes and rules.

People appreciate that in your next steps:

Your considerations will require intelligence and a lot of courage to work with civil servants and do the right thing on income trusts for the future of Canadian markets, the economy and society.

You are fighting an uphill battle because, despite the fiscal surplus in Canada, you are dealing with principles that may well show Canada to be in a moral and globally competitive deficit. The current Conservative and prior Liberal Minister of Finance destroyed social capital and damaged public trust of policy makers. Tax policies changed without reason or public understanding. Yet trust remains necessary for healthy participation in open markets and democratic society.

In a public poll the results of which have now been view by than 15,000 interested investors over 80 days starting November 15, 2006, 525 respondents to the statement, “New taxes on trusts win my vote for the Conservatives next election”, a whopping 87% said that they will definitely not vote for the Conservatives. Another 4% said that they never vote for the conservatives anyways.

Of potentially greater interest to other Parties, another 3% said that they “Don’t know: No Party is Trust Worthy.

Dealing with the income trust issue may be difficult. You may want to push it off your agenda, but do so at risk of silently killing political aspirations for all parties and further destroying social capital as well as Canadian leadership in global markets of the 21’st century.

What Canadians Saw and Heard in Testimony in the Public Hearings
The number of witnesses that appeared before the Finance Committee was relatively small compared to the extraordinary number of people requesting to testify.  You and the public heard testimony and receipt public Briefs that showed:

(1) A range of pro- and anti-trust proponents, experts and lobby groups seemed to share a common understanding of several key points:

* There is need for change in the Canadian tax system, perhaps calling for a complete overhaul to eliminate double taxation;

* Federal-provincial tax policy, programs and transfer funding policies need to better recognize provincial requirements for funding;

* Better market policy, regulation and enforcement is needed to protect investors and principles of market efficiency from dishonest or misleading sales efforts, self-serving brokerage services and inappropriate public offerings of public securities of any and all forms.

(2) The Department of Finance in relation to the Minister, Jim Flaherty who, together seemed to be proven either mistaken or dishonest in statements about tax loss.  They have been questioned about the methodology for calculation tax losses and have had independent economists apply those methodologies in the context of existing legislation and real tax department numbers to show that:

* Income trust tax losses are either less than calculated, by a factor of 1/32 on a moving basis; or

* Income trusts generate more positive tax flows for government than if the same companies had not formed income trusts;

* Critical assumptions in Department calculations were too narrowly defined. But even if accepted as given, were unrealistic as representing full corporate tax rates instead of the fraction of corporate rates truly paid by companies. For example, companies in the oil and gas sector that constitute traditional parallels to the largest sector within the income trust market, actually pay an average of 7% in corporate tax rather than full corporate rates;

* During the period of growth in income trusts for which individuals pay all tax due from the business, Canada Revenue has experience fast increasing tax revenues even from investors due to gains on Registered Retirement accounts in addition to increasing corporate and other income taxes.

(3) The Minister of Finance, Jim Flaherty testified that income trusts can not be allowed to exist because he thinks that:

* It is wrong that company directors be pressured by company owners to understand how money is being reinvested and if it is not being reinvested then that it be paid as a return to tax-paying investors.

* Canada should not follow or mimic policy of other countries and, for example, should not allow MLP flow-through entities like those that replaced trusts in the United States.  Yet the Minister says that he is getting rid of trusts because the Americans did that, in his theory.  And he is allowing for REITs because other markets around the world are embracing such flow-through entities.

(4) The Governor of the Bank of Canada, David Dodge testified that:

* The official position of the Bank</b> is that income trusts contribute to market efficiency and provide benefits to Canadian investors as a form of asset diversification. Furthermore, Mr. Dodge acknowledges that it is not the role of the Bank of Canada, so him as its head, to make comment on tax policy.

* In a summary of personal opinion and in regard to which he was evidently mistaken and, as a result, absurdly misleading: He suggested that “something had to be done” about income trusts because Canadians do not want them in our future if it depends on innovation as companies with flow-through securities can not retain earnings so can not be innovative.

* Mr. Dodge failed to remember or honor the words of his own speeches in which he said productivity and growth relates to the efficient allocation of capital, particularly through public markets, and that hoarding of cash by traditional corporations only diminishes Canadian economic capacities.  He failed on the public occasion of income trusts to uphold his own basic principles for market efficiency whereby investment follows innovation as great ideas attract capital. In reasonable contrast to Mr. Dodge’s informal testimony, there is nothing to stop companies from growing assets and investor equity in a trust. Income trusts have proven that if investors can rely on public securities for returns (as Mr. Flaherty seems to propose is not the policy regime he prefers) then investors see and make use of opportunity to efficiently allocate capital across the broadest range of potential options through public capital markets.

(5) Income trusts are neither all good nor all bad, but they are fundamentally better for Canada and investors than reported by analysis undertaking skewed or too narrowly defined analysis. In 2006 we know that:

* 88% of flow-through entities had positive net earnings in the traditional definition of such; and that:

* For every company to cut-back cash distribution, there were more than 3 companies that increased payouts.

* Three quarters of income trusts have either stable or growing cash distributions and have greater cash flow from continuing operations than the amount of cash they distribute to investors.

* More than a dozen companies are growing assets based on internally funded research and development efforts in a positive way unparalleled by any traditional equity traded on the TSX.

(6) Income trusts are clearly misunderstood by many investors and politicians, but that does not diminish their existing and potential positive merit. Annual studies by Merrill Lynch show that a vast majority of sophisticated investors around the world – along with Canadians—seek both flow-through entities and positive returns on investment. Flow-through entities other than REITs are less familiar to Canadian and foreign investors that REITs.  But that is no reason to eliminate securities that are not REITs. Flow-through securities and the market is unique because it is a valuable world-class leader.

Clear Implication of the Hearings:

Mr. Flaherty has made statements that ground him in both flawed calculations and theory opposed to efficient capital markets as well as diminishing of investor rights. He is therefore, opposed to both the Bank of Canada stance over time and the conceptual basis on which Mr. Dodge explains the imperatives of the Bank of Canada and its policies shaped to protect and grow the Canadian economy.

Despite hasty and limited media reports of news out of context, the public can clearly see that Mr. Dodge has made statements that show him as merely supporting his employer’s Minister of Finance, but has done so in an unofficial and personal capacity that ensures that any misinformation is readily quoted for consumption by the Canadian public.

Social and Economic Imperative:

The tax-paying public and market participants including productivity and growth proponents view this income trust issue as important. People are not stupid or lazily forgetting:

In 2006 and on an on-going basis without government remedy, Jim Flaherty destroyed $20 billion in the tax base with a view to destroying another $200 billion. He caused the Canadian dollar to drop significantly when he imposed punitive tax on new income trust owners and added 31% in taxes to tax-paying owners of trusts starting in 2011.  Furthermore, equity growth restrictions that require special case-by-case administration of policies make restrictive policies the policy of special interests and taxes unconstitutional.

In 2005, Ralph Goodale destroyed social capital by opening public consultation and then undermining the process by changing working tax policy when he eliminated advance tax rulings on income trusts. Public certainty about the integrity and consistency of policy was damaged despite the ultimate decision considering expert input, to ensure tax parity between trusts and companies by introducing an enhanced dividend tax credit.

When the Opposition joined with the Liberals to support their decision in 2005, and now with Opposition joined with the Conservatives in 2006, particularly following many years of back and forth on income trust restrictions, Party members proved that that are willing to play chicken with the markets and with investor savings and garner attention by focusing on the relatively small but fastest growing market sector, flow-through entities. But willingness is not the same as correctness.

The income trust tax has potentially negative impact on the current and future economy of Canada.

Extension of the introduction of taxes from 4 years to 10 may help in a political process if it’s necessary to do the right thing. But it’s much better to do the right thing without tinkering with elements of a flawed set of tax and equity rules:

The tax directly destroys asset value for those tax payers and so Canadian tax coffers.

Tinkering does not diminish the discriminatory nature of a tax that has been placed as an overcharge on those individual Canadian tax payers who chose to invest in securities that actually pay returns.

Delaying a flawed policy does not fix it as an ill-informed policy that turns our markets into the domain of special corporate interests and insider elite that wants to tap investor capital without taking responsibility for returns.

Obvious Questions Remaining for your Consideration:

The public is grateful to those Members of Parliament and particularly Finance Committee members who enabled public debate. Furthermore, the public has called upon your do the right thing and either keep the income trust debate open, or overturn the unfair taxes and plans to turn market policy into the policy of special interests.

Canadians appear to be asking fundamental questions about our government:

* Who is willing to stand up to take real leadership on a position of integrity and strength and allow Canadians market leadership?

* Who wants to be seen to be standing up for both investors and the efficient allocation of capital through public markets in a way necessary for productive and growth in the Canadian market and economy?

Summary

Many look forward to your answer.

It is not easy politically, but you and your colleagues have clear and informed alternatives with which you can fix the income trust tax fallacies.

Many people are appreciative of your efforts to create and support the hearings as they have made the facts obvious as well as the bad behavior of those attempting to misinform Canadians.

More Canadians have been hurt and have been enraged by the tax rules than you may know. In fact, we found that the number of witnesses of the hearings is larger than you may now think.  And it will grow over time if politicians fail to act in a decisive and honest manner.

You have a preliminary opportunity and the immediate ability to protect Canadians from policy seen as unfair and politicians seen as disinterested in stable policy.

You have the potential to ensure investors with demonstrated interest in paying taxes are paid due returns on investment, not punished for risking their savings in Canadian securities in order to earn fair returns.

The interests of the Institute are non partisan.  But we can not help but to observe that your constitutents feel they too have alternatives in their decisions about giving you the power to do the right thing now and again in the future.

I hope that this helps inform your decision and next steps.

Sincerely,

Leslie Hayman
President, iTrustInstitute
850-36 Toronto St.
Toronto ON M5C 2C5