Trust tax under fire as drain on revenue
Trust tax under fire as drain on revenue
Resulting takeovers could cost Ottawa as much as it hoped to recoup, critics say
The Globe and Mail
April 9, 2007
OTTAWA -- The rash of recent income trust takeovers that critics blame on the Harper government's trust levy will cost Ottawa tens of millions of dollars in annual lost tax revenue, Bay Street investment experts say.
That's tax revenue that would have been paid by trust unitholders and will now be lost to tax avoidance by predominantly foreign entities that have snapped up most of the trusts in the last five months.
It's a sign of how misguided the income trust tax was, critics say, arguing that the levy sold by Ottawa as a solution to tax leakage is actually causing its own bleed of revenue from federal coffers.
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.
That's because most of the 11 trust buyouts set in motion since Oct. 31 are being, or have been, orchestrated by entities that won't end up paying much Canadian tax, including foreign private equity, foreign multinationals and domestic private equity.
These can avoid paying taxes on profit generated by trusts purchased by deducting the interest on debt used to acquire the businesses, which can wipe out taxable income.
Mr. McIntyre's estimate includes $60-million in lost tax revenue, as well as $9.4-million in deferred taxes: levies that will go unpaid until some indefinite later date. This second category is important because federal Finance Minister Jim Flaherty has made it clear he considers deferred taxes to be tax leakage.
Mr. McIntyre's not counting an additional two trust buyouts because they were set in motion before the Oct. 31 trust tax last fall.
Looking ahead, the problem for Ottawa could grow much worse if present trends continue, Mr. McIntyre says, where the hungriest appetite for Canadian income trusts is among entities that will pay few Canadian taxes.
Each 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, he estimates.
This rule of thumb means it's not inconceivable that, down the road, Ottawa could stand to lose as much tax revenue from trust takeovers as it was trying to recoup in the name of "tax fairness" through the surprise trust levy, Mr. McIntyre says.
"If so-called tax fairness was intended to accelerate the sale of Canadian companies to foreign entities, then it is a success," Mr. McIntyre said. "If it was intended to increase Canadian tax revenues, it is a failure."
Mr. Flaherty justified the 31.5-per-cent trust tax by saying it was necessary to stem tax avoidance by trust investors that the Finance Department had estimated was at least $500-million a year.
It would only take slightly more than 15 per cent of the trust sector to be bought out by foreign private equity, and non-Canadian firms before Ottawa was losing annual tax revenue equivalent to what it said eluded its grasp before the trust tax.
The hefty trust levy applies to new trusts this year and existing trusts in 2011. The measure put downward pressure on income trust market values, increasing the incentive for outside buyers to scoop them up. It also made it harder for these businesses to gain access to more capital, leaving them underfunded and in need of equity.
"We had in income trusts a made-in-Canada solution to funding small- and mid-sized businesses that worked for both investors and the companies," Mr. McIntyre said. "Now as a result of so-called tax fairness we stand to lose both the ownership and the tax revenue."
A veteran Bay Street investment analyst, whose firm would not let him be identified, estimates the annual tax leakage as a result of the spate of recent trust takeovers alone is $130-million, somewhat higher than Mr. McIntyre's calculations.
This second analyst's figures forecast that Ottawa would lose $4.2-billion in annual tax revenue if the entire trust sector was taken over by investors that match the profile of trust purchases to date since Oct. 31.
Recent income-trust takeovers
Announced deals in which the buyer faces a lighter tax load in Canada:
Target Class of buyer
Halterm Income Fund Australian private equity
Lakeport Brewing Income Fund foreign corporation
Norcast Income Fund Swiss private equity
Entertainment One Income Fund U.K. private equity
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
Gateway Casinos Australian private equity
Calpine Power Income Fund U.S. hedge fund
SOURCE: SANDY McINTYRE, SENTRY SELECT