Rebottling the genie

The Globe and Mail Report on Business recently published a first-rate series on the income trusts debate which looked at the issues from all sides. In case you missed it, here are the main points that stood out for me.

Ottawa is dead serious. The assault on the trust sector is not window-dressing. According to The Globe, the Prime Minister himself is seriously concerned and has given instructions to Finance to do something to stem the tide. However, no one can predict with any certainty what actions will result, nor the time frame the process will cover. In fact, it may suit the government’s purpose to let the uncertainty persist, at least until after the next election.

The Liberals have blundered. The government has mishandled this file on every level and now risks paying a stiff political price. Reading The Globe’s series, I marvelled at the seeming obliviousness of the Finance Department to the whole trust issue until it had become a runaway growth industry. I was also mildly surprised at the apparent ignorance of federal politicians at the extent to which many retirees have come to depend on income from t trusts to maintain their standard of living. I suspected this was the case – the remark by Finance Minister Ralph Goodale that reactions received by his office were 75 per cent in favour of his move was a tip-off. But I had not realized just how out of touch he is with ordinary Canadians on this issue.

Other jurisdictions have succeeded. In one article, The Globe looked at precedents in other countries and reported how Australia and the U.S. nipped their fledgling trust industries in the bud. In both countries, business trusts were the target — real estate and energy trusts were relatively unaffected. Both countries moved to tax business trusts in the same way as corporations and both gave existing business trusts a time limit to convert to corporate status. In Australia it was three years, in the U.S. it was 10 years.

Our genie will be hard to rebottle. Both Australia and the U.S. acted relatively quickly to restrict the growth of trusts. Australia’s first effort to stop the expansion came in 1981 and was followed by more draconian legislation in 1985. That was 20 years ago! The U.S. moved soon after that, in 1987.

Income trusts already existed in Canada at that time but no one in Ottawa was fussed by them. The warning signs and the initiatives taken in Canberra and Washington were blithely ignored. Now the genie is out of the bottle here and the Liberals will pay a heavy price if they try to put it back in.

Think about it. We now have some 200 income trusts in Canada. Their total market capitalization is variously estimated at between $170 and $200 billion. They are about to be integrated into the S&P/TSX Composite Index. Plus, they form the backbone of tens of thousands of retiree investment portfolios – and that may be an underestimate.

By waiting so long to tackle this file, the Liberals risk throwing our financial markets into chaos (there is already widespread uncertainty), damaging Canada’s reputation as a dependable place to do business, and alienating a significant number of senior voters. Talk about your rock and hard place!

After The Globe’s series appeared, I re-read the Finance Department’s consultation paper on FTEs (flow-through entities). A paragraph that I had skimmed over before caught my attention. In it, Finance comments that Canada “seems to be in the unique position of having experienced such rapid growth with some of these structures in recent years”. In trying to explain why this happened, the paper notes that one of the key factors may be “that the corporate and personal income tax systems are fully integrated in Australia”. In other words, they have no double-taxation of corporate profits.

Could this be a subtle signal that this approach is high on Mr. Goodale’s short list of solutions? We can only hope! It would certainly be the least damaging route out of the quagmire.