The last nail

Zoomer | March 17th, 2010

Although it was clear a couple of years ago that the Conservatives were not going to retreat from their campaign to destroy the income trusts sector, a few people never gave up hope that somehow the government could be persuaded to change its mind or at least take steps to soften the blow.

This budget was the last chance for Finance Minister Jim Flaherty to do that. As any realistic person who has watched this story evolve could have predicted, he did nothing. The last faint hope vanished when his silence drove the final nail into the trusts’ coffin.

Well, that’s not quite true. He did do something, just not what the diehards wanted. The Finance Minister closed a loophole that made it possible for trusts to convert to corporations while gaining significant tax breaks in the process. More on that in a moment.

What he did not do was introduce a program along the lines of the so-called “Marshall Plan” that would have effectively grandfathered some trusts. The idea had been aggressively promoted by trust advocacy groups and by some respected journalists like Diane Francis of The National Post.

Nor did Mr. Flaherty do anything to ease the impact of the trusts’ demise on registered plans. Distributions from trust units (or their shares after they convert to corporations) that are paid into RRSPs, RRIFs, TFSAs, etc. will not be eligible for the dividend tax credit (DTC). So those investors will bear the full brunt of the new tax regime. By contrast, units or shares in non-registered accounts will benefit from the tax benefits of the DTC. In some cases investors may actually end up with a higher after-tax return as a result.

The one change the Finance Minister did introduce was to eliminate the use of tax-loss conversion strategies which some trusts had used to reduce the taxes they would have to pay after becoming corporations. However, he did not make the change retroactive, thereby eliciting sighs of relief from companies like Colabor Group, Algonquin Power, and Bonterra Energy, all of which were identified by RBC Capital Markets as among the seven who had made use of these financial manoeuvres. Also, Mr. Flaherty will allow any similar transactions which have already been agreed to in writing to proceed.

The strategy involves a trust purchasing a company with large available tax write-offs and then using those tax assets to maintain distributions after converting to a corporation. Mr. Flaherty had been asked about this several weeks ago and his response at the time raised concerns that the government would go after trusts that had already made use of the loophole. That won’t happen, unless of course government auditors find some evidence of wrongdoing down the road. But any trusts that had been contemplating using this strategy to protect unitholders have now been stymied.

This budget should bring an end to the trust debate. In my view, the policy was flawed from the outset and more should have and could have been done to protect unitholders. They did nothing wrong and had every right to expect trusts would continue to do business as usual on the basis of a specific Conservative Party promise.

But, as I have said several times before, we have to live in the real world and that means a financial system without income trusts. Anyone looking for above-average yields needs to shift their attention to high-dividend stocks and REITs.

Gordon Pape’s latest book is The Ultimate TFSA Guide: Strategies for Building a Tax-Free Fortune, published by Penguin Group Canada. It can be ordered at 28 per cent off the suggested retail price here.