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Mythbusters

The Income Trust topic is filled with many myths and urban legends. Here we will dispel the top ten myths about income trusts. Please click on the myth to learn the Truth about Trusts.

Myth #1:

Myth #2:

Myth #3:

Myth #4:

Myth #5:

Myth #6:

Myth #7:

Myth #8:

Myth #9:

Myth #10:


Myth #1: Income Trusts cause tax leakage

Mythbuster #1: Income trusts do not cause tax leakage, the government's flawed analysis "causes" tax leakage

The term tax leakage is used to describe a situation in which it is believed that the Government of Canada collects fewer taxes from one form of business ownership structure relative to another form of business ownership structure. Many who oppose the income trust form of business ownership would like Canadians to believe that Income Trusts cause tax leakage when compared to corporations. Tax leakage has to be determined by looking at the taxes paid not just by the business itself but also the taxes paid by its owners on the distributions/dividends paid from the business to its owners (shareholders/unitholders).

On this basis income trusts do not cause tax leakage, rather it is the Department of Finance's analysis (which to date our Minister of Finance refuses to release to his fellow MP's or Canadians) that causes tax leakage, since this analysis completely ignores 31% of the good when it performs its good/bad analysis of Income Trusts relative to Corporations. The Department of Finance does not include the taxes (retirement taxes) that it receives on the 31% of Income Trusts that are held in retirement accounts (RRSPs and the like) in the false treatment of retirement accounts as being "tax exempt" Charities and not-for-profits are "tax exempt" , retirement accounts and RRSPs clearly are not "tax exempt".

All withdrawals from retirement accounts are taxed at the highest marginal rate of personal taxation, just like income from employment. In fact retirement income is the second largest source of personal income taxed by the Government, second only to income from employment. During 2004, the most recent year for which data is available, Canadians paid $9 billion in retirement taxes on $52 billion of retirement income. Retirement taxes are not tax exempt, but rather they are tax deferred. When comparing income trusts to corporations in its analysis, the Department of Finance is not even "internally consistent" in its treatment of deferred taxes. The deferred taxes paid by income trusts held in retirement accounts are totally ignored, whereas the deferred taxes paid by corporations are included.

This profound analytical bias by the Minister of Finance and the Department of Finance causes tax leakage. Income trusts do not cause tax leakage.

Finance Minister Flaherty needs to justify his actions. Tax leakage is a discernable fact. Canadians need facts not fiction. MPs need facts not fiction, before voting Flaherty's so called "Tax Fairness Plan" into law. If there is no tax leakage why are we doing this?

Canadians will lose an important investment choice for both today and the future. Canadians have sustained a loss in their hard earned savings of $35 billion as a sole consequence of Mr. Flaherty's actions. This is profoundly wrong. This can not be justified.

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Myth #2: "The government remains determined to end the tax-free status of income trusts."- Jim Flaherty in the Toronto Star November 29, 2006

Mythbuster #2: This is profoundly misleading, Flaherty will only tax public income trusts owned by average Canadians to the exclusion of trusts held by others.

This statement is at best only half true. It's what Mr. Flaherty isn't saying that you need to know.

What Mr. Flaherty is actually proposing to do in his so called "Tax Fairness Plan" is quite different from this statement in three very fundamental ways.

First, to suggest that Income Trusts do not pay taxes is fundamentally misleading, since trusts distribute all of their pre tax income to their unitholders, and the unitholders must in turn pay taxes at the highest levels of personal taxation on these distributions. This is unlike dividends paid by corporations which are tax at reduced levels of taxation this holds true whether the income trust is held inside or outside of an RRSP or some other retirement account. By properly looking at the overall tax collection base involved, businesses that organize as income trusts generate as much, and often more, taxes than the same business would generate if it were a corporation.

Second, Mr. Flaherty fails to point out that it is only public trusts, and public limited partnerships namely those income trusts and limited partnerships held by average Canadians, that he wants to shut down. His policy would leave fully intact the "tax free status" of private trusts, like those formed by wealthy Canadians to hold business interests and financial assets and other income generating investments. In addition Mr. Flaherty will preserve the "tax free status" of private income trusts held in large private and public pension funds, the benefits of which only accrue to those select Canadians that belong to these plans, including the members of Canada's civil service. Furthermore, his policy would only shut down public limited partnerships held by average Canadians. His policy would leave fully intact the tax free status of private limited partnerships, like those formed by major Canadian law firms, including his former law firm.

Third, Mr. Flaherty is not shutting down the ownership of real estate assets in public income trusts. Mr. Flaherty has conferred a special status on REITs, to the exclusion of all other asset classes such as oil and gas and business trusts. Is there some strategic importance to Canada associated with fixed real estate assets that do not apply to oil and gas assets and Canadian businesses that employ over 250,000 Canadians? REITs are not major employers and nor are they engines of economic growth and global competitiveness.

In conclusion, it is only the public ownership of businesses by the average Canadian that Mr. Flaherty wants to shut down. His motives have nothing to do with tax leakage or loss of tax revenues. Mr. Flaherty wants to shut down trusts for the narrow interests of select members of Corporate Canada, who for personal economic reasons are not well served by the ongoing existence of this new form of democratization in the public ownership of Canadian businesses.

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Myth #3: The sky is falling... the tax threat of BCE and Telus converting

Mythbuster #3: This is false, the reverse is true, BCE would have paid $2.6 billion more as an income trust than as a corporation.

The back to back announcement of conversions into income trusts by Telus (on September 5, 2006) and BCE (on October x, 2006) provided an excellent backdrop for Mr. Flaherty to shut down income trusts. The Finance Minister told Canadians that the conversions of Telus and BCE from the corporate model to the income trust model would threaten the very foundation of Canada's tax collection. When it was correctly pointed out at the time that neither Telus nor BCE had paid any corporate taxes for some time, we were assured by our Finance Minister that both of these companies were on the very verge of becoming taxable and these imminent taxes would be "lost". That was early November 2006. No less than six weeks later, we learn from a BCE press release that BCE was able to reconfigure their corporate structure such that they wouldn't pay any taxes whatsoever for 4 full years. Not long thereafter, Telus revealed that it wouldn't pay taxes for 2 full years. Given theses corporations adeptness at sheltering themselves from taxes so quickly, who is to say 4 years won't become 10 years and 2 years won't become 5? It's clear that our Finance Minister hasn't pursued this question. Leaving this conjecture aside, it is very revealing to calculate the actual amount of tax that was foregone by Ottawa as a result of Flaherty's standing in the way of BCE's and Telus's conversion into income trusts.

This is a very simple analysis to conduct. As you can see below, Ottawa would have collected $2.7 billion more in taxes from BCE over the next four years as an Income Trusts (relative to zero as the corporation it will remain) and $1.1 billion more in taxes from Telus over the next two years as an Income Trusts (relative to zero as the corporation it will remain) for a total loss in taxes of $3.8 billion.


BCE Ownership:15% foreign
35% Canadian tax deferred
50% Canadian taxable
Tax Rates:38% blended tax on income as per Department of Finance Consultation Study dated Sept 28, 2005
19% blended tax on dividends
Distributions on 900 mm shares outstanding Trust distribution rate:$2.55 per unit
Corporate dividend rate:$1.46 per share

Federal Taxes (including deferred taxes paid on retirement accounts):
BCE as an Income Trust:$793 million per year federal tax
BCE as a Corporation:$240 million per year federal tax
Foregone Federal taxes:$553 million per year
Foregone Taxes over BCE's 4 year corporate tax holiday:$2.2 billion
Foregone Capital Gain on Conversion to Trust:$428 million (based on $5.00/share gain)
Total Foregone BCE Taxes:$2.6 billion

Given that Canadians lost $35 billion in their hard earned savings as a sole result of Mr. Flaherty's so called Tax Fairness Plan, perhaps the loss of $2.6 billion in taxes is considered a mere drop in Ottawa's bucket. What happened to strengthening Canada's social security system for Canada's seniors? What became of avoiding the shifting of tax burden onto the shoulders of the average Canadian?

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Myth #4: "Ensuring that taxes are not unfairly shifted onto the shoulders of Canadian taxpayers"- Notice of Ways and Means Motion of November 2, 2006

Mythbuster #4: This is false. There is no shifting of tax burden taking place. Average Canadians suffer the most under Flaherty's tax.

This myth reads like a bad laundry detergent ad. Canadians demand truth in advertising, they shouldn't have to demand truth in legislation.

The central notion of Flaherty's policy is false. The alleged "shifting of tax burden" can only arise if there is tax leakage (see myth #1), since there is no tax leakage (see Mythbusters #1), then there can not be any tax shifting. If there is no tax shifting, why do we need Flaherty's so called "fairness" provisions?

Average Canadians are actually harmed in a significant way by Flaherty's policy. Unlike our elected politicians in Ottawa, 70% of Canadians are not members of defined benefit pension plans. These Canadians have to fend for themselves to provide retirement income. The growth in the "made in Canada" income trust market over the last ten years reflects the fact that many Canadians who want to provide for retirement income, found that income trusts were an attractive investment CHOICE well suited to this investment goal.

Flaherty's policy will eliminate this important investment choice which will make it increasingly difficult for the average Canadian to provide retirement income, thereby negatively affecting many Canadian's standard of retirement living and limiting their retirement alternatives.

In all walks of life, more choice is always preferred to less choice. To the extent that Ottawa's tax collection base is unaffected by the ongoing existence of income trusts as an investment choice, which it is, Canadians should be free to make their own investment choices in a manner that they, not Ottawa, feels best suits their investment needs.

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Myth #5: "Strengthening Canada's social security system for pensioners and seniors"- Notice of Ways and Means Motion of November 2, 2006

Mythbuster #5: This myth is false. The reverse is true. Pensioners and Seniors suffer the most under Flaherty's tax.

Again, this myth reads like a bad laundry detergent ad. Canadians demand truth in advertising, they shouldn't have to demand truth in legislation.

Our Finance Minister is falsely invoking the weakest segment of our society to advance his cause. Namely senior citizens. This is truly shameful. The alleged strengthening that Mr. Flaherty asserts will arise from his so called Tax Fairness Plan can only arise if there was something associated with the ongoing existence of income trusts that caused a weakness. Again we are back to the urban legend called tax leakage (see Myth#1). If there is no tax leakage (see Mythbuster #1) there can not be weakening. If there is no weakening, how can there be strengthening? If there is no strengthening, how can Mr. Flaherty's policy purport to help seniors and those saving for retirement?

The opposite is true. Canadian seniors and those saving for retirement are the ones most hurt by Flaherty's policy. Canadian seniors and those saving for retirement are the very Canadians who have been responsible for the growth in the income trust market over the last ten years to its present level of $200 billion. These are the very people who have sustained a combined loss in their hard earned savings of $35 billion. This $35 billion loss is a permanent loss and it is the sole consequence of Mr. Flaherty's so called Tax Fairness Plan.

It is these very people, and Canadians like them in years to come who will soon be denied this important investment choice by Mr. Flaherty. It is truly shameful that Mr. Flaherty twists the truth about the impact of his policy on these very people, seniors and those saving for retirement, when the exact opposite is plain for anyone to see.

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Myth #6: "Helping corporations make choices"- Notice of Ways and Means Motion of November 2, 2006

Mythbuster #6: This is false. Flaherty's tax policy takes important choices away. It eliminates an important retirement investment choice for Canadians. It eliminates choices for Canadian business.

This myth reads like a bad laundry detergent ad. Canadians demand truth in advertising, they shouldn't have to demand truth in legislation.

The word choice is a very evocative word, so it is no surprise that Mr. Flaherty wanted to invoke the concept of choice to sell Canadians on the merits of his so called Tax Fairness Plan. The only problem is that Mr. Flaherty's policy results in fewer choices than exist today. Fewer choices for Canadian businesses and fewer choices for Canadians seeking to provide retirement income and those saving for retirement.

The statement "helping corporations make choices" actually means nothing more than "forcing outcomes". Forcing outcomes can not be considered making choices. Under Flaherty's policy, businesses will no longer be able to organize themselves under the income trust structure that average Canadians saving for retirement found so attractive. Mr. Flaherty will only allow Canadians to invest in public companies that are corporations. This is a very desirable outcome for the many influential members of Corporate Canada who have the ear of Mr. Harper and Mr. Flaherty. In this respect the first part of the myth statement is true: "helping corporations". It's the rest of the statement and what it attempts to imply for the average Canadian that is not true.

Flaherty's policy is a policy of fewer choices for retirement income and reduced income during retirement. His policy will adversely affect 70% of all Canadians at some point in their lives. Meanwhile Mr. Flaherty has unlevelled the playing field between average Canadians and those, like members of the federal Civil Service, who are members of public pension plans. Under the rules devised by members of the federal Civil Service, their pension plans can invest in the tax and economic equivalent of today's public income trusts, but Canadians fending for their own retirement income can not.

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Myth #7: Income trusts are "not consistent with economic growth and competitiveness"- Notice of Ways and Means Motion of November 3, 2006

Statements of fact that are devoid of fact are nothing more than assertions. Often false assertions. As with the false assertion concerning tax leakage, Mr. Flaherty has provided no facts to support this claim that income trusts negatively affect economic growth and competitiveness. The reason he provides no such studies or analysis is because the opposite condition, namely that income trusts actually stimulate economic growth and competitiveness, is true.

Even the Governor of the Bank of Canada, David Dodge, made a statement to this effect on October 20, 2006, before he abruptly changed his tune immediately following Flaherty's Halloween announcement.

Free of political considerations at the time, Mr. Dodge stated on October 20, 2006 that:

"Evidence suggests that income trusts may enhance market completeness by providing diversification benefits to investors and a source of financing to firms that might not otherwise have had access to markets."

We need not rely on the Governor of the Bank of Canada to set us straight on the true economic impact of income trusts, as there are many credible studies that have looked into this issue at depth. These are all available in the Resource section of this website, please click on the following studies" to learn about the true economic impact of trusts on the Canadian economy.

Pricewaterhouse Cooper Financial Review of Income Trusts of December 2006

Canadian Energy Trusts study of December 2006

HLB Decisions Economic Study of October 2005

A final word from Darren Entwistle, CEO of Telus, who stated on October 19, 2006:

"I can tell you categorically that Telus' conversion to an income trust will add to our innovation, will add to our economy, will also drive greater competitiveness in our industry and a better quality of life for consumers because of investments."

Neither our Prime Minister or our Finance Minister have any business experience whatsoever, and yet they profess to have greater insight into the business dynamics of economic growth and competitiveness than senior Canadian business executives like Mr Entwistle.

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Myth #8: "Levelling the playing field between trusts and partnerships and corporations"- Notice of Ways and Means Motion of November 3, 2006

Mythbuster #8: Flaherty's tax will eliminate the more competitive cost of capital alternative to entrench the higher cost and less competitive alternative for the economic benefit of influential Canadians.

This is probably the most revealing and truthful statement in Flaherty's Notice of Ways and means Motion. However its no less troubling.

Flaherty considers that the best way to level the playing field for the benefit of corporations is not to have an opposing team on the playing field, namely income trusts. He considers this leveling the playing field. Because the average investing Canadian prefers the discipline of a business that pays monthly distributions under the income trust structure to that same business under the looser discipline of the corporate model, the law of supply and demand results in these businesses having a higher market value as an income trusts. This value enhancement has nothing to do with taxes, as many would like you to believe. How could it, when distributions from income trusts are taxed at the highest level of taxation, unlike dividends from corporations?

This value enhancement actually means that businesses who form themselves as income trusts have a resultant lower cost of capital than businesses formed as corporations. This cost of capital efficiency creates a valuation imperative for corporations to convert to the income trust structure. Many in Corporate Canada consider this an unwelcome imperative as their personal economic circumstances are not well served by conversion to an income trust or the ongoing existence of income trusts whose market presence creates a "valuation imperative".

Therefore, Flaherty's solution is to level the playing field by eliminating this source of "made in Canada capital" and leave behind the higher cost of capital alternative and eliminate the lower cost of capital alternative. This is progress? It's a good thing that man's evolution as a species wasn't governed by a similar logic. Obviously Mr. Flaherty is unconcerned by the competitiveness of Canadian companies in an ever increasingly global marketplace where cost of capital efficiencies attract greater investment and greater economic growth and prosperity for the countries in which they reside. The global competitiveness of Canadian businesses only affects issues like employment, standard of living, head office control, economic sovereignty, and the strength of Canada's social security system, to name a few.

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Myth #9: "Bringing Canada... back in line with other jurisdiction"- Notice of Ways and Means Motion of November 2, 2006

Mythbuster #9: This is an extremely over-simplistic approach to formulating important far reaching economic policy which affects Canada's economic sovereignty.

If its good for the US, it must be good for Canada. How many times have you heard that refrain before? Cherry picking selective economic policies of other countries are a dangerously simplistic approach to policy formation, without a complete understanding of the broader context in which those policies were formulated. Furthermore, simply because another country did something in the past doesn't mean they would do it again today.

Its hard to believe, on the surface, that a certain policy that the US adopted in 1987 is the best policy that Canada could adopt in 2006. The importance associated with saving for retirement, which Flaherty's policy profoundly negatively affects is quite different today than it was in 1987. The global competitiveness of business is a profoundly different issue today than it was in 1987. Canada has budget surpluses, the US does not. When is it ever a good policy to vaporize $35 billion in Canadian's hard earned savings and discourage foreign investment in Canada with policies whose consequences are all negative and therefore whimsical to global market participants?

Unlike the US, Canadians do not have near-alternative investments to fill the void left by Flaherty's elimination of the income trust investment choice. Income trusts were embraced by Canadians as an investment choice well suited to retirement planning. Unlike the US, Canada does not have alternative investment choices like Tax Free Municipal Bonds or the enormous US High Yield market to fall back on.

Despite the repeated condemnations of Mr. Harper and Mr. Flaherty that they do not want Canada to become a nation of "coupon clippers", the reality is that Canada has an aging population, and with 70% of Canadians not being members of a defined benefit pension plan, the need for retirement income will go on unabated. Canadians who are denied "made in Canada" income investment choices by their government will increasingly look to global markets to fill their investment needs. Markets close to home, like the US High Yield market will be the greatest beneficiaries of this inevitable "flight of Canadian investment capital". Canadians saving for retirement will now find themselves funding the growth and prosperity of US companies and the US economy.

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Myth #10: Canadian corporations pay taxes at the statutory taxation rate of 21% for non resource corporations and 25% for resource corporations.

Mythbuster #10: Statistics Canada tells us that Corporations on average only paid taxes at the rate of 6.2%, because of the many deductions available to corporations that are not available to income trusts or average Canadians.

Only Pollyanna could be expected to believe this myth.

Corporations have become very adept at minimizing the taxes they pay Ottawa. This is one of the main reasons so many are loath to give up the "proven" corporate structure. Just look at BCE. One minute we're told that BCE will be paying taxes as a corporation, and the next we learn that they have "reorganized" themselves such that they won't be paying any taxes for a full four years. In the corporate world, this is called a "tax holiday". When was the last time you took a tax holiday in Canada? As an income trust, all of BCE's pre tax earnings would have been taxable at the highest levels of taxation in the hands of its Canadian unitholders, starting from day one.

The most pervasive way in which corporations "shelter" themselves from the payment of taxes is through the universally widespread use of the corporate deductibility of interest. Unlike interest on your mortgage, corporations can deduct all their interest payments from taxable income. In doing so, corporations are paying interest with pre tax income. As a result, the debtholders who are being paid the interest, are receiving "income" that has not been taxed by Ottawa at the corporate level. Often these debtholders reside outside of Canada, and therefore Ottawa receives no taxes to speak of from this corporate "income". Under an income trust, all income is taxed by Ottawa.

As a result of the corporate deductibility of interest and other generous tax deductions afforded corporations (and not income trusts), the actual level of overall taxes paid by Canadian corporations is not the statutory rates of 21% for non resources companies and nor is it the 25% statutory rate for resource companies, but rather it is 6.2%, according to Statistics Canada for the year 2003 (Financial and taxation statistics for enterprises, 2003 - Catalogue no.61-219-XIE).

Its no wonder that many influential members of Corporate Canada are loath to give up their corporate model for the greater discipline of the Income Trust model, when all they actually pay in taxes on corporate earnings is 6.2% and when it is recognized that dividends from corporations are taxed at 67% of the level at which distributions from income trusts are taxed. The situation is actually worse than this, when it is also realized that two thirds of income trust distributions are interest which is taxable at the full personal income tax rate. In contrast, 72% of corporate income is capital gains, which are taxed at half the full personal tax rate.

Knowing this, it is not hard to understand why no one at the Department of Finance was willing to even speculate on October 27, 2006 (four days before Flaherty's announcement) about the "strange unexplained surge" in personal taxes paid during the first nine months of 2006.

This surge in personal taxes has been attributed to the taxes paid by Canadians on income from Income Trusts that had been previously taxed at corporate levels of taxation in prior tax years and before they converted to income trusts. This is according to a senior tax official at the time of the unexplained surge and now in private practice.

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