Wednesday, July 25, 2007

The smokescreen called tax leakage

Apart from Jack and Judy of the NDP, who does Flaherty and his desk jockeys in Ottawa think they’re fooling with this nonsensical argument of tax leakage? Income trusts are a closed system of taxation. It’s impossible to avoid paying taxes on income trust distributions, unless you want to start falsifying your personal tax returns. Meanwhile corporations are an open system of tax, where there are a litany of inefficiencies rampant in the system that allow for (yes) considerable tax leakage. For example, why do shareholders of BCE pay reduced dividend rates of taxation on the earnings of BCE that have never been taxed in the first place? Why are BCE’s interest payments taxed as interest and its dividends taxed as dividends when both are being serviced with BCE’s pre tax cash flow? This situation could never exist under the income trust model, but is rampant throughout the corporate world. Want another example: Telus.

Yes, Mrs. Smith, the income trust issue has nothing to do with stemming the loss of taxes. Tax leakage is an outright falsehood being perpetrated by those with a grander vision and more devious purpose in mind. These purposes are being aided and abetted by many in Canada’s corporately owned media. The grander vision at play is controlling people’s capital. This is a struggle over who owns the cash flow of Canadian companies, the shareholders or the managers (CEOs and Boards of Directors). These folks would prefer to see all Canadian investors own common shares, since common shares are only a surrogate form of ownership that entitles the holder to virtually nothing in the way of direct economic entitlement and creates nothing in the way of enforceable obligations on the part of the issuer. The shareholders own a stock certificate of a given company, not its cash flow. That’s why private equity has abounded, since private equity acquires undervalued stock certificates in sufficiently large numbers, that it is entitled to the company’s cash flow, whereupon the managers of the company run it as if they were shareholders. And to think this all happens without the need for stock options or the favourable tax treatment (50% off) of stock option gains that Canada’s tax code has lavished on the employment income of the least entitled (as if they had capital at risk).

This access to cash flow on the part of the average Canadian investor is the insidious and pernicious thing about income trusts that Canada’s New Government was so intent on correcting for the benefit of the uber powerful, that they were prepared to lie to an entire nation to do so. They then attempted to justify the original lie by lying about the pretense for having lied in the first place by suggesting that the conversion of BCE and Telus would result in a loss of corporate taxes, and yet neither BCE or Telus were paying corporate taxes at the time, not to mention the future. God forbid that investors should feel that they are entitled to monthly distributions and the distribution of 95% (after capital expenditures to ensure the ongoing viability and strength of the company) of the companies cash flow that they “own”, in the truest sense of the word. Who do these average Canadians think they are, Cerberus, KKR. Ontario Teachers? We’ll teach them a thing or two, as we control their money, not them.

Let’s be honest, these uber powerful people built this country, or so they would have themselves believe. They learned marketing from Henry Ford who proclaimed that you can have a Ford car in any colour you want, provided it’s black. So too with this generation of corporate handlers, you can invest in the Canadian equity markets, provided it’s common shares. How long do you suppose it was after Henry Ford made that proud proclamation about the vast array of colours that his product was available in before he actually offered his cars in a kaleidoscope of colours? That’s right, two years and two and a half months. And why do you suppose he did it. Goodness of heart? No he did it because he came to the late realization that by not doing so he was losing sales to the upstart Chevrolet and Dodge Brothers. As a result, Henry Ford built the “big three”. Henry Ford got a rude lesson in competition and realized that consumers have choices and that he could not impose his narrow minded will onto the market place, as consumers will seek other alternatives from further afield.

So too with the investment preferences of Canadians. We certainly don’t need our government condemning our natural and prudent investment preferences by calling us a nation of coupon clippers. Do you suppose Flaherty accused John Snow (Chairman of Cerberus) in his private meeting with Snow in advance of Cerberus’ bid for BCE of being a coupon clipper? Among the many things that Flaherty just doesn’t get is that income trusts are the best thing that’s happened in the Canadian capital markets for a very long time. What could possibly be wrong with a new development that allowed Canadian companies of all sizes that are headquartered in Canada and run by Canadians to access a low cost of capital from Canadian investors to fund their expansion and growth at home and abroad? In fact the demand for this form of investment was so great that foreign investors were investing large sums into our market to further enhance the benefits to Canadians and all the while every last cent of pre tax corporate earnings of these companies was being taxed either through personal income tax or withholding tax in such an efficient manner that it drove a series of “strange and unexplained surges” in Canada’s overall tax collection. So let’s kill the golden goose. Meanwhile the 70% of Canadians without pensions had a hope of a decent retirement lifestyle in today’s protracted low interest rate market. Now that they have been totally frustrated in their attempts to get a decent stream of income by investing in the Canadian market and hampered by the loss of $35 billion in market value of their life savings, what do you suppose these people are now going to do to replace their lost source of income:

(1) buy Manulife’s Income Plus
(2) buy Great West Life’s deferred life annuity
(3) day trade in the Canadian stock market
(4) invest in the US High Yield market
(5) invest in the US Master Limited Partnership market
(6) vote Conservative/NDP in the next election

Tough choices. However I am certain the Canadian public is up to the task.


Anonymous said...

Praise the Lord for the Liberals! They are, of course, our best hope for rectifying in some way this terrible situation. And I am very glad for that.

Even so, even the Liberals fall short. Mark the words of Mr. Fullard: “…income trusts are the best thing that’s happened in the Canadian capital markets for a very long time. What could possibly be wrong with a new development that allowed Canadian companies of all sizes that are headquartered in Canada and run by Canadians to access a low cost of capital from Canadian investors to fund their expansion and growth at home and abroad?”

Why, then, would the Liberals want to put a moratorium on new trusts? Perhaps they are timid. Perhaps they feel that the average voter doesn’t understand this issue. But in their timidity, they fail to see some important things.

Many Canadians have been sold a lie that will cause them great financial and personal harm. The trust taxation aligns with other Tory moves that will force many Canadians to work longer or save more before retirement. Who will benefit from that? Governments and corporations will have a larger pool of a labor-force.

Income trusts are not going away. Just the ownership of the trust assets is changing, from publicly traded income trusts to private income trusts owned by the large pension funds. Income trust assets will help eliminate the pension fund deficits of the big pension plans. Who will benefit from that? Not the employees of the fund. When a pension fund has a surplus, the employer can reduce his annual contributions to the fund. So for a corporation, $1 of pension surplus is the same as $1 of profit; in the case of a government, $1 of surplus is the same as $1 more of budget revenue.

Other things that the Tories are doing to make work-life longer and life shorter include extending RSP age limit to 71, and taking steps to penalize CPP payments received before age 65.

In essence, the Harper government wants the average Canadian to do as the famous French economist Lulu Lamoure Lamort tells: Die too long, live too short.

Randy Meyer said...


I agree with evrything you've said except you've made one error. Employee stock options are treated as income not capital gains.

Dr Mike said...

I too believe that the liberal position on trusts needs clarification-they have proposed a drop in the current tax position to 10% from the present 31.5% , with the 10% refundable to Canadian investors--I still believe that the tax rate should be 0% & let the other corporations deal with it--force them to compete with trusts by becoming more efficient & offering products with comparable yields--why bring trusts down to their level--make them strive to better compete--if they refuse , let them languish--I have no sympathy for fat cat organizations who do not give a whit for their stock holders.

The moratorium on new trusts is ridiculous--let the financial markets decide who moves to the trust format & who does not--markets have a way of separating the good from the bad on their own--Jim Flaherty keeps emphasizing the fact that the Conservatives have no desire to interfere with the financial markets--so why did he???--leave them alone , they can look after themselves.

The Liberals are also not clear on growth constraints for trusts--this may be the most important element involved--if trusts will be bound by similar growth restrictions as we find linked to the Tax Fairness Plan , then trusts will languish--without the regular infusion of adequate capital , then there is very little hope of a viable trust market.

The Liberal proposal does give us cause for hope--unfortunarely , it is very slim on details--until we see something concrete , then we have to exhibit caution in giving our total support to their party--hopefully this will become clear with due diligence.

Will be waiting in Rodney--Dr Mike.

Paul Sirois said...

We have no choice but the Liberals! And don't forget, the proposed 10% tax is to be refundable to Canadians. Anyway, I just want to see the double-dealing CONS ousted; they have to pay for their damnable lies!

Anonymous said...

Jim Flaherty: the best friend the Liberals have ever had.


Some Conservatives hope Flaherty on the way out
By STEPHEN MAHER Ottawa Bureau | 6:10 AM
"Jim Flaherty could single-handedly defeat more Conservative MPs from Atlantic Canada than the combined efforts of all Liberal organizers in the region," Canadian Taxpayers Federation spokesman John Williamson said. The Halifax Herald Limited


Can we hope that Jim Flaherty will tour western Canada?

Dr Mike said...

Flaherty will be gone soon--my concern is who would be his replacement--the Conservative talent pool is very limited.

When they brought Jimmy in from Ontario , they were looking for a bull dog with major cojones that would have no fear when dealing with the trust issue--that was Flaherty alright--he had plenty of practice in Ontario where he left us with a major deficit which he claimed did not exist but which was later proven to be true.

The only other guy with this type of demeanor is John Baird--imagine having him around in the capacity of finance minister--we have already lost an arm & a leg , I guess what would be two more.

Dr Mike.

Polyian said...

During a period of fiscal prosperity most Finance Ministers enjoy a great deal of popularity, as did Paul Martin when he was fighting the deficit. The fact that Flaherty is so hated and despised during this prosperous time is a clear indication of why he needs to be removed. If he can't keep the people happy when he has all this surplus money then he is just plain stupid.

People want real tax cuts. people want honesty and ethics from a Minister. People don't like to be Lied to or patronized. Most Canadians don't understand the Income Trust tax issue but they clearly see and understand the betrayal of the Atlantic Accord and the buckets of cash being dumped into Quebec to buy a majority.

Harper must realize by now that Flaherty is one of the main reasons he can't get into majority territory in the polls. Let's hope Flaherty is gone soon. That would be a small victory for Canadians.

I wonder what reward he might get...could Harper toss his old rival Peter McKay out of Foreign Services? Where else to put an incompetent Finance Minister? God Help us and out troops if he gets Defence.

Kephalos said...

The 31.5% trust tax is a conundrum wrapped in an enigma obscured by a smokescreen. Except for those people who gain a benefit, directly or indirectly, the tax makes no sense.

If you’re a Tory supporter, and you’re enjoying the taste of power, you have to be fearful of the income trust investor backlash. For a leader who lusts power as shamelessly as does Harper, a policy which will reduce tax revenues and anger hundreds of thousands of individual voters makes no sense.

Who gains a benefit? Indirectly, the investment industry regains the benefit of the captive market of many Canadians who left mutual funds and the high cost fees for income trusts. Rob Carrick says “Canadian investors pay among the highest fees in the industrialized world” (Globe, 26-Jul-07.) Last February, following the October trust meltdown, the Canadian mutual fund industry enjoyed its highest month of sales—ever.

Income trust are not going away. Only the bus drivers are being changed. In future, the income trust buses will deliver their profits to private rather than public owners. While Flaherty continues to tell the lie that that public income trusts “would lead to a loss to the treasury of up to $3 billion” (Paul Vieira, Financial Post , 26-Jul-07), tax analysis shows that when trusts are owned by private and/or foreign equity, the private trusts will put less taxable income into the system than do public income trusts. Does it make sense to have a Finance Minister who is a liar, stupid or both? Anyway, the new private owners of trusts will benefit directly by enjoying the cash-flow from the trust assets at lower tax rates.

If that’s the conundrum, the enigma is that the Canadian financial press has failed to fairly or fully report this story. As Brent Fullard has recently point out, reporters have been fired for trying to bring this story to light. Is there a cover-up? And is the Canadian press involved in the cover-up? Stay tuned.

Another part of the enigma is that foreign owners, using leveraged buy-outs, will be able to remove their private trust income from Canada tax-free. This part is enigma is almost unbelievable. Have you ever heard of a democratic government allowing non-voting foreigners to remove income tax-free? Never before have I heard of such. Except there may be a simple explanation. The foreign money only looks foreign. The foreign private equity managers may be merely hired faces for some off-shore Canadian money. We live in a world of complicated, international tax treaties. Flaherty’s recent budget has set-up a tax regime that allows Canadian business income to flow to nations where the tax rate is lower. If we could get behind the veils of the investment structure, I expect we’d find some Canadian investments parked in a country where the corporate tax rate is 10% or less. This part of the enigma may connect with the fact that Canadian newspapers are owned by a small number of very rich Canadians.

Another part of the enigma is the NDP. They have been actively complicit in getting the income trust legislation passed—even having one of their very best journeyman carpenter accountants vehemently argue that income trusts are a tax wet dream. It’s mind boggling that the NDP, the guardian of the rights and freedoms of individual Canadians, has done such a turncoat. What lie did Harper tell Layton? That is the biggest mystery.

And what is the smokescreen? If you do a detailed tax analysis of the cash-flows from trusts to investors to tax treasury for non-registered holdings of income trusts, the before-2011 and after-2010 numbers are almost identical. It’s not about tax leakage.

Another sign that it’s not about tax leakage, and this is something else that is unbelievable, is that the 31.5% tax is delayed four years. Have we ever seen before a Finance Minister who says “I have $3 billion tax loss problem but I’m going to wait four years to fix it?” Such incompetence would be an outrage. Except there’s nothing to be outraged about. There is no tax leakage. The tax is delayed to give the private equity investors a long lead-time to do income trust takeovers.

Bottom-line: we have a Finance Minister who is a liar, stupid or both, and a Prime Minister who approves of having a Finance Minister who is a liar, stupid or both.

But who voted for these guys? How smart can we be?

nineofiveland said...

"every last cent of pre tax corporate earnings of these companies was being taxed either through personal income tax or withholding tax in such an efficient manner that it drove a series of “strange and unexplained surges” in Canada’s overall tax collection"

Somehow this is the message we have to get out to the Canadian Public .. when you mention Income Trusts to your friends and family .. their eyes glaze over and they mutter something like "isn't that all over now .. or .. they weren't paying tax anyway".

I try the strategy of comparing ITs to Mutual Funds .. since most are structured as trusts .. remind people that they get T3s and T5s at the end of the year from MFs and that ITs push their cash out to investors to be fully taxed in their hands.

It's a helluva fight .. but let's not give up .. I am very glad to see the comments growing on this most excellent blog .. hats off to Brent!!!

Dr Mike said...

Excellent comments guys--very impressive indeed--any one of you could take over Flaherty`s job in a heart beat.

We are all trust investors--we have a right to be proud of the fact that we have become a most knowledgeable lot & knowledge on most levels is power.

I know personally , it took the trust fiasco to make me as such--that is the only thing I can thank Jim Flaherty for doing on my behalf.

I am proud to call you colleagues in the fight for tax fairness.

Dr Mike.

Randy Meyer said...


Thanks for bringing up the point I've been making on other blogs and in my letters to Harper.

That is the fact that the dividend tax credit is a huge source of tax leakage. There are many companies that pay no income tax yet still issue dividends. Yet the receivers of the dividends are still able to claim a dividend tax credit.

The purpose of the dividend tax credit is to offset taxes already paid by a corporation on the income made to pay the dividend. In other words, it's an attempt to correct double taxation.

If a corporation didn't pay tax, why should there be a dividend tax credit afforded to the dividend receiver?

Furthermore, not all corporations pay the same percentage of tax on their earnings. Why should the dividend tax credit be the same for corporations that pay say 6% versus those that pay say 20%.

Talk about tax leakage!

Dr Mike said...

Nineofiveland said : (cool name by the way)

"Somehow this is the message we have to get out to the Canadian Public .. when you mention Income Trusts to your friends and family .. their eyes glaze over and they mutter something like "isn't that all over now .. or .. they weren't paying tax anyway".

I would imagine all of us have run into this reaction on many occasions--it is the same everywhere I go--people will change the subject the first chance they get--I probably would to if the shoe was on the other foot & I thought that I was not affected personally.

This has certainly been aided by Mr Flaherty--his spin has done wonders for his cause--calling it "The Tax Fairness Plan" & telling everyone that corporations need to pay their fair share because they do not pay tax within the trust structure , all but cooked our goose in the publics eye.

The term "tax leakage" imparted a vision of escaping tax dollars from a gaping hole in the tax system occupied by corporations under the trust structure.

Telling everyone that this was imposing a burden on the backs of hardworking canadians further enhanced his cause.

Mr Falherty refused to supply any direct evidentiary proof of his claims thus avoiding any possible ensuing controversary --this kept this essentially out of the public eye--MSM was unwilling to dig any deeper making our attempts to dispell Flaherty`s claims that much more difficult.

Short of ducttaping everyone we know to a post & forcing them to listen , I am not sure what we can do to get our word out more effectively--most people do not want to take the time to understand the problem here--as such they perceive that no problem exists.

The few that will listen to what we have to say about trusts & who will try to understand the situation will be much more informed of the nature of this government & will likely make an informed choice in any upcoming election.

The others will need to be approached from a different angle--they don`t want to hear about trusts since they look at it as a dead issue--I have found that if I inform them about things such as possible future taxes on RRSPs or Future tax on Capital gains from house sales--just things that may affect them in the future--they tend to start to listen--the fact that the Tories could break a promise costing the public so much on the income trust file , then it is a short jump to future tax grabs which may dig deep into their wallets.

it is important for us to discuss on this blog the things that each of us have found to work when talking to the public--this will help us all to be more effective in the future.

Dr Mike.

nineofiveland said...

Caldwell Securities has a full page ad on the back of the first section of The Globe and Mail today (Fri) "The Sellout of Corporate Canada" .. which lends support to the issue of corporate managers feeling entitled to the rewards of ownership without the risk.

What a novel idea it would be to just take the profit earned by an enterprise and give it to the investors who then pay their taxes and do as they please with the remaining money .. no wait .. isn't that what Income Trusts were all about?

Instead we have:
- less tax flowing to Ottawa and the Provinces .. to be made up how?
- a lower standard of living for those of us seniors without "real pensions"
- the buyout of Canadian enterprises by foreign entities supported by domestic partners

Meanwhile corporate managers reap inflated pay, bonus and options benefits.

Canada .. the best place in the world .. let's get it right!

Anonymous said...

Well, nineofiveland, I humbly submit that the Caldwell Securities ad shows a rising fear of THE DEVIL THEY KNOW NOT.

Do you recall some time ago the Canadian securities industry was living in fear that the whole country, from Bonavista To Vancouver Island, would be trust-ized? The fear very nearly turned to panic when the wannabe Prime Minister promised never to tax trusts. People in the securities industry did not like trusts, because trusts let the investor do his or her own thing. Even so, trust investors still needed the TSX, brokers and banks, etc. Anyway, income trusts were the Devil Caldwell Securities Knew.

But along comes Sally on the arm of THE DEVIL THEY KNOW NOT. The new DEVIL is a private equity manager riding on a gargantuan pension fund. If we were going to make a movie about this, imagine Two-face Flaherty riding on the back of a greenback Godzilla. Got the picture. It might not seem like a swell idea to use Two-face Flaherty as a character because we’d have license Two-face from Batman. But our movie will made a tonne. TRUST me, eh?

In this movie, coming to any large Canadian business you know, THE DEVIL THEY KNOW NOT will gobble up the corporation. In the final scene THE DEVIL THEY KNOW NOT will destroy the TSX. Got the picture.

So, Caldwell Securities, we hope you’ll remember how sweet life was when the Devil you knew was just some income trusts.