BCE: A simple IQ test for Jim Flaherty

Jim Flaherty likes to portray himself as the all knowing, all seeing Minister of Finance.

For example, he would like us to believe that he foresaw the downturn in the US economy and that he took measures in the last budget which anticipated that event. For example he lowered the GST?

Here is a direct quote:

"We knew that there would be an economic slowdown in the United States, and we took the steps in terms of making sure we in Canada were prepared for this economic slowdown,"

It’s easy to say that you foresaw something AFTER it has occurred, quite another to foresee something BEFORE it has occurred.

Flaherty’s income trust tax provides a simple IQ test for Jim Flaherty’s capabilities as a Finance Minister and his true abilities to look into the future and predict the consequences of his actions:

Here was his rationale for the income trust tax on November 1, 2006 as quoted in the Globe:

“You have to either leave it alone or fix it,” Mr. Flaherty shrugged Wednesday. “We were going to see the two largest telecommunications companies in the country not pay corporate taxes. That's a clear and present danger to fairness in the Canadian tax system. I thought we had to act.”

Evaluating Jim Flaherty’s IQ and acumen as Canada’s Finance Minister can be easily determined by how well this statement predicted future events.

It must first be pointed out that at the time of this statement, neither BCE nor Telus was paying any corporate taxes as a corporation, as the following statements from those two companies attest to:

BCE forward looking statement of December 12, 2006: “Bell expects it will have no significant federal cash taxes through 2010,”

Telus forward looking statement of December 14, 2006: “Based on a an updated review of the company's tax loss position, TELUS now expects minimal cash tax payments in 2007, a preliminary estimate ofapproximately $100 million in 2008 with the payment of significant cash taxes largely deferred to 2009, rather than 2008 as previously anticipated.”


So the question becomes, how could the government lose taxes that it wasn’t even collecting at the time?

Perhaps Jim Flaherty was referring to a longer time frame when he made that statement to rationalize his policy.

In that case we only need to look at the events of the next six months following the date of this statement by Flaherty.

According to BCE’s takeover bid circular, we learn that the private equity leveraged buyout of BCE was precipitated by the events of Halloween.

That is revealed by the fact that BCE’s circular provides a history to their proposed transaction. The first four events recounted are:


October 11, 2006: BCE announces its intent to convert to an income trust

October 31, 2006: Jim Flaherty shuts down income trust market

November 3, 2006: KKR rumoured to be considering a takeover bid for BCE in the aftermath of its devaluation following Flaherty’s Halloween announcement. BCE CEO calls KKR that day.

November 15, 2006: BCE CEO Michael Sabia meets with Henry Kravis of KKR. Teachers’ catches wind of these discussions, which precipitates an auction of BCE to private equity firms by way of a leveraged buyout

As for Flaherty’s IQ test. How well did he do? How well did he predict the future? Did he even portray the present circumstances honestly and correctly? Did he ensure that Canada’s two largest telecommunications companies would pay taxes? Here’s the answer to that:


Flaherty's tax conundrum

BCE Privatization could cost him $800-million
Paul Vieira, Financial Post Published: Wednesday, April 18, 2007

OTTAWA - Jim Flaherty, the Minister of Finance, could face another major tax loss headache --on the scale of income trusts -- should a buyout deal be reached between BCE Inc. and a consortium of private-equity investors.

Financing experts say a buyout of BCE -- led by tax-exempt pension funds Caisse de depot et placement du Quebec and the Canadian Pension Plan Investment Board -- would produce virtually the same results, taxwise, had the Montreal-based company converted to an income trust as planned.

"It is basically income trusts revisited," said Laurence Booth, an expert in structured finance at Toronto's Rotman School of Management. "And the implications for Ottawa are pretty much the same."

Yesterday, BCE confirmed it was in talks with the Caisse and CPPIB about taking the publicly traded company private. If successful, it would result in the largest buyout in Canadian corporate history.

It has been estimated the conversions of BCE and competitor Telus Corp. would, collectively, shrink corporate tax revenue by $800-million a year. David Lambert, a telecom analyst at Canaccord Adams, said yesterday he estimates that BCE alone pays, on a per-share basis, about $1 per share from its free cash flow toward taxes.

BCE has 808 million shares outstanding, which would translate into an annual $808-million tax bill under Mr. Lambert's calculations.

Last year, BCE had announced its intentions to convert to an income trust. But those plans were killed when Mr. Flaherty slapped a tax on income trust distributions to put an end to the popular corporate structure that allowed companies to avoid tax by dishing out most of the cash flow to investors.

Mr. Flaherty said he decided to act because the investment vehicles were costing Ottawa $500-million in lost revenue annually, and warned that planned conversions would further threaten federal finances.

Under private-equity transactions, or leveraged buyouts, the investors finance the acquisition mostly with debt and a small equity component. The interest payments on that debt allow the investors to avoid, or greatly reduce, the amount of tax paid.

Further compounding possible problems for Mr. Flaherty is that pension funds can defer taxes owed. So if they own equity, dividends from those shares flow through without facing a tax hit.

"Financial markets are getting more innovative and you are getting some very low-risk businesses that can support more debt, and [investors] are finding ways of having them carry more debt in order to avoid the corporate income tax," Mr. Booth said.

He likened the Finance Minister's efforts to stem tax leakage to the title character in a Dutch legend. "[He] is a bit like the Dutch boy who has his finger in the dyke. He plugs one hole but then, bingo, another hole pops up."

Mr. Flaherty yesterday declined to comment on developments at BCE, or even mentioning the company's name. "I am not going to talk about anything that is subject to current market activity," he said.

But he dismissed suggestions that private-equity investors are, as Mr. Booth suggested, converting to a trust through the back door.

"That is nonsense," he said. "When you are talking about a company becoming an income trust under the old rules, you are talking about a company getting a preferred tax rate. When you are talking about a corporation continuing as a corporation but under different ownership, it is still taxable--at the same rate."

Mr. Flaherty has come under pressure, from corporate Canada and the Liberal party, for handicapping the business community with the trust tax and recent changes to interest deductibility of foreign financings. These moves, his critics argue, will leave Canadian firms ripe for foreign takeovers and make them less competitive on a global scale.

John McCallum, the Liberal finance critic, said Canadians are starting to see the consequences of the trust tax.

"The effect of what he is doing is exactly the opposite of what he intended, because the holders of income trusts pay lots of tax," Mr. McCallum said. "All of these trusts are now being taken over in such a way so that the new owners will pay no tax.

"So, instead of a situation where a lot of personal taxes were being paid, you are having these induced takeovers by highly leveraged private-equity companies that will pay no tax."

pvieira@nationalpost.com