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FLAHERTY'S TAX CONUNDRUM

BCE Privatization Could Cost Him $800-Million In Tax Leakage; More Tax Loss Than From BCE & Telus As Trusts!

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 what he attributed to 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 [who paid the tax personally].

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. [He failed to mention that individual trust investors would have paid even more taxes than the trusts would have, by way of the personal tax imposed on the distributions they received from the trusts.]

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 private-equity investors to avoid, or greatly reduce, the amount of tax paid. [And there are no longer any trust investors to pay personal taxes on the revenues generated by the new company].

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." [However, because of interest and other deductions for the new private-equity owner, little or no taxes are paid to the Canadian government by the new owner. And there are no longer individual trust investors to pay personal taxes on the generous revenues generated by the company.]

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 by Canadian companies. 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."