Reason to keep income trusts: to promote competitiveness

By LUC VALLEE,
Montreal Gazette
June 4, 2009

A few weeks ago in Montreal, I attended a private presentation given by a leading international consulting firm on Canada's global competitiveness. The report found that innovation was the key driver of a country's competitiveness and that Canada was lagging in this matter. As a result, our country has been suffering a slow erosion of its competitiveness since the early '90s.

In the discussion that followed, a debate erupted about what would be the best policies to foster competitiveness. One prominent participant claimed that nationalistic procurement policies by governments were the secret to industrial development.

"The Americans do it all the time," he argued, noting that by favouring local engineering firms to build the huge hydro-electric dams in the James Bay region of northern Quebec in the '70s, the Bourassa government helped launch SNC and Lavalin (not yet merged) and other thriving engineering firms into the international scene. Today, these firms are global leaders. They innovate and compete on a global basis in part because the government helped them by giving them contracts that allowed them to build their expertise.

"Not so quick!" responded another prominent attendee. "You've got to sell goods on a global basis. If today you restrict purchasing options of Canadian governments to local providers and exclude foreign competitors, your protectionism will cost you - foreign governments will retaliate."

Other participants then eagerly asked, "So how do you do it without hurting yourself?" The first participant smiled and suggested the following answer: "You do it discreetly!"

Someone else suggested that the Americans do it because they can: "Who wants to enter into a trade war with the United States?"

In other words, we let the U.S. set the rules of international trade because it has most of the bargaining power. And after all is said and done, it still runs the largest trade deficit of any country. So while Americans may play tough, they still have the most open borders to world exports. As Canadians, we take that position in the form of a "Buy Canada" act.

"What about Norway?" (Norwegians apparently have protectionist procurement policies), someone else asked. Although some attendees claimed Norway is a mystery, it clearly is not: Norway has only oil to sell! And no countries impose tariffs on oil imports.

On the other hand, the fact that Norway's Petroleum Fund (the country's equivalent to Alberta's Heritage Fund) is not allowed to invest its assets in Norway suggests that economic development policies usually associated with protectionist leaning countries are not in favour. Not that Norway has much choice in the matter as the massive royalties generated by its oil exports would quickly overwhelm its small economy.

The conclusion of the evening seemed to be that Canada does not appear to have the upper hand in the matter of procurement policies.

So what can actually be done by Canadian policymakers to foster innovation in Canada without incurring the ire of our global partners?

The solutions are not readily apparent. But here's a suggestion: Let resources companies retain their income trust status beyond 2011 when they are set to definitively expire. I know, it sounds reactionary, but let me make the point. Before 2006, when income trusts did not have to worry about conversion to corporate tax paying entities in 2011, many actually fostered risk-taking and innovation.

Take the example of Calgary-based Penn West Petroleum. It may not have had the funds or the technology to develop its vast oil reserves. However, by leasing its land to small innovative exploration companies willing to take risks and allowing them to be rolled into the trust structure upon an oil find, it encouraged industrial development.

What happened since then? With the tax incentive gone, the business model is broken and the incentives to take risks have been considerably reduced. As a result, we find much less oil and gas.

More importantly, with the tax advantage set to expire, income trusts will lose their protection against takeovers by larger foreign competitors. Why? Because when a taxable corporate entity buys an income trust, the newly merged entity loses the tax benefits that the acquired trust had prior to the acquisition. This means that it usually makes the valuation of the trust by the acquiring corporation lower than the market value of the stand-alone trust, in effect protecting Canadian income trusts against tax-paying predators.

Since the oil trusts themselves do not have the in-house expertise, are today cash constrained and are currently valued at depressed prices, these companies endowed with very large reserves will soon make perfect targets by international corporations looking to boast their own dwindling reserves.

Canadian commodity income trusts are likely set to all be taken over within a few years by large international corporations; which, by the way, conduct most of their R&D outside of Canada. These companies are also more likely to procure their goods and services abroad. In other words, income trusts were a discreet way for Canadians to be acting American. Is it too late?

Consultant Luc Vallée was formerly chief economist for the Caisse de dépôt et placement.
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