Factually incorrect statements appear in the textbook: Financial Accounting

Dr. Maureen Gowing
Assistant Professor, Accounting
Odette School of Business
University of Windsor

Dr. George Kanaan
Associate Dean, Associate Professor
Department of Accountancy
John Molson School of Business
Concordia University

Cc.
Robert Libby, Cornell University
Patricia Libby, Ithaca College
Daniel Short, Texas Christian University
David Swail, President and CEO. McGraw-Hill Ryerson Canada

Dear Dr. Gowing and Dr Kanaan:

The third edition of the textbook that you co-authored along with Libby, Libby, and Short (you being the two additional Canadian co-authors) entitled “Financial Accounting” (published by McGraw Hill Ryerson) that is in widespread use in colleges and universities across Canada contains three very significant errors/omission in the section entitled “Accounting and Reporting for Income Trusts” that I call upon you to correct, in the name of academic accuracy, and for the sake of properly educating its student readers, as follows:

(1) You state: “By distributing most of the cash received [from the equity and debt held by the trust] to unitholders, income trusts avoid paying income taxes”.

Nowhere do you go on to say that the unitholders, in turn, are the ones who pay the income tax on the earnings of these businesses that are paid directly to them? Therefore, your depiction of the tax treatment of income trusts, as some “tax avoidance” mechanism, provides the students with an incomplete and inaccurate understanding of what is actually going on here, from a financial and taxation point of view. Nowhere do you paint the larger picture by informing the students that income trusts are merely one form of a much broader classification of business structures known as “tax flow through entities”, or “FTEs” and that FTEs are in widespread use throughout Canada and elsewhere in the world and include businesses as common as law firms and all other forms of partnerships as well as mutual funds etc. The important distinction and common attribute of FTE’s being that they themselves do not pay tax, but are obligated to pay out their earnings to their owners, who in turn are the ones who pay the tax. To mention one aspect of income trusts tax treatment (that is negative) and not the other (that is positive) is both incomplete and misleading on your part.

In contrast, I notice that in your section devoted to partnerships you fail to make a similar observation that partnerships “avoid paying income taxes”. Why are income trusts the target of such a distinction, when partnerships are not, and yet both are identical to one another in that fundamental respect? This again is inherently misleading to the student readers and represents a clear form of editorial bias that does not belong in any academic text book.

(2) You state: “The potential loss of sizable amounts of taxes prompted the Canadian government to introduce in late 2006 a new form of tax on cash distributions by income trusts to their unitholders”.

This statement of yours only has the semblance of being true, since you inserted the word “potential”, however I believe the context in which this statement appears would suggest that the word “potential” was meant to address the “potential” of whether companies would convert to income trusts, rather than to suggest to the students that there was any doubt about whether “loss of sizable amount of taxes” would occur or not.

This notion that taxes were being lost by the Canadian government from the conversion of businesses to income trusts formed the central rationale for this government policy of taxing income trusts in the first place. It just happens to be patently false. This so called “tax leakage” argument was completely debunked during the formal public consultation process that took place in the fall of 2005, under then Finance Minister Ralph Goodale. A highly reputable and independent economics consulting firm, HLB Decision Economics was retained to work collaboratively with the Department of Finance to answer this question about whether tax leakage is real or simply a myth. HLB concluded that tax leakage is a myth and that the government collects as much tax revenue from a business formed as a corporation as it does upon conversion to a trust. I suggest you read HLB’s attached report entitled “The tax revenue implications of income trusts”. These findings of no tax leakage ,conducted in 2005, would be different today, in light of the fact that corporate tax rates have been reduced at both the federal and provincial level since 2005 whereas personal income tax rates have not, meaning that conversion of a business from a corporation to an income trust, that shifts tax collection away from the corporations (taxed at a lower rate today than in 2005) to an individual (taxed no less than in 2005) would actually be revenue POSITIVE for the Canadian Government and NOT revenue NEUTRAL as concluded by HLB in 2005 and certainly NOT revenue NEGATIVE, as students of your text book are being misled into believing in 2009.

I also suggest you acquaint yourself with what has now become of these income trusts following the Harper Government’s decision to double tax publicly traded income trusts (but not private income trusts) , and which caused them to become devalued and thereby the target of foreign takeovers and takeovers by the public sector pension funds, who were given a loophole by the Harper Government to avoid paying the new income trust tax, whereas RRSPs were not so lucky, despite the fact that RRSPs were created in the first place with the single policy intent of placing RRSPs on the same footing as pension funds? As noted above, HLB proved there was no tax leakage to begin with, but these subsequent takeovers of devalued trust caused by this policy, has led to real tax leakage. I refer you to the study by Deloitte at: http://www.deloitte.com/view/en_CA/ca/services/tax/article/ac0cf16bc31fb110VgnVCM100000ba42f00aRCRD.htm

(3) You state: “The tax savings that resulted from converting common shares to trust units prompted many companies to seek conversion of their businesses to income trusts simply to avoid paying income taxes”.

You have fallen victim to a common misperception in making such a claim and it only captures what is going on with the advent of income trusts at a very superficial level.

Ask yourself, would the conversion of a business from a corporation to a trust accomplish what you are alleging, if the taxes in question were simply borne by the owners rather than the business itself? As the HLB Decision Economics study referred to above concluded, the same amount of tax is collected by the government under trusts versus corporations, so clearly there is no tax incentive per se, that is motivating the conversion of businesses to trusts. You have come up with the wrong diagnosis for why these conversions to trusts were taking place, that you are presenting to students of finance as a statement of fact, even though it is the wrong diagnosis. The correct diagnosis concerning why businesses were converting to income trusts is that investors in the marketplace would and were assigning higher valuations to businesses that subjected themselves to the regime of income trusts versus corporations. This created the motivation to convert. The essential element of the income trust regime that investors valued more highly, was the LEGAL requirement that these businesses PAY OUT some 90% of their discretionary (i.e. after capital reinvestment) earnings to their owners, as distinct from corporations whose managers can do whatever they want to do with excess earnings of the business. The marketplace has come to mistrust managers of corporations to do what is in the owners best interest with excess earnings. BCE is the perfect example, as the managers of BCE had squandered the excess earnings of BCE on everything from Teleglobe (BCE wrote off their $5 billion in Teleglobe in less than 18 months) to Montreal Trust (another BCE write-off) to Daon Development (another BCE write-off). With a failed track record of earnings reinvestment like that, it’s obvious to understand why the value of BCE was enhanced by the announced conversion to an income trust, and it had nothing to do with what you are saying (tax treatment of income trust) and everything to do with what you are not saying (the legal requirement of income trusts to pay out excess earnings).

Conclusion:

Apart from the above noted errors and omissions that appear in your textbook, there is also a general tone to the section devoted to income trusts that implies the government’s actions were appropriate and just. You have not taken the time or applied the appropriate academic rigor required of you to make any such conclusions or inferences. Use of terms like the “flurry of conversions” implies that something untoward was going on here, rather than investors (source of capital) gravitating businesses (users of capital) to adopt investor’s preferred means by which to own Canadian businesses, that are more consistent with investors’ investment objectives and bringing needed discipline to the Boardrooms of Canada, by transforming companies like BCE from being serial squanderors of their owners’ capital into more productive entities, better aligned to their owners’ wishes and the desires of the capital markets.

You have done a great disservice to this topic and to the student readers of your textbook that is in widespread use throughout Canadian universities and colleges, not unlike the disservice done to this topic by the Canadian main stream media. The newspapers in Canada who are commercially owned and motivated, like the Globe and Mail, National Post etc , as well as the news media at large , like CTVglobeMedia and CanWest Global have done a pathetic and grossly misleading job at reporting on this topic and its fundamental factual underpinnings. This is explained by the fact that Canadian media is owned by commercial interests and therefore motivated by commercial interests and too wiling to distort and misrepresent the true facts. I expect more from the academic community, such a people like yourself, than to simply parrot the nonsense that one reads in the press and the many wives’ tales that emanate from the Harper government, in the form of (false) post-action justification for their policy, that saw Canadians lose $35 billion of their hard earned life savings and left some $220 billion in market capitalization of Canadian businesses vulnerable to foreign takeover, causing the inevitable loss of $7.5 billion in annual tax revenue to the government and to all taxpayers, to solve an alleged $500 million in annual tax revenue, that never existed in the first place.

And finally, as a the co-authors of a textbook in Financial Accounting, and as Professors of Accounting, I challenge you to prove the existence of tax leakage, as you clearly imply in your text, on the basis of the only evidence provided to taxpayers, namely the 18 pages of blacked out documents, issued under the Access to Information Act, that are attached. This was the only proof of tax leakage provided by Canada’s Finance Minister, Jim Flaherty, who incredulously stated that it was a matter of National Security, that the true analysis not be revealed.

I would counter that absurd claim about invoking National Security, by stating that it is a matter of academic urgency and academic rigor that the truth about this topic be known and call upon you to bring that truth to light, in a way that is not occurring in your text book, and in a way that is consistent with the facts, rather than simply adopting a position that is consistent with the dogma coming out of Ottawa and in newspapers across this country.

Otherwise, what is the purpose of academia and textbooks in the first place if not to speak the truth and to base themselves on facts? We already have two other professions, that of politicians and the media, who have the market cornered on doing the exact opposite. There is no need for a third profession devoted to such pursuits.

Let me know if I can be of any further assistance. Others in the academic community you may wish to speak to include Professor William Stanbury of the University of British Columbia. His views have been guided by the facts, rather than guided by the press of the sound bites coming out of Ottawa. You might also like to contact Dennis Bruce, the lead author of the work conducted by HLB Decision Economics. Both of their emails appear above and have been copied on this email.

Thank you very much. I look forward to your reply.

Brent Fullard. B.Sc. (Toronto), M.B.A. (Queen's)
President and CEO
Canadian Association of Income Trust Investors
www.caiti.info

647 505-2224