Letter to: Pension Investment Association of Canada

Mr. Peter Waite
Executive Director
Pension Investment Association of Canada

Dear Peter:

Re: The manifold inequities of the Tax Fairness Plan

Thank you taking the time to speak with me on the phone yesterday. As promised, I am writing to review in greater detail the matters that I raised on the phone, some of which you acknowledged you were not aware of.

Our association’s mandate:

Our association defines its mandate in much the same way that your association defines its mandate. We represent the interests of the 75% of Canadians who are without pensions and who seek to preserve the investment vehicle of profit sharing income trusts while also preserving the integrity of policies that have governed RRSPs since their inception, whereas you represent pension funds who manage the pensions on behalf of the 25% of Canadians with pensions.

It is instructive to note that to the amount of money that Canadians have invested in RRSPs for retirement income is roughly equal in size to the amount of money managed by your pension fund members, some $600 billion in each instance. As such we should be afforded with similar respect, albeit from different vantage points, on matters that affect the viability of Canadians saving/providing for retirement income. The income trust tax is one such matter.

Income trust matter, past and present:

As you know the policy rationale for making changes to the income trust marketplace and to income trusts themselves was the widely invoked premise that income trusts cause tax leakage and the less prevalent argument that income trust may have some negative consequences to Canada’s economy. Both of these notions were laid to rest, during the extensive work that was done by the private sector during the Public Consultation Round (PCR) when Mr. Goodale was Finance Minister. As you will recall this public consultation process was prematurely truncated and never reached its final conclusion, since a snap election was called, culminating in a change of government in early 2006.

That change of government was ushered in, in part, because of the promise made by Stephen Harper of “Unlike the Liberals, a Conservative government will never raid seniors nest eggs,, by taxing income trusts”.

I reference the Public Consultation Round of 2005, because your association submitted a letter dated December 6, 2005 (at which point it has been concluded by Finance Minister Goodale that no changes to the taxation of trusts would occur) in which you state:

“As noted in our letter to the Prime Minister of Canada and the Minister of Finance in April 2004, our main concern was that any proposed solution not discriminate against pension funds by, for instance, introducing caps on income trust holdings or tax on income trust distributions that only applied to pension fund holdings. PIAC is pleased that the solution proposed by the Department of Finance will result in pension funds not being treated differently than any other income trust investor.”

Our association supports fully the words and principles of “fairness” and “level playing field” that are at the core of your comments above. You go on at the close of your letter to say:

“Our fundamental objective is to ensure that any other changes do not place pension plans in a disadvantaged position in relation to any other investor, given our responsibility of funding and providing pension income for millions of Canadians.”

On that point, again, our association whole heartedly agrees. However I do wish to point out that this important principle was not adhered to in the changes that the Harper government, under Mr. Flaherty, made in October 2006, since Mr. Flaherty’s provisions place “other investors”, namely RRSP investors at a “disadvantaged position in relation to other investors”, namely pension funds. This disparity between investors arises from the simple fact that Mr. Flaherty’s income trust tax applies only to “publicly listed” income trusts, but not to private trusts. Private trusts are ineligible investments in RRSPs whereas private trusts are eligible investments with pensions plans, who are members of your association. This public versus private provision does nothing more than create an unlevel playing field amongst different classes of income trust investors, and immediately gives rise a “tax arbitrage” that can be exploited by one type of investor but not the other, and leaves the one type of investor susceptible to the predatory actions of the other type of investor, as discussed later below.

The idea that tax policy is designed in a way that is discriminatory against one type of investor while favoring the other, is the very position that you strongly advocated against. I call upon you to strenuously object to this same adverse outcome that has arisen under Mr. Flaherty’s policy, as if it was your members who were being discriminated against, even though it is our members who are bearing the brunt of that discrimination. I say this for reasons of integrity of our capital markets as well as the integrity of public policy, but also for the following reasons:

(1) The entire income trust policy is based on a false premise that income trusts cause tax leakage:

This false premise only has the semblance of truth when one adopts a flawed analytical methodology that “manufactures” tax leakage. The manner in which tax leakage has been manufactured by Mr. Flaherty is the act of leaving out all the deferred taxes that are paid by the 38% of income trusts that reside within either RRSP and/or pension plans. This is very dangerous precedent to set, and this skewed analytical framework may come to haunt future public policies and directly adversely affect you, in the same way that it has directly adversely affected RRSP holders of income trusts.

During the Public Consultation Round a definitive study was done by the independent economics consulting firm, HLB Decision Economics, who are the only group to actually work collaboratively with the Department of Finance and together they created a model for answering the otherwise unanswered question of tax leakage or no tax leakage. That study is entitled “The tax revenue implication of income trusts” and is available on line here:

http://www.caif.ca/incometrusts/publications_studies.htm

In reading the above study it will become quite clear to you that the methodology of leaving out deferred taxes, as if they were never paid or collected is wrong. Leaving out deferred taxes is also in complete contradiction to the proper rules of Accrual Accounting employed by the Government of Canada in its own financial statements, and Accrual Accounting is the standard laid down by the Auditor General. To create tax policies on a basis that is incompatible with how the government is told to conduct its affairs by the Auditor General is not only wrong, but also arbitrary and capricious in nature, particularly when the policy to which that flawed analysis was put, caused Canadians saving for retirement the permanent loss of $35 billion of their hard earned retirement savings (including the $300 million loss incurred by the CPP) and the loss of an essential “profit sharing” investment vehicle ideally suited to providing retirement income as well as saving for retirement.

This error by Finance in arriving at their claims of tax leakage, was also acknowledged by Jack Mintz in an email to me of November 26, 2006 in which he stated:

“I do want to point out that there is a serious flaw in some analyses especially on the taxation of pension and RRSP accounts. Finance was not right to treat the impact as zero.”

To validate what I am saying on this crucial point, I recommend that you contact the lead author of the above noted study. His name is Dennis Bruce and can be reached at (613) 234-0080; Cell: (709) 632-1708, or dennis.bruce@hdrinc.com

I have also included at the bottom of this letter a press released that was issued at the end of the Public Hearings on Income trusts by Dennis and HLB entitled “Independent economists discredit govt tax leakage claims”

(2) Not only did tax leakage not exist in the first place, this policy’s outcome created real tax leakage, along with a “welfare loss”:

The inevitable takeover of artificially devalued, cash flow rich income trusts, that was predicted by knowledgeable professionals from the very outset of Mr. Flaherty’s income trust taxx, has now seem 51 income trusts moved from the hands of taxpaying Canadians into the hands of non-tax paying foreigners and other entities all of which use means such as leveraged buyouts to evade the payment of any taxes in Canada. This “zero” tax collection outcome was further assured when Mr. Flaherty reduced the withholding tax paid by foreigners on interest payments to service leveraged buyout loans from 15% to 0%, while at the same time arguing that the 15% withholding tax paid on income trust distributions to foreigners was stripping Canada of much needed tax revenue.

As debatable as that observation might be, what is not debatable is the real tax leakage that Mr. Flaherty’s income trust tax has caused, where none existed previously. The 51 takeover of income trusts announced and completed since the announcement of Mr. Flaherty’s income trust tax on October 31, 2006 amount to $58.9 billion in total. These 51 businesses pay approximately $5.3 billion in annual distributions that previously were taxed in the hands of Canadians at the rate of 38% (according to the Department of Finance) resulting tax revenue of $2 billion, that is now foregone now that these businesses have been acquired using means that eliminate the payment of taxes to Revenue Canada. To the extent that these businesses, as income trusts, were held 15% by foreigners and 85% by Canadians, the foregone tax revenue is still a whopping $1.5 billion per annum, or some three times the amount of Mr. Flaherty’s wildest claims about “tax leakage”, a condition that never existed in the first place.

The damage from this policy is far from over, as we enter the final year before the implementation of Mr. Flaherty’s unfounded income trust tax, as there are still 169 of the original 220 income trusts in the marketplace, that remain highly vulnerable to the same unwelcome outcome that befell the first 51. Meanwhile there is the welfare loss that these takeovers have cost Canadians who found there investment losses caused by the income trusts tax, “crystallized” by events beyond their control, as precipitated by these hostile takeover of their income trust investments by parties who are able to evade the very tax that has significantly diminished the value of these trusts in Canadians’ hands, but not in foreigners hands. Meanwhile this is a welfare loss with no offsetting benefit to the Canadians directly affected, nor any other Canadian.

(3) The income trust policy contradicts the very premise on which RRSPs were created in 1957:

The RRSP as we know it today was the creation of the Liberal government of Louis St Laurent when Walter Harris was Minister of Finance. The debates in the House of Commons are reaffirming of why RRSPs exist today and the reason they were created in the first place, comments such as:

Mr. Michener: “ This could affect some 400,000 taxpayers who are self employed; in fact it could go beyond that as framed because it is open to the employees who are not already contributors to an approved pension fund. I recall that my first plea on behalf of the self-employed described them as being discriminated against by the legislation as it stood in May of 1953 when Mr. Abbott was finance minister. I further believe representations have been made, perhaps over a period of ten years by different associations of self-employed persons, who find themselves in the invidious position of not being able to save for their retirement money which had not been taxed as would have been the case had they been contributing to approved plans.”

Mr. Herridge : “ Mr. Chairman this interesting provision will be to the advantage of possibly, I understand, half a million Canadians, mainly professional and business people. It will, I think, give those people a measure of fair play which had been denied them in the past. We feel that such a scheme is necessary if industrial workers are to have a measure of security on retirement, and the mobility which is their right in a modern democratic civilisation so that they can move from one company to another and not be chained to one area, in other words the right to full security that would be provided by such a national scheme, I think that in view of the large public investment in pension schemes - and a much greater investment still will result from the present changes to the Income Trust Act – the government has a direct responsibility for some action with respect to a national scheme in this country, I recall that last year we were told that over $30 million was lost to the federal government owing to pension schemes, and that sum will probably increase rapidly in the future. Future contributions, deductions and so on will make for even faster growth than in the past and I think that in the present occasion is a splendid opportunity for the minister, in the words of Winston Churchill, to “bring the magic of the law of averages to the rescue of millions who need it at this time.”

Mr. Harris: “On the other hand, there is no question at all in my mind but that stability of income and security for the future do work out to the advantage of the taxpayers of Canada generally, because such security minimizes the number of occasions on which emergency measures might have to be taken here in order to look after persons who otherwise might have been able to look after themselves through this kind of pension program that the hon.member has in mind. I merely say this to indicate that the Minister of Finance is not disinterested about seeing that adequate security and income is provided at all times

The Deputy Chairman: “shall the resolution carry? Some hon. Members: “Carried” The Deputy Chairman: “I think that completes the paragraphs.”

In these seminal comments that addressed the original policy intent of RRSPs of matching the benefits otherwise only available to that subset of the Canadian population that belonged to pension plans, you will see the words “discriminated against by the legislation”, “in the invidious position of not being able”, “as would have been the case had they been contributing to approved plans” and “the Minister of Finance is not disinterested about seeing that adequate security and income is provided at all times”.

These are most instructive to the current circumstances of the so called Tax Fairness Plan, that sees all of these seminal objectives of the RRSPs original intent being violated, in which pension funds can evade the payment of the onerous 31.5% tax on publicly traded income trusts, by the mere act of taking them private, whereas this is an option that is precluded from the 75% of Canadians who rely on RRSPs in the belief they would entitled the holder to “the right to full security that would be provided by such a national scheme”, which under Jim Flaherty’s income trust policy they do not.

(4) The tax arbitrage embedded in the income trust tax discriminates in favour of pension funds and against RRSPs

Tax arbitrage is defined as “Trading that takes advantage of a difference in tax rates or tax systems as the basis for profit”

Mr. Flaherty’s income trust tax policy is a policy that created a difference in tax rates for income trusts on the basis of whether an income trusts is public, and taxed at 31.5%, versus an income trust is private, and taxed at zero. This creates a huge incentive to “trade” income trusts from public to private, as “the basis for profit. This particular “trade” is only something that is available to pension fund and not to RRSPs, since RRSPs are precluded from holding private investments. This “carve out” provision for private trusts to be free of the 31.5% tax, is an unfair proposition and contrary to the basis on which RRSPs were created in the first place. This condition is also contrary to the views expressed by your association in the letter referenced above since this arrangement violates your principle of “not being treated differently than any other income trust investor”, except in this instance it is RRSPs that are being disadvantaged as opposed to pension funds.

Be it discrimination or reverse discrimination, neither is acceptable to our association and I would hope the same holds true for your association.

Compounding this problem is the fact that many public trusts have been acquired by pension funds and taken private. The vast disparity in value that arises when one party incurrs a 31.5% tax on distributions, and the other does not, creates a large “profit” for pensions funds who engage in this predatory practice. Take for example the going private takeout of Teranet Income Fund, which is the monopoly land registry system for Ontario, which was taken private in a hostile bid by OMERs. Not only was the bid by OMERs hostile, they actually exploited the absence of competing bidders to lower the price they originally agreed to pay. That event was covered in a Globe and Mail; article entitled “OMERS cuts Teranet bid because it can:.

Quite apart from the dynamics of that one example, the thing that all these go-private takeout of trusts by pension funds have in common is that $1.00 of distributions that previously was worth $1.00 inside an RRSPs is now going to be worth only $0.685 to an RRSP, but still worth $1.00 to the pension fund.

Given that the value of an income trust in the marketplace is almost exclusively derived from its level of distribution payment, it is clear that this unlevel playing field is rife for exploitation by the pension funds and to the disadvantage of RRSP holders. Not only do these forced sellers, faced with a looming 31.5% tax not receive any takeover premium relative to the undisturbed price (had the tax not been operative) they are faced with the valuation that is ascribed to the newly reduces $0.685 rather than the $1.00 distribution. The difference is the “profit” referred to in the definition of tax arbitrage above.

This tax arbitrage opportunity has been exploited in these “going private” transactions by pension funds:

OMERs: Teranet Income Fund $2 billion (September 2009)
Caisse: Legacy Hotel Income Fund $815 million (August, 2007)
OMERs: Golf Town Income Fund $237 million (August 2007)
PSP: Thunder Energy Trust $419 million (April 2007)
BCIMC: CHIP Income Fund: $1,265 million (August 2007)

(5) Pension Income Splitting in not a salve, but rather a compounding inequity

Pension income splitting was offered up along with the income trust tax as if it were some type of salve for the immense financial damage that had been inflicted on income trusts investors, without warning and without justification, given that tax leakage did not actually exist. Rather than acting as a salve, the manner in which this tax break has been administered is grossly unfair to seniors as it only benefits 14% of seniors to the exclusion of 86% of seniors, and requires that a senior have qualifying pension income. Something that income trust investors are least likely to have, as income trust investors are almost exclusively without pensions and therefore without pension income. This pension income splitting benefit is worth up to $12,000 in after tax income for those senior couples lucky enough to benefit from it.

I would not normally mention income splitting with you, as it is a benefit that extends beyond the mandate of the pension funds that your association represents, and is an “out of plan” benefit, except however certain of your association’s members did make this association between those matters of Mr. Flaherty’s omnibus trust tax policy that were “in plan” with those aspects of his policy that were “out of plan”, namely the matter of pension income splitting, as per this press release from OTPP:

November 1, 2006

Teachers' response to new federal income trust policy
The Ontario Teachers’ Pension Plan has advocated for a taxation policy on income trusts that does not discriminate against pension funds, and we are pleased to see that this is the case with the government’s announcement yesterday (October 31, 2006).

The reality is that, in a protracted period of low interest rates, it is important to find alternate investments with yields that help make up the difference. Income trusts have allowed us to do that in recent years. The challenge will be to find the investment vehicles that will replace the income and cash flow that income trusts have represented to us, but we are confident that our investment team will find them. The four-year implementation period for this new policy will enable us to gradually make any necessary adjustments to our portfolio.

There is good news for pensioners and other seniors over age 65 in this new policy, which will help take the sting out of the new tax policy on income trusts for them: the age exemption tax credit will be increased by $1,000 and income splitting will be permitted.

Contact: Deborah Allan, Director, Communications and Media Relations, Ontario Teachers' Pension Plan, (416) 730-5347, deborah_allan@otpp.com

For income trust investors who are among the 75% of Canadians without pensions, there was no such silver lining in the income trust tax, as they did not benefit from pension income splitting and nor were they able to evade the 31.5% income trust tax by the mere act of taking an income trust private, instead they were left with only the “challenge will be to find the investment vehicles that will replace the income and cash flow that income trusts have represented”, which has become a virtually impossible task, as there are no such alternative investments in the public markets, which means the 75% of Canadians without pensions will suffer a major dimunition in their retiremnt income and a corresponding decrease in their standard of living. Or what I call the hidden pension deficit crisis. The one you NEVER hear the politicians, policy makers or the press even talk about or acknowledge.

(6) Marshall Savings Plan Solution:

Fortunately there is a solution to address the mess that has been created by Mr Flaherty’s rash and ill-conceived income trust policy for inclusion in Budget 2010. Apart from its many virtues of this proposed solution known as the Marshall Plan is that virtue that this solution is a face saving solution for the Harper government. This solution was conceived of by our association on behalf of two or our association’s members, David and Lorraine Marshall of Cornwall Ontario, and on behalf of the 75% of Canadians who are without pensions and all other members of our association

Rather than explaining the policy for you here, I will refer you to the Diane Francis article of January 19, 2010 entitled “Tories must correct income trust blunder The Marshall Plan”

That article is available here: http://network.nationalpost.com/np/blogs/francis/archive/2010/01/19/tories-must-correct-income-trust-blunder.aspx

I would also refer you to the extensive feedback that we have received from Canadians across the country in support of the Marshall Plan. This feedback will soon be available on the website we are launching entitled MarshallPlan.ca, but for the meantime is available here:

http://caiti-online.blogspot.com/2010/01/200-reasons-to-adopt-marshall-savings.html
http://caiti-online.blogspot.com/2010/01/another-200-reasons-to-adopt-marshall.html

Here are a few selected comments:

St. Albert, Alberta Comments: For many years of my wife & I owned and operated a small business. Since we were among the estimated 75% of Canadians without pensions, we invested heavily in income trusts for our retirement income, based on Harper's election promise/lie to not raid senior's nest eggs by applying any new taxes to them, which he broke 10 months later. The net result of this reneged promise and the unproven allegation of tax leakage (witness the finance department's 18 pages of blacked out documents, end result of foreign takeovers of trusts etc.) was an irreplacable loss in all of our retirement accounts of over $300,000 and a much reduced retirement income.
Please do what is the right and responsible thing to do---resolve this income trust fiasco and implement the proposed Marshall Savings Plan to restore the chance of seniors to provide for themselves the retirement income that we diligently planned and saved for most of our lives.

Terrace Bay, Ontario Comments: The Marshall Plan would seem to be an excellent way to start to earn back some of the respect lost by the ambush of the most vulnerable members of society - those whose sole source of income are the fruits of their own careful investment choices. Broken promises (i.e. - lies) have no place in government, especially when they are so blatant and damaging to such a wide sector of the people.

Caledon, Ontario Comments: Restore a level playing field between the 75% of Canadians without pensions (RRSPs) and the 25% of Canadians with pensions

Joliette, Québec Comments: J'espère que vous voudrez aider les gens à la retraite qui n'ont pas de pension comme les élus. Nous avons besoin d'un revenu minimum et de bénéficier du revenu d'entreprises stables et matures qui ne visent plus à grossir.

Conclusion:

Thank you very much for taking the time to speak with me on the phone yesterday and for turning your attention to the troubling matters contained in this letter. I hope your association can see its way to supporting our proposal for the creation of a Marshall Savings Plan to arrest and partly correct the damage caused by Mr. Flaherty’s income trust tax and to restore a measure of fairness and equality of treatment and investment opportunity as between the 75% of Canadians without pensions and the 25% of Canadians with pensions.

Alternatively, serious consideration should be given in Budget 2010 to rescinding the Tax Fairness Plan in its entirety and in all its manifold inequity of outcomes.

I don’t think it behooves your association or the members of your association to be advocating for government policies that seek equal treatment for you in one instance, while on other occasions being acceptant of policies that result in unequal treatment for others. For principles such as fairness to even be considered principles, means that they must be adhered to consistently and uniformly, rather than selectively and arbitrarily, as has occurred and continues to occur under that abuse of the English language and abuse of moral principles known as the Tax “Fairness” Plan.

Please let me know if I can be of any further assistance to you on this matter, and we look forward to your association’s support in ensuring that no investor “be treated differently than any other income trust investor”, as presently exists today under a policy that needs to be rescinded or remedied via the Marshall Savings Plan.

Yours truly,


Brent Fullard
President and CEO
Canadian Association of Income Trust Investors/Taxpayers
www.caiti.info

647 505-2224 (cell)

cc. Members of CAITI and the 75% of Canadians without pensions.



Independent economists discredit govt tax leakage claims

OTTAWA, Feb. 1 /CNW Telbec/ - In remarks delivered to the House of
Commons Finance Committee Thursday, Dennis Bruce, Vice President of HLB
Decision Economics Inc., provided data and supporting documentation to
discredit the Department of Finance's tax leakage claims.
"The department is sharply overstating tax leakage," said Mr. Bruce, who
added that there would be minimal costs associated with a 10 year phase-in of
the new tax on income trust distribution payments.
HLB Decision Economics, an Ottawa-based independent consulting firm that
provides analytical consulting services to industry and governments worldwide,
has been working on behalf of the income trust sector to develop a comparative
analysis of taxes generated under the income trust structure versus the
corporate structure.
Mr. Bruce told committee members that his firm worked with the Department
of Finance as it prepared the federal government's 2005 consultation paper on
the tax effects of income trusts. Specifically, HLB was asked by the
department to develop a common methodology and assumptions for deriving tax
leakage estimates.
Mr. Bruce said that HLB and the Finance Department achieved consensus on
the methodology with one exception - they disagreed on whether to include
deferred taxes. Deferred taxes are derived from distributions, capital gains,
and dividends received in tax exempt accounts. While they are not immediately
taxable, they are taxable upon withdrawal from such accounts.
"The discussions that you are hearing about deferred taxes reflect
confusion about budgeting convention versus policy analysis," said Mr. Bruce.
"While federal budgeting is done on a current basis, federal policy analysis
is done on a life-cycle basis. Accounting for the life-cycle effects of tax
changes, namely deferred taxes, is appropriate in the consideration of tax
policy."
Mr. Bruce went on to outline the factors that resulted in the differences
between HLB's tax leakage estimates and the tax leakage figures put forward by
Finance Minister Jim Flaherty. These factors include:

<<
1) The Department's assumed effective corporate tax rate for energy
trusts fails to reflect the reductions in the tax rates for resource
corporations from 2004 through 2006, from 27.12% to 24.12%. This
results in an overstatement of tax leakage of $84 million;
2) The Department's figure for income trust units held in tax exempt
accounts is overstated. Derived from data from surveys, Statistics
Canada, interviews and Scotia Capital Markets data, the percentage of
units held in tax exempt accounts is 31 percent, less than the
Department's 38 percent estimate. This results in an overstatement of
tax leakage of $125 million;
3) The value of deferred taxes is excluded from the Department of Finance
analysis. This results in an overstatement of tax leakage of
$80 million; and,
4) The Finance Department's atypical inclusion of the impact of limited
partnerships, which reduces the tax leakage to $45 million.
5) The impact of future legislated tax changes post 2010 has not been
accounted for. Doing so reduces the ongoing federal tax leakage after
2010 by $232 million.

Mr. Bruce stressed that the discrepancies between HLB and the Finance
Department led his firm to conclude that the Finance Department is "sharply
overstating tax leakage."

Specifically, HLB concluded that:

- Federal tax leakage for 2006 was $164 million, not the
half billion dollars stated by the Department; and,
- Ongoing tax leakage, post 2010, after taking into account legislated
tax changes, is $32 million per year, about five percent of the
Department's figures.
>>


For further information: Dennis Bruce, Vice President, HDR - HLB
Decision Economics Inc. (613) 234-0080; Cell: (709) 632-1708