Today's Hill Times: Adopt the Marshall Plan

Stop the income trust bleeding: adopt the Marshall savings plan

Whether the PM and the finance minister put the MSP into the coming March 4, 2010 budget depends on their political savvy.

Adopting the MSP could lance the large boil of justified anger caused by the 31.5 per cent tax on income trusts.

By W.T. STANBURY
Published February 8, 2010
The Hill Times

Due to the scale and scope of their activities, when governments make errors, the consequences can be devastating—even generational. The Harper government's 31.5 per cent tax on income trusts announced on Oct. 31, 2006 caused a permanent loss of $35-billion in investment value of Canadians' savings. This figure does not include the unintended consequences, the most notable of which is the ongoing takeovers risk facing the 220 targeted public trusts by foreigners, and on going private transactions by public sector pension plans, as their means to avoid the tax. The result was a significant loss of tax revenue for the federal and provincial governments. In summary terms, the income trust tax has been a public policy train wreck for the Harper government (see Stanbury, The Hill Times, Sept. 22, 2008).

Ironically, the tax on trusts was never intended to generate much revenue. Its clear purpose was to eliminate a particular type of business organization favoured by investors. Why? It appears that secret lobbying by a small number of leaders of regular business corporations, fearful of the growing competition from the favoured trust model, along with vague (and highly questionable) arguments about the adverse effect of trusts on investment and growth, were influential with the minister of finance and the PM. The government's arguments were based on "tax leakage" and "fairness." Both arguments were soon proven to be false. They fuelled the intense, innovative and prolonged campaign to change the tax by the Canadian Association of Income Trust Investors/Taxpayers (see Stanbury, The Hill Times, Feb. 23, 2009).

A Surgical Salvage Operation

Today's challenge is how to contain future adverse economic effects of the error made on Oct. 31, 2006. This is possible for two reasons: The first is an extraordinary example of "distributed intelligence" in the form of the Marshall Savings Plan (MSP) proposed by David and Lorraine Marshall, retirees and residents of Cornwall, Ontario to their MP. The second is that, ironically, the transition period built into the tax can now be used to move the remaining 169 affected trusts into the MSP because the tax does not start until Ja.1,2011.

The influential columnist Diane Francis has called the MSP "a brilliant idea" (National Post, Jan. 14, 2010). It has gathered other reputable supporters (see IncomeTrustResearch.com, Jan. 22, 2010).There is now a website devoted to it: www.marshallplan.ca. An edited version of the Plan is in Appendix 1.

For a government closely identified with a policy decision gone bad, changes are very hard to make. However, the Marshall Plan does not involve recanting the 31.5 per cent tax and delivers a simple and elegant solution. Thus the MSP permits the Government to "save face." That is of great significance (see Stanbury, The Hill Times, Dec. 21, 2009).

Whether the PM and the finance minister put the MSP into the coming March 4, 2010 budget depends on their political savvy. Adopting the MSP could lance the large boil of justified anger caused by the 31.5 per cent tax on income trusts.

There are other major benefits which I now outline.

Benefits of the MSP

The MSP will help the 75 per cent of Canadians without a defined benefit pension plan to restore a valuable retirement income vehicle.

The MSP will create net tax revenue estimated at $6-billion per year based on income trust distributions of $16 billion per year from the remaining 169 income trusts taxed at an average rate of 38 per cent (according to the Department of Finance). This is the equivalent of an increase in the GST of 0.75 per cent.

The MSP will eliminate future takeovers of the affected 169 income trusts by foreign corporations, foreign state-owned entities and foreign private equity. This halts further erosion of Canada's tax base.

It will restore a level playing field between the 75 per cent of Canadians who rely on RRSPs/RRIFs for their retirement income with the 25 per cent of Canadians with defined benefit pensions (e.g., OTPP). The latter are able to own income trusts (privately) and avoid the 31.5 per cent tax on income trust distribution, whereas RRSPs can not.

The MSP will promote saving and investment and direct retirement savings into real investment in the Canadian economy.

Conclusion: The MSP provides the Harper Government with an elegant and savvy means of containing the adverse consequences of their serious mistake in October 2006. It should be implemented in the coming budget and have the support of the Liberals.

Appendix 1: Outline of the Marshall Savings Plan

The MSP is a new retirement savings vehicle designed to eliminate further damage from the government's 31.5 per cent tax on income trusts announced on Oct. 31, 2006.

The MSP is a hybrid of the existing RRSP and the TFSP (the federal government's tax free savings plan) and combines concepts from both and maximizes tax revenues for Ottawa, as follows:
(1) As with RRSPs, monies can be contributed to MSPs from individuals' pretax earnings in amounts equal to the contributions that can presently be made to RRSPs, and a taxpayers' contribution limit can be apportioned between an RRSP and/or MSP.

(2) All trust distributions earned in a MSP are taxable in the hands of the holder of the account, in the year received. Thus, more tax dollars are collected by Ottawa relative to either RRSPs or TFSPs.

(3) All capital gains earned in a MSP can be deferred under circumstances where new securities are purchased during a six-month period, consistent with the Conservative Party's election promise of 2006, to provide capital gains rollover, although restricted to MSPs only. This will result in significantly more tax dollars than from TFSPs, and will raise no less tax revenue than RRSPs, in which gains can be deferred.

(4) The former RRSP holdings of income trusts, moving into MSPs, will attract a cash tax averaging 38 per cent (according to the Department of Finance) thereby eliminating the claimed tax leakage. Thus, as with taxable accounts presently, there is no need for the 31.5 per cent tax on MSPs come Jan 2011. To facilitate the payment of these cash taxes to Ottawa, all income earned within MSPs would be available for payout to the account holder.

(5) For a transition period of 12 months following budget 2010—when the MSP should come into effect—Canadians will be allowed to transfer their holdings of income trusts in their RRSP to an MSP without triggering a deemed disposition.

(6) The cost base of such transferred income trusts will be assigned a value of zero, which is the effective cost base of these income trusts within RRSPs, for tax purposes. Importantly, this means Ottawa is "kept whole" on any capital gains taxes.

(7) The existing 31.5 per cent tax will continue to come into effect for all income trusts held in RRSPs , exactly as planned on Jan. 1, 2011. However, the government would be well-advised to remove this tax insofar as foreign investors are concerned and/or lower it substantially.

W.T. Stanbury is professor emeritus, University of British Columbia. He has never held any income trust units. news@hilltimes.com