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Daniel Ferguson's Submission in Response to Finance Canada's Tax and Other Issues Related to Publicly Listed Flow-Through Entities (Income Trusts and Limited Partnerships) consultation:
September 29, 2005
Department of Finance
17th Floor East Tower
140 O'Connor Street
Re: Department of Finance's FTEs Consultation Paper
This letter represents my submission with respect to the referenced issue and I submit same in my capacity as a Canadian citizen and resident of Ontario.
I must begin by congratulating the Department of Finance on undertaking this consultative process and soliciting input from all concerned. I sincerely hope that the Department of Finance will follow through on this positive start by ensuring that the process remains transparent and constructive until completion.
I have the following general observations on the FTEs issue as defined and the Department of Finance's related consultation paper.
1. I have very little confidence in the tax dollar amounts contained within the consultation paper. This reflects the very poor track record which the Department of Finance has exhibited in financial forecasting matters over the past decade (eg, projected federal surplus amounts) as well as the multi-variable assumptions built into the forecasts discussed within the consultation paper. While I am sure that there will be no lack of submissions which will address this issue in much greater technical detail, I would much prefer the analysis to be based on facts rather than assumptions. To the best of my knowledge, each of the public FTEs existed in some non FTE corporate form before their conversions into FTEs. Surely, one form of analysis would be to look at the taxes paid by said companies, their lenders and their owners pre the conversion and compare same to taxes paid post conversion. While some normalization would be required to ensure an apples to apples comparison, this type of analysis would by its nature add a great deal of credibility (or otherwise) to the related forecasting models.
2. Business FTEs, as defined within the consultation paper, are still in their relative infancy and have not yet undergone underlying major stress conditions such as high interest rates, high inflation rates, etc., which would test how the managers of the FTEs would perform and how investors in the relevant FTE securities would react. Underlying conditions have generally ranged from benign to positive for Canadian FTEs over the past 5 years and the Department of Finance's analysis should extend to considering a range of outcomes including those arising in a material economic downturn.
3. The underlying fundamental issue relates to the individual taxpayer more so than legal business organization forms. Said individual taxpayer is the one who ultimately owns shares in corporations or income trust units and who is the contributor to and beneficiary of pension plans and registered retirement savings plans and who is the owner of units in mutual funds which purchase securities. In my opinion, this fact is as certain as death and taxes and the Department of Finance must ensure that it addresses the issue from the end investor's perspective and not simply as a legal and accounting issue related to organizational form.
My specific observations on the FTEs issue are as follows:
1. At a time when so many macro financial variables are negative insofar as Canadians are concerned (eg, consumer debt, savings rates, underfunded corporate pension plans, massive governmental spending, low relative productivity growth), the recent performance of the FTEs has been outstanding as reflected in their absolute and relative growth. While the underlying economic conditions have materially assisted same, I believe that the investor's ability to obtain a generally stable to increasing monthly/quarterly cash distribution from individual FTE investments have allowed investors to increase their confidence that they will be able to successfully manage their ongoing or future retirements.
2. The discipline on FTEs managers of having to make a regular cash distribution (together with the perception that the ongoing rate of distribution will remain stable) appears to have materially sharpened their focus on ensuring that any capital expenditure and/or business acquisition must prove itself worthy. This managerial discipline must be positive with respect to improving efficiencies and productivity. The FTEs investor's ability to influence management by participating or declining to be involved in a follow-on units offering provides more tangible empowerment to an FTE investor and reduces the chances of an inefficient/unproductive investment decision by management.
3. The Department of Finance itself refers to double taxation in its discussion of the current dividend tax credit rules. I do not believe that the concept of double taxation is consistent with efficiency and productivity concepts and that it is more logical to reform the corporate dividend tax rules to reflect the existing FTEs tax treatment than it is to impair the FTEs tax rules to match the inefficient dividend tax approach.
4. Given the ever increasing economic and financial convergence between Canada and the United States, a modification of the dividend tax rules as opposed to the FTEs tax rules would be more consistent with the tax landscape applicable to American investors. This approach would likely make Canadian securities more attractive to foreign buyers which would be a positive development for Canada's economic health.
5. If Canada continues to build on the productivity and efficiencies inherent within the FTEs, it will likely be very positive insofar as capital market revenues are concerned and may provide an actual competitive advantage. Today's announcements by IPL.UN and SPF.UN of material business acquisitions in the U.K. and the U.S. respectively are but one day's examples of what would likely be an expanding trend.
In conclusion, I believe that the Department of Finance has performed admirably in facilitating the material growth of the Canadian FTEs market to date and in laying the groundwork for the further expansion of same. The revision of the dividend tax credit rules to reflect the FTEs approach so as to level the playing field is the only material tax modification which I view as being necessary. A congruent FTEs / dividend tax credit approach would be good for Canada's competitive position and engender greater productivity and more liquid and vibrant capital markets. These outcomes must be directionally positive for governmental revenue generation in general and specifically given the Department of Finance's own recognition that income retained within a corporate entity generally bears less tax than income earned at the personal level. The ongoing distribution of cash by FTEs directly to individuals on a current or deferred basis (ie via pension plans and/or RSPs) ensures that the government maintains overall control of tax revenues at the personal level which appears to me as completely congruent with a one person / one vote form of government.
Thank you for your attention to this matter and the best of luck in your deliberations the outcome of which will likely be of significant economic and political import.