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Greystone'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:

November 21, 2005

Denis Normand
Tax Policy Branch, Business Income Tax Division
Department of Finance
17th floor, East Tower
140 O'Connor St.
Ottawa, Ontario
K1A 0G5

Dear Mr. Normand:

SUBJECT: Tax and Other Issues Related to Publicly Listed Flow-Through Entities

(Income Trusts and Limited Partnerships)

Greystone Managed Investments Inc. is pleased to comment on issues related to publicly listed flow-through entities (income trusts and limited partnerships).

Greystone Background

Founded in 1988 and headquartered in Regina, Saskatchewan, Greystone is an independent investment counselor. We are one of Canada's largest money managers, overseeing $25 billion in assets, and rank as the 8th largest manager of Canadian pension investment assets. We have in-house expertise in management of bond and short term asset classes, commercial mortgages, Canadian equities, US equities and real estate.

Greystone is a tax-paying Canadian corporation majority-owned by its employees – nearly 50 individual, tax-paying Canadians who work every day in the business of serving approximately 200 clients located from coast to coast in Canada. Our clients include corporate and public pension funds, educational institutions, foundations, trusts and charities, religious orders, trade unions, hospitals and cultural organizations. Through select third-party affiliations, we also serve private individual investors.

Income Trust Matter 

It is the Greystone view that the current rhetoric surrounding "income trusts" is largely misplaced. For example, debating the theoretical magnitude of the so called "tax leakage" resulting from income trusts is a totally unproductive exercise without conclusion. Alternatively, assertions that investors seeking high current income are about to be unfairly disenfranchised are exaggerated and unjustified. All participants to this debate need to pause, take a step back and consider what really is important.

In our opinion, the focus of this issue should centre on the long-term best interests of the Canadian economy and the competitiveness of Canadian capital markets. The reality is that Canada is a participant in a dynamic global market place that offers vast opportunities, but one that at the same time has become intensely competitive. Accordingly, it is mandatory that Canada find ways to competitively position itself in this global market. If the Canadian economy is going to thrive in this environment, it must continually find ways to enhance its competitive position. This is a challenge that will require an ongoing commitment by both the private and public sectors.

Income trusts and related vehicles are relevant to the long-term interests of the Canadian economy, because their operation transcends taxation policy, strategic corporate planning and investment decision-making. Each of these factors will necessarily have a material impact on Canada's competitiveness and economic future.

At issue here is something far more fundamental than simply some tax revenues being lost by federal and provincial treasuries. The problem is that, because of flawed past initiatives, current taxation policy is having unintended consequences for corporate and investment decision-making. Our fear is that decisions at these levels are being unduly influenced by ill-founded considerations, and as result, will be detrimental to the future vitality of the Canadian economy.


Recommendation #1: Level the playing field.

Eliminate the difference in corporate taxation as between dividends and trust unit distributions.

Greystone does not believe that taxation policy should discriminate between corporate structures with respect to current income payout. The inequitable tax treatment of dividends versus trust distributions is seriously distorting corporate and investment market decision-making.

In basic terms, income trusts exist to avoid the double-taxation of corporate earnings payout. However, because the fundamental objective of an income trust is to maximize current payout, it necessarily precludes any meaningful corporate reinvestment of earnings. In our view, this is a very negative distraction for corporate strategic planning.

A key responsibility of a company's management and its board of directors is to establish a balanced payout ratio. That is, a determination of the portion of the firm's profits that is required for its ongoing maintenance and investment in growth opportunities versus the portion that should be paid out to owners as a return on their investment. It may be that a high payout ratio is appropriate for a particular company's circumstance, but that decision should be based on business fundamentals, not on the tax treatment of a particular corporate structure.

Management and boards should focus solely on the long-term best interests of the firm and not be distracted by outside influences regarding earnings payouts. Reinvestment of corporate earnings is far too important an element of Canada's future economic growth to be put at risk by arbitrary taxation rules.

The role of investment markets is to contribute to the efficient allocation of capital within the economy. Prejudicial income taxation biases investment decision-making and thus market valuations. Because of biased valuations, markets are not fully efficient and the optimal allocation of long-term investment capital is being compromised.

Greystone believes that the Canadian stock market does a thorough job of evaluating management's performance with respect to maximizing return on a firm's assets (real and human), investing for future growth and setting a payout ratio that is both fair and sustainable. However, market prices also reflect the realities of after-tax consequences for investors. For corporate income payout to be taxed in dramatically different ways is illogical and therefore, not surprisingly, distorts market valuations. The disparity is so large that many Canadian Chief Executive Officers feel compelled to recommend that their companies switch to an income trust structure. Of course, the more corporations that switch, the greater the impediments will be to earnings reinvestment and sustainable growth.

Curtailing incentives for real corporate investment is not a good thing for Canada's future. Therefore, we recommend that the differences in taxation of corporate earnings payouts be eliminated.

Recommendation #2: Reduce/eliminate rather than increase corporate taxation.

Level the playing field by reducing/eliminating various aspects of corporate taxation, not by introducing new forms of taxation.

In our view, the controversy surrounding income trust s and taxation policy is symptomatic of a far more fundamental problem: aggregate Canadian corporate taxation is too high. We consider the immense popularity of income trusts as clear evidence that investors feel taxation is taking far too large a share of their returns as risk takers. Returning to the theme of the long-term best interests of the economy, Canada needs risk takers, and will require increasing amounts of risk capital into the future. In formulating tax policy, governments have a fiduciary responsibility to all Canadians to ensure that from a tax perspective, risk takers are competitively rewarded. This is a necessity if adequate risk capital is going to be attracted into our economy. Sustained growth and prosperity hinge upon this occurring.

Canadian corporate taxation rates are disproportionately high and uncompetitive with our major trading partners. Canada has the admirable record of eight successive years of a fiscal surplus, an accomplishment not shared by any other G7 country. However, far less admirable is that Canada has the second-highest combined corporate income tax rate in the G7, as reported by the OECD.

More troubling are the reports (Attention G7 Leaders: Investment Taxes Can Harm Your Nations' Health and 2005 Tax Competitiveness Report: Unleashing the Canadian Tiger), published earlier this year by the CD Howe Institute. The attendant study assessed a broader definition of corporate taxation. In addition to income tax, it also considered depreciation rates, sales taxes, financial transaction taxes and other levies. On this basis, Canada has the second-highest "effective tax rate" for medium and large sized corporations among 36 industrialized nations. In other words, Canada's all-in taxation on returns for corporate capital risk taking is abysmally uncompetitive. We find this very ironic, given the high expectations Canadians have for their comparative standard of living. If the current circumstance does not change, then these expectations are doomed to major disappointment.

Therefore, we recommend that the overall corporate taxation rate be reduced and that all double-taxation of returns to owners be eliminated. Canada not only has to meet its competition in this regard, but go further if Canada's economic future is to be secured.

Recommendation #3: Evaluate tax reform as an investment not a revenue item.

Evaluate corporate tax reform as an investment program rather than a reduction in a revenue item.

Greystone believes that there is a clear and well-established relationship between levels of taxation on corporate capital and rates of sustainable economic growth. Competitive taxation incentivizes risk takers and attracts risk capital. This, in turn, begets investments in innovation and improvements in productivity. Improved productivity generates higher income growth. With higher levels of income throughout the economy, the cycle begins to regenerate itself.

The CD Howe study referred to earlier contains an interesting comparison of effective taxation rates on corporate capital and levels of direct foreign investment. Canada's effective tax rate (second-highest) is 39%; Ireland's is a modest 13.7%. Ireland's direct foreign investment as a share of GDP is an impressive 18.2%, while Canada's is a paltry 3.8%.

Therefore, we recommend that, in the process of resolving the taxation imbalances related to income trusts etc, the Government of Canada go further and address the far larger and more fundamental problem of uncompetitive taxation of corporate capital. The feasibility of this magnitude of reform should not be assessed simply on the basis of its short-term impact on tax revenues. Rather, it should be assessed on its merits as an investment program, similar to the recent initiative for infrastructure investment. Indeed this could be viewed as the most fundamental of all infrastructure investment programs. The Ireland/Canada comparison illustrates the potential for attracting and sustaining much higher levels of direct investment. The subsequent benefits for Canada's economy would be truly remarkable.

We recognize that the Government of Canada has many objectives to prioritize in its budget process. We also understand that what we are recommending would, to a degree, preempt spending on other current consumption programs.

However, leadership taken today on corporate tax reform will serve to dramatically improve Canada's longer-term competitiveness. Improved competitiveness is wealth-creating and as such would ensure the continued viability of other programs.

Canada has the fiscal capacity to act on this initiative; most other countries do not. Accordingly, this is a unique opportunity to create a major Canadian competitive advantage, one that should not be foregone.

Greystone greatly appreciates the opportunity to comment on these issues. If we can provide additional information related to the recommendations outlined in this letter, please contact us.



Greystone Managed Investments Inc.