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Kevin L. Klippenstein'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:
To Whomever it may concern:
Let me start by stating that I am a Chartered Accountant and a Chief Financial Officer at a privately held company. I have no bias related to involvement in the investment industry or as a result of my position of employment. I am simply stating my opinion as someone who is an informed, interested participant in Canada' business environment and is very interested in the financial health of our country. I have not written a submission like this before but am extremely passionate on the topic of income trusts.
The current debate on income trusts greatly over complicates the issue. Income trusts are not some mysterious financial tool which creates profits or cash flow. It simply defers the payment of taxes on profits.
An income trust is one of several formats around which a business can be structured. The other obvious options are: a corporation, a partnership and a sole proprietorship. When the management team of a business selects one of these structures for a business there are a number of key factors which influence the choice and the most significant is the tax treatment of profits. At one end of the spectrum is a sole proprietorship where all profits are taxed each year in the hands of the business owner. In the middle is the corporation where the option is given to pay taxes at a corporate rate, which is lower than the personal rate, and to reinvest in the business or to pay out profits to the business owners. At the far end of the spectrum are income trusts which do not pay income taxes but otherwise largely enjoy the benefits of being structured like a corporation. This means profits are paid out to shareholders without any tax being paid and if these shareholders have their investments in a retirement plan (e.g.. RRSP) the tax won't be paid until the shareholder removes the funds from the retirement plan.
The result is that investors are willing to pay more for ownership in a business where they will receive pre-tax dollars in their retirement plan as it increases the funds available to reinvest. As an investor and someone who will spend the next twenty-five years saving for my retirement I like this concept. However, the benefit to investors is too big and it is resulting in unintended consequences which are distorting Canada's financial landscape.
Income trusts were created as a tool for specific situations where a business had a defined life and sold a non-renewable resource like a coal mine. They were not intended for Royal Bank, A&W or CI Financial. However, the premium an investor is willing to pay for pre-tax cash flow is so significant that there can not be a company in the country which has not considered becoming an income trust. And here-in lies the issue.
To be extreme, if every corporation in Canada became an income trust there would be no one left to pay corporate income tax. Now I am not a fan of our income tax system, but I am realistic and realize the apocalyptic implications on our country's finances if the corporate tax base continues to be significantly reduced by the conversion of businesses into income trusts. I would argue that the current loss of $300,000,000/yr is already significant.
I believe there are only 2 possible outcomes from this debate:
1) The government does nothing: in this scenario the trust conversions continue to accelerate and our tax system is thrown into disarray;
3) The government equalizes the tax status of income trusts and corporations: this removes the motivation for corporations to convert into trusts and protects the tax base from which the Government of Canada derives much of it's revenue.
If the government does nothing it is effectively stating that it does not need the tax revenues currently earned on corporate profits. If this is the case it should simply eliminate corporate income taxes entirely and eliminate the suspense.
This is a simple, off the cuff submission which I believe summarizes the sentiments of many business leaders. Please take it seriously.
Kevin L. Klippenstein, C.A.