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Gordon Pape'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: Department of Finance

From: Gordon Pape
Re: FTE review
Date: Nov. 18/05
416-445-3382

Toronto Ontario

Any action in the trust sector must be based on one overriding principle: fairness.

The financial community and individual investors have every right to expect the government to play by the rules it established. Everyone who purchased shares in an income trust or units in a mutual fund that invests in them did so under a structure that was put into place by Ottawa and allowed to flourish for more than a decade. Trusts that were created during that time acted in accordance with the law of the land, in many cases securing advance tax rulings to ensure they were in full compliance. No government should attempt to turn back the clock and penalize those who acted legally and in good faith.

If the government views the trust sector as a potential threat to future revenues, there are steps that can be taken to curb its growth without harming those who based their decisions on the laws that prevailed at the time. Here are my suggestions:

Impose a tax on new trust conversions. One way to reduce the rush to trust conversion would be the imposition of a one-time Trust Conversion Tax. This might be based on the net assets of the entity being converted. The percentage of tax should not be so high as to preclude all new trust conversions but high enough so as to make the decision less clear-cut. Such a tax would raise additional money for the government without penalizing existing trusts.

Introduce a public offering tax. Alternatively or conjointly, implement a tax on new public offerings of trust units. This would apply to both initial public offerings (IPOs) and to the issuing of additional shares by existing trusts. The percentage of tax would need to be carefully calculated so as to produce more tax revenue without destroying the market.

Introduce a pension plan purchase tax. In his 2004 budget, Mr. Goodale tried to put a 1% cap on pension plan holdings of business trusts. The plan failed for a variety of reasons. There has been talk of resurrecting the idea. I suggest it's a non-starter. A compromise could be to impose a small tax (say 5%) on the purchase of business trust units by large pension plans. Personal plans like RRSPs and RRIFs would be exempt. To illustrate how this might work, as of March 31 the Canada Pension Plan held about $310 million worth of trusts in its portfolio (market value). A 5% purchase tax on that amount would generate more than $15 million in tax revenue. Apply that across the entire pension plan universe and it would add up to a significant amount of money.

Tackle the foreign ownership issue. One of the big problems with trusts from the government's perspective is that they have been too successful. Americans, desperate for cash flow, have invested billions in them. Because of the Canada-U.S. tax treaty, Ottawa can only withhold 15% from distributions paid outside Canada. That's much less than would be collected from most Canadian taxpayers.

One proposed way to deal with this is to increase the withholding tax to, say, 25%. But this approach fails the fairness test. Foreign investors don't vote here but that does not mean that they should be treated unjustly. A better solution would be to tighten the foreign ownership restrictions on trusts, with long-term transitional provisions for existing trusts that exceed the revised limit.

Make dividends more attractive. Our system of taxing dividends is clearly unfair. Profits are effectively taxed twice, once at the corporate level and again in the hands of investors when dividends are paid out. This is one of the compelling attractions of the trust structure. This double-dipping has always existed but most people have forgotten that a decade or so ago the dividend tax credit was more generous. A reversion to the former system is the very least the government should do. Ideally, we should follow the Australian model which eliminates double-taxation entirely.

Some combination of these ideas should allow the government to deal with any concerns about the trust sector without harshly affecting existing stakeholders. But whatever the government does, it is imperative that all interested parties be treated fairly. Imposing punitive rules retroactively would cause serious financial hardship to tens of thousands of retirees and would greatly diminish Canada's credibility as a reliable place to invest.