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William Barrowclough'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:

Response To Request For Comment Regarding The Taxation Of Flow-Through Entities

One hopes that this request for input is real and not just a smokescreen to cover a fait accompli hatchet job done at the behest of some corporate whiners and the mutual fund establishment. One can only hope, and assume, that the request is legitimate and that no decision has yet been made by the bureaucrats; just awaiting a seal of approval by the political leadership.

I shall deal with your questions in order, and try to avoid overlap. I have neither the expertise nor the access to provide my own assumptions regarding figures used in your talking paper. Once again, I must take on faith that they are unbiased and thorough, although I have some doubts.

Question for Consideration:

1. Does the tax advantage of FTEs relative to public corporations have a significant impact on how businesses are organized in Canada?

1. Of course the tax treatment of Flow Through Entities impacts upon decisions regarding how businesses are organized. Just as I take note of tax treatment in selecting my investments, any business leader must be acutely aware of how taxes affect his bottom line. Those who ignored tax structure will soon be shown the door. Surely you don't mean to imply that business should ignore tax policy entirely?

In my view it isn't so much the tax treatment of FTEs which skews the business world, but rather the continued double taxation of dividends which provides a major disincentive to owning even those corporate stocks which do pay a dividend. Once-upon-a-time most corporations paid dividends, but now few do as it is discriminated against by tax policy. If corporate profits were taxed fairly it would do away with one of the major incentives to convert to trust status.

Question for Consideration:

2. Have FTEs had a significant impact on tax revenues? Is there potential for revenue losses to grow in the years to come?

2. FTEs may well have had some impact upon tax revenues, but I question whether your research takes into consideration fully the tax paid on trust distributions by direct owners and by those taking monthly payouts from mutual funds and trusts of trusts. I have no grounds to debate your assumptions, but I sense that they are not universally accepted. In my case alone, I shall be paying over twice as much income tax for 2005 as I did for 2004; and the previous years had increases of about 15% annually. My previous investing in corporate Canada seemed to generate more capital losses than capital gains.

What happens to all of those distributions paid out to eager investors? Those in most need of income spend them, thus stimulating the economy and increasing consumption taxes. Those not immediately in need of income re-invest them in the markets, providing more capital for growth and expansion Surely no one will try to tell me with a straight face that it would be better to leave those dollars with a megalomaniac CEO (surely I need not name names) or with a free-spending government. Keep in mind that I have been a life-long centre-left voter. This is not a reactionary's response.

Yes, if there is tax-leakage now, there may be more in the future. I am not convinced that it is a significant loss, and I would hold that nomatter what it is, it is insignificant compared to the benefits provided by FTEs to their investors and families. Their increased wellbeing will convert to increased prosperity and more taxes paid in the future by us and by our descendants. Only the most short-sighted political argument would put present tax gouging above longer term prosperity.

Question for Consideration:

3. What impacts are FTEs having on investment decisions and the allocation of capital in Canada? Is the overall impact on the economy positive or negative?

3. Yes, money is pouring toward the income trusts. With bond yields so low, what could one expect? When bond yields rise (when, not if) the conservative money will abandon trusts and head back to its normal home in GICs and bonds. You are facing an anomaly, and thus it would not be prudent to change the rules to adapt to what is, by definition, a short-term situation. Personal investment decisions are naturally conservative, so the bond market will win back its natural constituency when the rates get back to more normal levels.

As to corporate and institutional investment, I should think that it is macro issues which are more likely to colour those decisions. Anything with the word Energy in its name is going to attract money like a dot-com back in '99. Some struggling manufacturer trying to compete with Chinese production will have to kidnap a lender's family members in order to get a dollar. That is the reality and it is far beyond the impact of FTEs of any kind.

Question for Consideration:

4. Given the important role that tax-exempt investors play in Canadian capital markets, and could play in the FTE market, what impact could this have on government revenues and economic efficiency?

4. Your question seems to suggest that tax-exempt entities are somehow less attuned to profit than any other structure. Did prices at Shopper's Drug Mart go down as the Ontario Teachers' Pension Plan gradually divested itself of ownership? Nor did they go up. The owners were interested in building a profitable property. Tax-exempt entities such as pension plans may have a longer investing horizon than the quarter-to-quarter fixation of the average corporation (and would anyone dare to suggest that isn't a good thing?) but they are just as fixated on the growth and good health of their investments. In fact, a pension plan with a long term view would be far less likely to rape the assets for short term gain than would a drive-by CEO looking to line his pockets and build for himself the brightest of golden parachutes. I seriously doubt you will find more diligent guardians of our corporate good than those very pension plans which this question seems set to besmirch.

Were the proliferation of tax-deferred entities to have some minor effect on government revenues, would that be a bad thing? Healthy pension plans would reduce the massive bail-outs of bankrupt plans we have witnessed too often, and secure retirement incomes would reduce the claims upon income supports for the ever-increasing number of retired citizens.

Question for Consideration:

5. Overall, are there public policy concerns about FTEs and how the tax system influences their existence, and if so, what actions should be considered to address these concerns?

5.In the great scheme of things, we are dealing with a short-term phenomenon which you fear may upset the normal patterns of investment and taxation. Stand back. Take a deep breath. Look at the longer term, and don't panic into a short-term solution to a problem which doesn't exist.

The abnormally low bond and GIC yields of the past few years made investors search out any vehicle which could finance the retirement they had been promised. The number of trusts exploded in order to meet the need. A structure which had been created for real estate and energy, came to be applied to every sort of business imaginable. There was a demand and it was met. The free market worked to perfection. Rather than being a problem, the presence of FTEs actually met a public policy need and gave seniors and near-seniors a vehicle which could finance the retirements promised them. There are no public policy concerns about FTEs thus there is no need for any action to address the existence of such entities.

This is a moment when, hard as it is for government, it is best to do nothing at all. The present situation is an anomaly. It will pass. The universe will eventually unfold as it should and there will be no need for action of any kind. Trusts, like tulip bulbs and junk bonds, will have their day and then settle back to be just one of the many investment vehicles available to investors. As an aggressive investor highly leveraged and completely in energy trusts, I shall exit the scene when interest rates rise and yields slip to the point that I can't make 6% between distributions and my cost of margin. It is just a simple question of risk assessment. At that point I shall liquidate my positions, pay down my margin, and take advantage of the higher bond rates which will have killed the golden goose. It's not rocket science. Like doctors, governments should have to swear first to, "Do No Harm".

You have my permission to post this response if you see fit. Please reply to me in English.

William Barrowclough
Peterborough, Ontario