- News Release 2007-007 -

January 30, 2007

Archived - Remarks by the Honourable Jim Flaherty, Minister of Finance, to the House of Commons Standing Committee on Finance

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Introduction

Good morning.

Mister Chairman and members of the committee, I want to thank you for the opportunity to be here today.

You have received a briefing book with a copy of my statement, a document outlining our revenue estimates and calculations, and a series of charts illustrating the growing trend towards trust conversions and foreign ownership.

I insisted on being the first witness to remind this committee directly of the critical importance of moving forward with our income trust policy and our Tax Fairness Plan.

Make no mistake, the decision that was taken on October 31st is all about fairness.

  • Fairness for Canadian taxpayers and their families who would be asked to pay more and more;
  • Fairness within the corporate sector, where the current rules give income trusts a tax advantage and distort investment decisions;
  • Fairness for Canadian taxpayers, who are seeing tax dollars sent out of the country to foreign investors; and
  • Fairness for all Canadian governments, federal and provincial, who are experiencing a significant loss of tax revenue.

I want to take the next few minutes to:

Quickly outline the Tax Fairness Plan;

Walk the committee through the numbers and our methodology. As I indicated in the fall, we estimate the federal revenue loss was about $500 million in 2006 and growing, and this is a conservative estimate.

I will also point out the hundreds of millions of dollars in tax loss to the provinces.

I will talk about the fact that the landscape had changed dramatically with almost $70 billion in trust conversions taking place or being announced in the first 10 months of 2006.

I will also explain why it would be a mistake to carve out the energy sector and provide them with a permanent tax holiday.

And finally, I want touch on the need to maintain a four-year transition period in order to avoid billions more in revenue loss.

Tax Fairness Plan

I want to say from the outset that it is regrettable that some investors suffered financial losses. Although it was a very difficult decision, it was an absolutely necessary decision for the country and for future generations of Canadians, our children and grandchildren.

Our Tax Fairness Plan achieves two critically important goals. It restores balance and fairness in the tax system and strengthens the Canadian economy, now and into the future.

The Tax Fairness Plan achieves these goals through:

  • A distribution tax on distributions from publicly traded income trusts with a four-year transition period for existing trusts;
  • An additional reduction in the general corporate income tax rate of half a percentage point in 2011;
  • An increase in the age credit amount by $1,000 to benefit low- and middle-income seniors; and
  • The ability for pensioners to split income beginning this year. Pension income splitting is a major positive change in tax policy for pensioners and seniors. It significantly enhances the incentives to save and invest for family retirement security.

I want to be clear with the members of this committee and with all Canadians. I have no intention of altering the substance of the government's decision, including the four-year transition period for existing trusts.

Canadians are looking for fairness and for certainty. And our Tax Fairness Plan provides both.

An Unfair Burden

I've said it repeatedly as Finance Minister: Canadians pay too much tax. And this government has already taken steps to reduce their tax burden.

Simply ignoring this issue would have resulted in Canadians paying more tax, not less, today and for years to come.

Why? Because, as more and more companies converted to income trusts, they were shifting their corporate tax responsibilities onto the backs of individual taxpayers and their families. There was a growing trend towards corporate tax avoidance.

In fact, in a news release on September 11th, 2006, Robert McFarlane, executive vice president and CFO of TELUS, stated, "TELUS is pursuing a trust conversion at this time since it has recently utilized all of its tax assets and a conversion early in 2007 will optimize its future taxable position."

This wasn't an isolated case, but rather a disturbing trend that was moving into the core of our industrial and knowledge-based economy.

Since we took office, the landscape began to change significantly. In the first 10 months of 2006, almost $70 billion in new income trust conversions took place or were announced. Chart A shows clearly this trend in income trust conversions and the path we were all on.

This represented a clear and present danger to our tax system and our economic structure. Evidence was mounting that we were running a real risk of turning into an income trust economy. An economy where tax avoidance drove business investment decisions and foreign investors stood to make significant gains at the expense of Canadian taxpayers.

No responsible government could stand by and let this happen. It wasn't fair and it wasn't right. Regardless of the political consequences, we had to act. And we did, accepting our responsibility and acting in the best interest of Canada.

As I stated on numerous occasions, we estimate that the federal revenue loss was about $500 million in 2006, as Chart B and the supporting material you have received clearly demonstrates. And we believe this is a conservative estimate.

Now, consider what these calculations don't include.

They don't include any further conversions by any other companies. We estimate that TELUS and BCE alone would have added substantially more to this total.

Widely reported estimates from financial experts based on information from the companies themselves indicated the corporate tax savings over the next two years would have been about $1.3 billion for TELUS and about $1 billion for BCE.

Just imagine what the total would have been had other large corporations, like EnCana or large financial institutions that currently pay billions in corporate income tax, followed suit.

The numbers also don't include provincial tax impacts. During my meeting with provincial Finance Ministers on December 15th, 2006, in Vancouver, they expressed serious concerns about the loss of tax revenue and unanimously endorsed our Tax Fairness Plan.

Letters from the provincial Ministers are included in your package, here are a few examples of what we received:

Carole Taylor, B.C. Minister of Finance, wrote, "I believe the measures you propose are necessary to address the policy and revenue impacts of converting corporations to income trusts..I believe that without action the continued conversions to income trusts would have led to a serious disruption of the tax system."

Manitoba's Minister of Finance, Greg Selinger, said, "Corporations were increasingly under pressure to convert to income trusts solely as a result of tax considerations, even in instances where trusts were not otherwise the most appropriate form of organization."

Michel Audet, the Minister of Finance for Quebec, said it was clear that the advantages enjoyed by income trusts had gone on too long and that action was called for.

Conservative Estimate

Now, some critics have questioned these figures.

In fact, these estimates are very similar to those made by Jack Mintz of the Rotman School of Business, and former president of the C.D. Howe Institute.

On October 19th, 2006, Mr. Mintz said, "It is silly to argue that there isn't any tax loss. Everyone knows the reason people go into income trusts is because there are tax benefits..That's the way the law is."

The methodology used to determine federal revenue loss should also be familiar to the Liberal committee members, since it's the very same methodology their own government used in preparing its 2005 consultation paper.

The revenue loss estimates are based on a sound and consistent methodology, and we stand by them.

These are conservative estimates. The tax loss number could actually be higher.

As Chart C demonstrates, by increasing the effective tax rate by 1 percentage point from 6.6 per cent to 7.6 per cent, the annual revenue impact would jump by over $200 million to $710 million per year.

You will no doubt hear from some witnesses that there is no real tax loss and if there were, it would be more than made up in the future through personal income taxes or withholding taxes on foreign investors, or taxes on deferred pension plans or RRSP withdrawals.

Think of what you are being told: give income trusts a definite tax break now but get it back sometime in the future.

As Minister of Finance, I have a fiduciary obligation to the taxpayers of today, not tomorrow. I have an obligation to pay for needed social, environmental and economic programs today, not tomorrow. I cannot and will not fund today's programs from tomorrow's revenues.

Clearly, income trusts had a special tax advantage that regular business corporations did not enjoy. You know it, they know it, and the market knows it.

The market reaction to a policy that levels the playing field between income trusts and corporations-that makes them equal, not worse-shows that a built-in tax advantage existed. Otherwise, the investors would not have reacted the way they did. There would have been no market correction.

And for those who, faced with all of this evidence, still claim that we don't know whether there will be a loss of government revenue from income trusts, all I can say to that is:

  • We have federal and provincial government estimates that clearly demonstrate tax loss.
  • Income trust distributions are being sent out of the country to a large number of foreign investors who are reaping a financial windfall. The only Canadian tax they are required to pay is a 15 per cent withholding tax-far less than the taxes paid by trust holders here in Canada.
  • We have had two of Canada's biggest companies explicitly citing tax considerations as the reasons for announcing plans to convert last year.
  • We know that these same two companies have since renounced their conversion plans since our announcement that any new trusts would be taxed as corporations.
  • We know that other large firms that were actively planning to convert to trusts have abandoned their plans.
  • And we know that groups such as the Coalition of Canadian Energy Trusts must realize that there is tax loss-otherwise, they wouldn't argue that the trust structure gives them a lower cost of capital than the corporate model does.

Who Pays

Now, faced with these tax losses, the natural question should be, who will pay for all of this lost revenue?

Your constituents will, of course-the people of Markham-Unionville, the people of Joliette, the people of Winnipeg North, and certainly the people of my riding of Whitby-Oshawa.

By failing to implement the Tax Fairness Plan, we would harm our government's books and affect the budgets of every single province in this country. As I pointed out earlier, they are extremely concerned about this issue.

Why? Because ongoing trust conversions were costing them millions. And they understand that converting our businesses into income trusts is not the way to build a dynamic, competitive economy.

The province of Alberta, for example, estimated in its 2006 budget that it was losing $400 million a year before we introduced our Tax Fairness Plan.

The Atlantic provinces lost one of their biggest corporate taxpayers when BCE converted Aliant into an income trust. This conversion had a significant impact on their corporate tax revenues.

And Quebec has estimated that the province would have lost $150 million annually if the conversions of certain large corporations had proceeded as announced.

How would it be fair that foreigners would reduce their tax bills through this structure, but not hard-working Canadians who pay to keep our schools, hospitals and emergency services running?

The Future Costs

As you can see, the costs of indecision would have been substantial and unfair, not just for our government, but for all governments.

Our Tax Fairness Plan recognizes that investors, many of whom are seniors, have been affected. We are taking steps to protect investors in four key ways:

First of all, we are providing a fair and reasonable four-year transition period before the new distribution tax will apply to existing income trusts.

Secondly, we are providing generous growth guidelines during this transition period, allowing existing income trusts to actually double in size.

Thirdly, we are putting in place this year pension income splitting for seniors and pensioners; a significant improvement to our tax system worth approximately $700 million a year.

And fourthly, we are increasing the age credit amount by $1,000 from $4,066 to $5,066 effective January 1, 2006. This measure will provide tax relief for low- and middle-income seniors.

This committee will be urged to make a recommendation to extend the transition period from 4 to 6, to 8 or even 10 years. I want you to consider the ramifications of such a move. A transition extension is actually a policy reversal. It gets through the back door a policy change you can't get through the front door.

A longer tax holiday period for trusts would just mean tax unfairness for a longer period of time. It would do nothing for some investors who decided to sell their units between November 1st and today.

Most of all, it would create a greater financial burden on Canadian taxpayers. Extending the transition period from 4 to 10 years would cost the federal treasury approximately $3 billion. It would also cost provincial treasuries. Alberta would lose over $2 billion and Quebec would lose hundreds of millions.

So I would say to the Member for Joliette, are you in favour of a wealth transfer of hundreds of millions of dollars from the pockets of Quebec taxpayers by extending the transition period to 10 years?

This isn't how you build a 21st-century economy. This isn't how you build a productive future and a better quality of life for all Canadians, the ultimate goal of our economic plan, Advantage Canada.

It certainly isn't how our competitors are doing it-not the U.S., not Australia, not the U.K.

As Peter Godsoe, former Chairman and CEO of the Bank of Nova Scotia said on October 23rd, "We are using a structure that the Americans looked at and shut down. The Australians had trusts, they shut them down. The British looked at this, and decided not to allow it. What do we know that everyone else doesn't?"

Canada's New Government agrees. Watching the world go by will do nothing to help future generations, whose standard of living will be determined by the investments we make today.

Who Should Pay Their Fair Share

Delaying, in other words, only puts off the ultimate goal of this decision-an economy driven by sound business and economic decisions, not by the kind of tax planning and tax avoidance our major competitors have clearly rejected.

Let me deal with one final issue before I take your questions, and that's the effect of our decision on energy trusts in particular.

Some in the energy sector have called for special rules based on the sector's history with these tax vehicles.

I don't agree, and I don't believe most Canadians do either.

I believe it's reasonable to expect that all sectors of the economy pay their fair share of taxes.

Critics have often pointed to the U.S. energy sector and called on our government to treat energy income trusts the same way the U.S. does with Master Limited Partnerships-or "MLPs."

First of all, Canada has no intention of mimicking the U.S. tax code.

Secondly, U.S. MLPs are almost exclusively owned by domestic investors. In Canada, energy income trusts are to a considerable extent foreign-owned. As the chart behind me clearly indicates, foreign ownership rates for large energy trusts are about 50 per cent.

Thirdly, structural impediments under U.S. law have the practical effect of limiting the investment of U.S. mutual funds and tax-exempts in MLPs.

Fourthly, we do not accept that the U.S. MLP rules will provide a tax advantage as compared to Canadian energy trusts, as the tax treatment of taxable investors under both regimes is effectively the same.

And finally, it's important to understand how much more significant the issue with energy trusts is in Canada. The value of Canadian publicly traded energy trusts represents roughly 4 per cent of the TSX market cap. Income trusts alone comprise over 15 per cent of Canadian oil and gas production. In comparison, the total value of U.S. MLPs amounts to less than a third of 1 per cent of the market capitalization of the NYSE and NASDAQ.

And had we not acted, the energy trusts' share of the marketplace would have risen even further. More and more businesses would have asked, why should that company benefit and not mine?

Then, that $500 million revenue loss would grow, because if a company like EnCana opted to become a trust, you can be certain that they would not be alone.

Talk to Newfoundland and Labrador, a province with an historic opportunity before it to build prosperity and lift its citizens out of debt, and see what they would think about Hibernia, for example, becoming an income trust.

This is not a hypothetical illustration. In the case of Hibernia, the federal government has received several proposals to do just that.

As Mr. Marshall, the province's Finance Minister, wrote to me: "The potential erosion of this revenue source resulting from the proliferation of Income Trusts had been of grave concern prior to your announcement."

Newfoundland and Labrador, Nova Scotia and the federal government all believe very strongly that energy projects should pay their fair share of tax.

Our government remains committed to tax fairness and fulfilling our commitment in Advantage Canada by lowering taxes further as we prepare our next budget.

Our last budget reduced taxes in 29 different areas. While not giving anything away, I can tell you that, had this government not acted on income trusts, any plans for future tax reductions in the next budget would be at risk.

Conclusion

A few finals thoughts to conclude.

In the end, our government was faced with a hard choice, and now this Parliament is faced with a big decision: to make the Tax Fairness Plan a reality.

We chose not only to recognize a growing problem occurring in Canada's tax system, but to fix that problem.

We made our decision based not on political calculations, as did the previous government, but on principles of tax fairness, balancing the needs of individual investors with the interests of taxpayers and their families.

And we acted responsibly and decisively.

It is not tax fairness if it is only for a few. And it is not strengthening the economy if the playing field is not level for all businesses.

And committee members should recognize that they can't turn the clock back. There has been a substantial change of ownership in trusts since October 31, 2006-for a number of trusts, up to one quarter of the shares have changed hands.

Where there was once speculation as more and more large corporations opted to become income trusts, today there is certainty.

Businesses are making their own choices to grow this economy. They're moving on.

It's time we all move on in the interests of all Canadians.

The result of our decision is clear: a tax system that is fairer for Canadians and that will help make our economy more productive, efficient and dynamic today and for years to come.

I would now be pleased to answer any questions you may have.

- News Release 2007-007 -