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Taking the hit: the Tories have either made the hard but right decision, or they have stupidly angered their core supporters.

Death and taxes are the only two certainties in life, it is said. But perhaps a third should be added: politicians' broken promises. Because, after all, bad things come in threes. When the federal Conservatives went back on their pledge of last March and announced they would slap corporate tax on income trusts, Oct. 31, that unexpected Halloween trick-or-treat drew a collective howl from angry investors across the country, watching the value of their portfolios plummet. It's estimated that well over a million people were hit, when as much as $38 billion in market value instantly evaporated from their investments. And many of them wanted Ottawa and the rest of the country to acknowledge their loss; the Western Standard received literally hundreds of angry letters from readers, cursing the Conservatives and disavowing the party they had supported in the last federal election.

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Eugene Parks, a Victoria-based executive development officer, does not like the government's about-face. He uses the analogy of building a house. "You build [it] according to all the building codes, and then you wake up one morning, and there's a wrecking crew outside; the government is saying, 'We changed the codes, so your house is no longer built properly,' and down it comes," Parks says. "That's basically what they've done."

In the House of Commons, the Opposition Liberals sensed blood, manifestly gleeful that their opponents were now bedeviled by an issue that had contributed to their own downfall. Last year, just before the federal election call, then Liberal finance minister Ralph Goodale hemmed and hawed over taxing the trusts, finally deciding against it. But his department so botched the announcement that word may have leaked out, and the RCMP is investigating whether some profited from the insider information. Now the Liberals focused on how Conservatives broke their promise, not whether the policy change was necessary or not--which may suggest implicit agreement. Still, when the legislation came before the House, the Liberals voted against it, but it got through first reading with support from the NDP and the Bloc.

Standing in the storm, federal Finance Minister Jim Flaherty has refused to budge--though he did apologize to injured investors. He justified his action on the grounds of tax fairness. Big companies like BCE Inc. and Telus Corp. were getting ready to convert to trusts, and there were rumours--later confirmed--that energy giant Encana Corp. was switching as well. If corporations didn't pay their tax share, Flaherty argued, the burden would shift onto individual taxpayers. The government's $32-billion take in corporate tax in 2005-2006 made up 14.3 per cent of its base. Yet trust investors argue that they pay income tax on any trust earnings, so the move was unnecessary.

Parks thinks there was no need for the move for another reason; he doesn't buy the shortfall argument. "The federal and provincial governments are revenue rich at the moment, with record revenues and record surpluses. So the notion that there was a problem is one they have to prove because the books say that's not quite true," he says.

The political fallout over the issue doesn't seem too toxic, except perhaps among traditional Conservative supporters. Opinion polls showed no steep decline in Tory popularity following the move; and Flaherty had softened the income trust blow by simultaneously announcing new income-splitting measures for pensioners. Most Canadians have no money in income trusts, and if they have any understanding of the fuss, likely see it as the inevitable closing of an accidental loophole.

A company becoming an income trust converts from a corporation issuing stock to a trust fund in which units are sold. This type of trust was first developed in the 1980s for the real estate and the oil and gas sectors as a low-risk investment on income producing properties. If a company has a producing oil well and chose not to reinvest the profit from that well in further exploration, that well itself becomes a low-risk investment. Since the company retains no profits for reinvestment, the well ceases to be an equity growth entity, and the money flows through to investors, subject only to their income tax. In 2002, this loophole was discovered by other businesses, and the creation of and conversion to trusts began. They proved popular, and the pressure began mounting on investment-hungry CEOs of large corporations to convert.

The tax issue aside, the government had long-term concerns about income trusts, loosely expressed by another old maxim: don't eat your seed grain. Because they leave no profit for reinvestment, some believe they are poor models for an investment market that must balance dividends against growth. National Post columnist Terence Corcoran called trusts a "gimmick" and wrote, Nov. 2, "You cannot build and maintain a national corporation-based economic system on a tax mistake that had the effect of wrecking the underlying corporate structure."

Another potential problem lurked: if corporations were exempt from tax, people might have started structuring their lives as corporations to minimize their personal tax burden, warns John Williamson, federal director of the Canadian Taxpayers Federation. "I would be John Williamson Inc. tomorrow, if that's the way it was," Williamson argues. And he says that, on balance, his organization supports the move, noting that existing trusts have been given a four-year buffer. "When those trusts do start paying tax [in 2011], the corporate tax rate will go down for everybody a half a point," he says. He's happy to see the billion-dollar tax cut for seniors through the age exemption and income-splitting measures, announced at the same time as the trust tax. "When governments embark on tax changes of this nature, they do soften the blow when the overall tax bite goes down," Williamson says.

According to Jess Chua, a professor of business management at the University of Calgary's Haskayne School of Business, the long-term impact of the decision will be difficult to gauge, because it may affect the perception of the political risks of investing in Canada. "These days, political risk isn't the government sending in the troops to block your passage. It's more changing the rules of the game," Chua says. If investors have already committed their money, then the government changes the rules, some may start thinking of Canada as a risky place to do business. "It's not just stability of the government; it's stability of regulation, too. So if regulation changes frequently, then you have a high-political-risk country, because you can't make long-term plans," says Chua. Canadians can invest outside the country, so they're not captive and may start shifting their money, and foreigners might become more reluctant to shift money in.

That's a gamble the Conservatives seem willing to take, likely calculating that most people will see it as a brave decision to do what's best for the country. There is evidence the announcement hit hardest within the demographic most prone to support the Conservatives: older middle-income investors living on RRSPs and pension funds. And in the words of another old maxim, those Conservative supporters might "cut off their noses to spite their faces," denying the Tories their support in the next election. Still, Stephen Harper's minority government must be preparing to fight that election on its next budget; so the apparent equanimity with which his cabinet has absorbed the trust tax criticism may be a harbinger of kinder, more investor-friendly measures to be proposed next spring.
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Title Annotation:TAXATION
Author:Steel, Kevin
Publication:Western Standard
Date:Dec 4, 2006
Words:1227
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