Income trust changes more light than heat
By John Williamson
As a guiding principle the Canadian Taxpayers Federation (CTF) supports any legal means to minimize Canada's heavy tax burden. We favour lower - never higher - taxes for individuals and businesses. Yet companies should not avoid paying any income taxes by flipping to income trusts.
We advocate a single, low rate of taxation for all individuals and businesses, not just tax relief for some. We oppose a reduction or elimination of deductions unless matched dollar for dollar by further reducing marginal tax rates.
One year ago, the CTF called on Prime Minister Paul Martin to end the double-taxation of dividends rather than impose a new tax on income trusts. With the federal government growing weary of companies switching to the income trust model, the fear was Ottawa would take the easy route by taxing more. It might slap a tax on income trusts to end the trust tax preference and thereby level the playing field with other corporations.
We argued in our October 2005 TaxAction to supporters "income trusts are the response to a glaring problem with the income tax system: namely the double-taxation of dividends." This double-taxation meant income earned from traditional businesses was taxed more heavily than income from trusts. In fact, we believed - and still do - the rational for converting to trusts was not based on a sound business case but rather an irresistible tax calculation.
Our TaxAction noted that "investment dollars are shifting to income trusts, not because of a better underlying investment, but because of favourable tax treatment. Income trusts, for example, are penalized if they do not pay out an adequate amount of income [to investors], thereby creating disincentives to reinvest in the business." Our philosophy is for a tax code neutral in its application that rewards business and investment decisions on the underlying profitability.
Our demand on the federal government was "to do away with the double-taxation of dividends. Or, lower corporate tax rates. This will do two things. First, it will reduce if not eliminate the incentives to create income trusts and second, it will create opportunities for Canadian businesses to turn profits and pay higher dividends."
Our goal was to avoid another tax grab by Ottawa - something that would see the government collect ever more revenues and, of course, spend more. Pleasantly, the Liberal government decided to not increase taxes and instead adopted the policy advocated by the taxpayers' federation, lower dividend taxes.
It was a positive accomplishment. The change reduced the problem of double-taxation of dividend income. It also assisted in leveling the playing field, but did not eliminate it. As a result, it did not stem the corporate rush to income trusts because the tax advantage remained. (Let this be a lesson to people who say taxes do not impact behaviour.) Business giants BCE Inc. and Telus Corp. announced conversions and others were similarly eyeing the tax benefits.
Our campaign was never for Ottawa to "save income trusts." This was the policy of the Conservative Party in opposition. And it was broken by the Conservative government on Oct. 31 when Finance Minister Jim Flaherty announced tax changes that resulted in a large stock market adjustment and a massive paper loss for some investors.
Our review considers the overall tax impact and implications to Canada's economy.
Mr. Flaherty imposed a new tax on trusts to stop a future loss of tax revenues and ensure upcoming conversions will be based on a business rational, not a tax dodge. He also announced a reduction in Canada's corporate income tax rate and a billion dollar annual tax cut for seniors.
The federal government will start taxing trusts in the same manner as traditional corporations. New trusts will be taxed beginning in 2007. Existing trusts will be given a four-year grace period and taxed only in 2011. Also in 2011, the general corporate income tax rate will drop one-half a per cent.
Ottawa's revenues will not rise as a result of the new tax and ending the trust loophole means a lower income tax rate on business. The increase was matched with an overall corporate tax reduction. This will end the incentive on becoming a trust on grounds other than it being a sound business decision. Ottawa also left intact the dividend tax cut announced last year, removing investor distortions caused by the tax code.
Some suggest Ottawa could have simply eliminated corporate taxes to put all businesses on an equal footing. Government cannot have zero corporate taxes with Canada's high personal taxes. The result would be people suddenly organizing their affairs as corporations just as corporations were structuring themselves as income trusts to avoid tax. Ultimately, the government would face a different income trust problem. People with the best lawyers would pay the least tax with remaining taxpayers stuck paying the bills.
Minister Flaherty sweetened the pot - and cooled tempers - by announcing a retroactive increase in the senior's age credit by $1,000 from $4,066 to $5,066. This will benefit low- and middle-income seniors. Ottawa will also permit income splitting for pensioners beginning in 2007. The latter will permit senior couples to split their pension income and thereby reduce their income taxes. For example, if one spouse earns $100,000 and the other $50,000, splitting the income will mean an annual tax savings of $1,500. If one spouse earns $60,000 and the other collects no pension income, the tax relief will be $2,700. And if one spouse earns $40,000 and the other also collects no pension, the savings will be $2,500. Moreover if Ottawa permits income splitting for some citizens why not push to extend it to all Canadian families?
The investments of many, many Canadians were impacted when the stock market tumbled after Oct. 31. The finance minister corrected a corporate tax discrepancy by imposing a new tax. His reforms end the tax advantage for some investment instruments but lowers taxes on businesses as a whole. The pension splitting benefits seniors and opens a new avenue for family-friendly income splitting.
Ottawa's overall tax bite has been reduced. As such, the finance minister's policy prescription is - on balance - supported by the CTF. So what's next?
The morning after Mr. Flaherty's announcement the CTF received a call in Ottawa from the department of finance. The government official wanted to assure us the 2007 Budget will contain additional tax relief for all Canadians. And should we believe this? Increasingly it appears voters will go to the polls in the spring. Prime Minister Stephen Harper will need to give Canadians a powerful reason to re-elect his government. Significantly lower personal taxes will prove to be a powerful vote getter.
John Williamson is federal director of the Canadian Taxpayers Federation.