Federal income trust

The federal government’s decision to increase dividend tax credits to level the playing field with income trusts has done very little toward attaining that goal, according to one of Canada’s leading taxation experts.

While the changes may have brought taxation neutrality between trust distributions and corporate dividends for taxable accounts, such investors make up the minority of the income trust market, says Jack Mintz, president and CEO of the C.D. Howe Institute and professor of taxation at the Rotman School of Management.

“While taxable accounts under the new tax credit will be roughly indifferent between income trusts and corporations, that won’t be true for a broad part of the market,” Mintz told the audience at Insight Information’s fourth annual Income Trust Conference in Toronto. “Sixty to sixty-five per cent of the market is still going to be very interested in holding income trusts.”

Under the new plan, the federal dividend credit would rise from 13.13% to 19% for 2006. Even in the case of taxable accounts, Mintz says the credit does not fully correct the disparity, as it is only applicable toward federal taxes. The average provincial dividend tax credit is about 7%, which he says would need to be raised to 13% to close the gap, creating a combined dividend tax credit of 32%.

Since the tax credits are delivered at the investor level, non-taxable entities such as pension funds and RRSP accounts receive no benefit. In fact, since dividends are drawn from result of post-tax income at the corporate level, income trusts continue to offer a superior stream of income, as they are not subject to corporate taxes.

Assuming the top marginal tax rate, Mintz says the combined corporate and personal income tax rate will drop from 56% to 48%. Breaking it down, for every $100 in corporate profits, the company would pay 35% in tax, leaving $65 to distribute. According to Mintz, that $65 would be subject to personal taxes, partially offset by the dividend credit, leaving $52 in the hands of the investor.

The same $100 profit realized by an income trust would face no corporate tax, but the full distributable sum would be subject to the investor’s marginal tax rate. Assuming the investor is in the top tax bracket of 46% that would leave $54, making the trust’s profits only slightly preferable to the corporate profits.

For a non-taxable entity, however, the income trust still represents a far more efficient delivery system for operating profits, as income is neither taxed in the hands of the investor, nor the operating company.

“Because they don’t pay personal income taxes in those accounts, they always have an interest to eliminate corporate income tax to be paid on the dividend,” Mintz said. “They will still have great interest in income trusts over corporate securities because they can bypass the corporate tax.”