Feds hit trusts in surprise mini-budget

The federal government has announced a new plan to tax the distributions of income trusts, among other measures, in what amounts to a mini-budget released late Tuesday night.

“The measures I am bringing forward are necessary to restore balance and fairness to Canada’s tax system, to ensure our economy continues to grow and prosper and to bring Canada in line with other jurisdictions,” said Finance Minister Jim Flaherty.

In an effort to level the playing field between income trusts and corporations, the government’s “Tax Fairness Plan” will levy a tax on income trust distributions. Since trusts distribute virtually all of their profits, this would be akin to levying a corporate income tax.

The government also announced a plan to reduce the general corporate income tax rate an additional half-percentage point, to 18.5%, as of January 1, 2011.

“The current situation is not right and is not fair. It is the responsibility of the Government of Canada to set our nation’s tax policy, not corporate tax planners,” Flaherty said, pointing out that trust conversions effectively allow businesses to duck corporate taxation, downloading the tax burden to investors.

The increased tax burden on trust distributions was clearly intended to head off new conversions, taking effect in next year for businesses that are not yet trading as trusts — BCE, for example, has already put its conversion plans on hold. For existing trusts, the changes will not take effect until 2011, giving them time to adjust.

“What that basically means is that starting in the year 2011 the income trusts will need to start paying tax and that will affect distributions,” says Jamie Golombek, vice-president, taxation & estate planning, at AIM Trimark Investments. “If it affects distributions, if you believe that the price of an income trust is the present value of all future cash flows, then it could affect the market price and we’ve seen that so far this morning.”

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• The future of the trust structure • Trick or treat?: More on Ottawa’s tax changes • Funds shrug off tax

• TEMPLATE LETTER: Ottawa’s new “tax fairness” plan

The finance department pointed out that other jurisdictions — namely the U.S. and Australia — have already recognized business trusts as a drain on tax coffers and have shut the structure down.

“They don’t allow this in the U.S. That’s why you had US companies coming into the Canadian market to issue income trusts up here because of this tax arbitrage opportunity,” says Golombek. “So it clearly could not go on and I think from a policy point of view it’s probably the right thing ultimately, although there may be some pain in the short term.”

Still, the move came as a surprise to many.

“It’s a big shock to people, but we’ll see what happens,” says Cynthia Kett, a planner from Stewart & Kett Financial. “I suspect that everybody will gasp but it will all settle down and everything will normalize again.”

“[This] totally shocked everyone. I even gave a presentation on Monday and I was asked if they were going to do anything. I thought it would be highly unlikely that a Conservative minority government would introduce something so controversial. But I was wrong,” Golombek says.

Also announced were a pair of tax measures for seniors, including a $1,000 increase in the Age Credit Amount, bringing it to $5,066 , retroactive to January 1, 2006; and the option of income splitting for pensioners, beginning in 2007.

Specified Investment Flow-Through Tax Rates: Distributed Non-Portfolio Earnings, 2007-2011
	2007	2008	2009	2010	2011
Basic rate (federal)	21.0%	20.5%	20.0%	19.0%	18.5%
Additional rate (in lieu of provincial tax)	13.0%	13.0%	13.0%	13.0%	13.0%
Total	34.0%	33.5%	33.0%	32.0%	31.5%

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com, and Kate McCaffery kate.mccaffery@advisor.rogers.com (11/01/06)