OTTAWA -- Stung by plans for multibillion-dollar conversions to tax-advantaged income trusts, Canadian Finance Minister Jim Flaherty shocked markets on Tuesday when he announced plans to tax the sector.
Flaherty signaled concern that the flow of conversions to income trusts could become an uncontrollable torrent that would damage the economy and erode government revenues.
His new plan, which he described as a way to level the playing field between trusts and regular corporations, broke a campaign pledge by the minority Conservative government not to change rules on how Canada taxes the trusts.
"Things changed a great deal this year and we faced a situation where Canada was moving to an income trust economy. Is that a good thing for Canada?" he said at a news conference.
"The answer is no, it's a very bad thing for Canada, it's bad for the Canadian economy. We're concerned about competitiveness and productivity."
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Flaherty's package of measures would tax distributions by income trusts while also cutting corporate taxes by half a percentage point and changing tax policy for pensioners. He said it would ease the tax burden by C$1 billion a year.
Income trusts, now a C$200 billion ($180 billion) sector of the Canadian market, avoid most corporate taxes and pay the bulk of cash flow directly to investors. They have surged in popularity in recent years as investors embraced their rich yields.
However, even the government admits that the structure robs it of hundreds of millions of dollars of tax revenues, and economists say the model can deplete firms' capital and leave them less able to invest for growth.
One of the largest Canadian trusts, CI Financial Income Fund, savaged the surprise move.
"This is the most bizarre, Third-World policy that I could imagine," CEO Bill Holland told Reuters. "It doesn't even make sense to me -- how can they keep changing the rules?"
Flaherty said this year alone had seen C$70 billion in new conversions, and the tipping point appeared to have been trust conversion decisions by phone giants Telus Corp. and BCE Inc..
"It was cumulative this year. It was both the quality and the quantity (of announcements)," Flaherty told Reuters.
"It was the companies that were doing it and going to income trusts, the size of them and the fact that they're not passive investment firms -- they're capital-intensive firms -- and then BCE in effect feeling obliged to follow Telus."
But now with the new set of rules, he predicted: "Telus and BCE are not going to happen."
The total secrecy in Tuesday's announcement, as bankers and parliamentary staffers left early for Halloween, caught everybody off guard, in contrast with how the former Liberal government appeared to telegraph a decision a year ago to cut taxes on corporate dividends but to leave income trusts alone.
Knowledgeable market players made tidy profits as that decision was made, attracting a police investigation that contributed to the Liberal loss in January's election.
"I think this is a huge, huge surprise. Huge. I don't think they consulted with anyone," said Calgary lawyer John Brussa, considered the father of the income trust format.
"To do this seems quite troubling, and for a government that's supposed to be encouraging of business. This arbitrary action is not very conducive to business. This is going to cost a bunch of people a lot of money tomorrow."
Flaherty said trusts that begin trading from now on would be subject to his new measures in the 2007 tax year, while existing trusts would have a four-year transition period.
Full details are available from Finance Canada at http://www.fin.gc.ca/news06/06-061e.html
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