Our Finance Minister is a worried man. That became abundantly clear last week when he virtually pre-empted his department's consultation process and tried to stem the tide of income-trust conversions with an announcement that advance tax rulings have been suspended. Predictably, the stock market shuddered, CEOs issued defiant statements, and ordinary investors fretted.
Ralph Goodale's precipitous move caught everyone by surprise. It came less than two weeks after the publishing of a consultation paper in which Finance raised the question of whether income trusts are really a problem at all. Mr. Goodale seems to have pre-judged the answer. In his mind, they are.
It's not clear why he felt the need to suspend advance rulings (which won't necessarily stop new conversions). It may have been the sudden rush of new announcements from major companies such as CI Fund Management Inc. and CanWest Global Communications Corp. that prompted him to fire a shot across the bow of other potential conversion candidates. What is clear is that the whole trust sector will now be forced to operate under a cloud of uncertainty for months to come.
The public has been given until Dec. 31 to make submissions in response to the consultation paper. Once that process is completed, the results will have to be digested and a policy drafted. Even working at warp speed, it's hard to see how Finance will be able to come up with a coherent approach before late February at the earliest — unless, of course, they have already decided what they want to do and the whole consultation process is just window-dressing.
Forgive my skepticism but I suspect that's exactly the case. This is hardly a new issue. Mr. Goodale tried to deal with it in the 2004 budget, only to run into some stiff opposition from the pension community and a major policy headache when it was revealed that the Quebec Pension Plan and all associated plans would be exempt from any federal restriction on trust holdings.
I'm sure that Finance has a very good idea of how they intend to proceed. The consultation process is largely a sham, although it could serve one important political purpose by identifying in advance any potential pitfalls in the course they have chosen. One major embarrassment on this issue is enough; Mr. Goodale does not want to have to retreat again. This time when he speaks, he intends it to be the last word.
His problem is that the available options are limited. A total ban on future business trust conversions, with a grandfathering of existing entities, is feasible but draconian and politically unpalatable. Imposing a special tax on trust distributions has been suggested but it would not affect holdings in registered plans, unless the government wants to establish a precedent that could have unpredictable consequences. The concept of making it more difficult for trusts to deduct interest costs would run counter to one of Mr. Goodale's stated concerns: the importance of encouraging economic growth in Canada. Leveraging is one of the most important expansion tools for both trusts and corporations. It's hard to see how artificially increasing the cost of borrowing will help to stimulate the economy.
That brings us to the idea of changing the taxation of dividends to reduce government double-dipping and level the playing field with the trusts. It appears to be the fairest way of tackling this problem and it would certainly be popular with investors. But it would cost the federal treasury a lot of money – perhaps $1-billion according to an estimate by Don Drummond, TD Bank's chief economist. That's a lot more than the $600-million he figures that Ottawa is losing now because of the trusts. And such a move is not likely to please the NDP, which forced the government to postpone tax breaks for corporations in exchange for their support last spring. Alienating their closest ally in a minority Parliament certainly is not on the Liberal agenda.
So Mr. Goodale faces a delicate balancing act on this one. While he prepares for his high-wire trip, keep a watchful eye on Ottawa and expect some softness in the trust market. That will be a buying opportunity for savvy investors.
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