Trusts still a taxing issue

National Post

2005-02-28



It's hard to believe that it's only been five days since the Liberal minority
government's "something for everyone" federal budget. So far, much of the
attention has focused on the removal of the foreign property limit and increased
RRSP contributions.

But, buried at the back, beginning on page 410, is a section vaguely entitled
"Update -- Taxation Issues." One of these issues is the current tax treatment of
income trusts.

Over the past several years, the income trust industry has exploded in
Canada. As a result, there has been much speculation about how the government
would respond to various reports that there may be a significant tax leakage
from businesses that have been structured as income trusts.

Typically, a business income trust will distribute its income to its
unitholders on a pre-tax basis. These distributions are considered to be income
in the hands of the unitholders who then pay tax at their own personal rates.
This structure differs from corporations that must first pay corporate income
tax before distributing their net after-tax income to investors in the form of
dividends.

The use of income trusts therefore typically shifts the taxation of income to
unitholders such that tax revenue foregone at the corporate level may be largely
compensated by increased tax revenue at the unitholder level. If, however,
income trust units are held by deferred income plans such as registered pension
plans and RRSPs, this tax can be deferred, resulting in significant potential
revenue loss to the government.

In addition, the passage of provincial legislation in 2004 to limit the
liability of trust investors may stimulate additional investment in trusts by
tax-exempt pension plans, leading to further potential lost tax revenues.

The 2004 budget attempted to limit this lost revenue by restricting the level
of pension fund investment in business income trusts. In May, 2004, however,
after a huge lobbying effort by various pension plans, stakeholders and
provincial governments, Ottawa suspended the implementation of these proposals
and launched further consultations.

In last week's federal budget, the government announced that it will continue
to consult with stakeholders on the various tax issues related to income trusts
and will be releasing a consultation paper for discussion shortly.

So, what will the feds do? That is certainly up for debate. Last fall, in the
Canadian Tax Journal, various academics proposed solutions to the income trust
dilemma. One of the most popular solutions, proposed by Dr. Jack Mintz,
president and CEO of the C.D. Howe Institute, would be to increase the dividend
tax credit, thus levelling the playing field between dividend-paying stocks and
business income trusts.

Whether the government adopts Mintz' recommendation remains to be seen but
hopefully the feds will come up with a better approach than simply trying to
restrict investment in what is becoming an ever-more significant part of the
Canadian economy.