News Releases
Tax Policy Branch, Business Income Tax Division
Department of Finance
17th Floor, East Tower
140 O'Connor Street
Ottawa, Ontario K1A 0G5
Dear Mr. Normand:
Re: Tax and Other Issues Related to Publicly Listed Flow-Through Entities
BMO Financial Group welcomes this opportunity to respond to the Department of Finance’s Consultation Paper on publicly listed flow-through entities (FTEs).
We believe that well-functioning capital markets are the key to economic efficiency and prosperity, and an even-handed tax regime is a prerequisite.
As a market participant, we believe that any policy approach that results from this Consultation should enhance efficiency, competitiveness, integrity and stability in capital markets and economic and financial systems. Any policy changes should be guided by five principles:
1. the FTE structure is a viable choice for many businesses;
2. the playing field between corporations and FTEs should be level;
3. businesses should have the freedom to choose the most appropriate structure for their particular circumstance;
4. there should be a minimum of government intervention around choice of business structure; and
5. the international competitiveness of our tax system is a necessary and critical element of ensuring that Canada remains a prosperous nation.
By way of background, the number of FTEs has grown dramatically over the past decade. There are now 224 income trusts listed on the TSX, with a peak market capitalization of more than $180 billion. FTEs have become the leading equity capital raising security, outpacing common equities since January 1, 2005.
In aggregate, FTEs pay out in excess of $1 billion in monthly cash distributions to investors, a majority of whom are retail investors. Of those, many are retirees who rely on this income. On average, FTEs pay out 10.5% on investments vs. 4% on ten-year Government of Canada bonds and 2% to 3% on GIC-type instruments. This notable spread indicates that without FTEs, many Canadians, including those on fixed pensions, would have limited choice to support their retirement by earning after-tax returns that keep pace with inflation.
In its 2004 Budget, the government noted that “income trusts have become an increasingly important investment vehicle in Canada”. Policy-makers should be congratulated for allowing this sector to prosper and for helping to create a uniquely Canadian asset class that is sound and attractive to both domestic and foreign investors. Going forward, policy-makers should recognize that moves to hinder growth of this sector could have significant negative repercussions on the Canadian economy. Any one of the following most-often mentioned changes could possibly have a negative impact on economic efficiency, business competitiveness and opportunities for income-oriented investors:
• Restricting the FTE structure to energy trusts and real estate investment trusts would mean that government is determining business structures;
• grandfathering business income trusts and not permitting new ones would mean that some firms within a particular sector would have an unfair competitive advantage; and
• imposing an additional tax on unitholders of FTEs would impair the tax competitiveness of the economy.
BMO Financial Group maintains that the real problem in the current tax system is not the tax treatment of FTEs, but rather the discriminatory tax treatment of income earned in public corporations that is distributed as dividends.
The double taxation of corporate earnings – once in the hands of the corporations and a second time in the hands of shareholders when they receive dividends – is a fundamental source of unfairness in the system.
Clearly, dividends should not be taxed at a higher rate than capital gains as is currently the case. At a time when investors are hard-pressed to find attractive income-generating investment vehicles, we can see no rationale for a tax policy under which investors would prefer to see share buybacks rather than increased dividends.
We believe that any attempt to address this issue by adding a new layer of taxation on trust income would exacerbate an already significant problem in the Canadian economy – uncompetitiveness and poor productivity growth. The government has repeatedly expressed its concern over the competitiveness and productivity of Canada’s business sector. At the risk of stating the obvious, adding a new tax to the FTE sector, which is in many respects uniquely Canadian, would reduce this sector’s productivity and competitiveness, while doing nothing to enhance the corporate sector’s situation.
The solution, therefore, does not lie in introducing a new tax. Nor should the government tinker with a business structure that provides for sound governance and economic efficiency, comparable to any other existing corporate structure.
BMO Financial Group therefore recommends that, as a priority, the Department of Finance:
• reaffirm its support for the FTE structure in order to end the uncertainty in capital markets; and
• equalize the tax treatment between trusts and corporations by, as its fiscal position allows, enhancing the dividend tax credit as expeditiously as possible.
If Finance follows this approach, we are convinced that Canadian businesses will adopt the most appropriate structure for their organization. Moreover, Canadian corporates may respond by increasing dividend payments, mitigating the cost of the change to tax revenues. The FTE structure will continue to be the right choice for many, but certainly not all, businesses. Forward-looking policy will enhance efficiency and productivity, and provide businesses seeking access to capital markets, and investors, particularly retirees, seeking income, with additional flexibility and choice. To achieve this, the market, not government, should determine the most advantageous structure for particular circumstances.
In its call for submissions, Finance has posed five questions for consideration. We are pleased to respond:
| 1. Does the tax advantage of FTEs relative to public corporations have a significant impact on how businesses are organized in Canada? |
• The extent to which the tax advantage of FTEs relative to public corporations affects how businesses are organized in Canada is unclear. As the government noted in its 2004 Budget, “businesses that put a premium on growth tend to use the corporate structure as this form improves their capacity to finance growth through retained earnings. However, when both corporate and shareholder taxation are considered, the corporate structure may result in higher taxes on distributed earnings, when compared to other business structures. Accordingly, certain mature and stable businesses that are not seeking additional capital have been attracted by the business income trust structure because it improves their ability to distribute earnings.” We agree with this assessment. Businesses considering organizing under the FTE structure do so with the knowledge that investors value stable income that they receive today and are willing to pay a premium for it, which, in turn, contributes to higher valuations for the FTEs.
| 2. Have FTEs had a significant impact on tax revenues? Is there potential for revenue losses to grow in the years to come? |
• Examining the impact of trusts on total tax revenue is a complex issue. We are not experts in this area, but we believe that any future leakage is likely to be limited because there simply are not that many publicly traded corporations in the S&P/TSX Composite Index that remain suitable for conversion to the FTE structure. As the government noted in its 2004 Budget, “foregone tax revenue from business income trusts is modest because reduced tax revenue at the corporate level is largely offset by increased tax revenue at the unitholder level”. The Equity Research Department of BMO Nesbitt Burns has pointed out in a series of commentaries that some of the methodology and assumptions in the Consultation Paper were not consistent with the empirical data. We feel the public policy debate would benefit if Finance were to respond to these questions.
| 3. What impacts are FTEs having on investment decisions and the allocation of capital in Canada? Is the overall impact on the economy positive or negative? |
• We do not believe that FTEs have a negative impact on investment decisions and the allocation of capital. To illustrate this point, in aggregate, capital spending by the top 50 FTEs (by market capitalization) has increased 29% since IPO. Therefore, the FTE structure does not diminish the productivity and competitiveness of businesses.
| 4. Given the important role that tax-exempt investors play in Canadian capital markets, and could play in the FTE market, what impact could this have on government revenues and economic efficiency? |
• We do not believe that FTEs that are held inside tax deferred plans should be considered a tax loss, any more than any other investment held inside such a plan. When invested funds are ultimately withdrawn, seniors are provided with much needed income and the government reaps tax dollars.
| 5. Overall, are there public policy concerns about FTEs and how the tax system influences their existence, and, if so, what actions should be considered to address these concerns? |
• We believe that policy concerns have more to do with the tax system’s discriminatory treatment of dividend income than its treatment of FTEs.
Thank you very much for considering our views. As we welcome public debate on this important public policy issue, you have our permission to post these documents on your website.
Sincerely,
| Yvan J.P. Bourdeau
President and Chief Operating Officer BMO Nesbitt Burns |
Richard M. Egelton
Senior Vice-President and Chief Economist BMO Financial Group |