Saturday, November 04, 2006

More Income Trust Fallout

The Globe's Gloria Galloway was quick to pounce on this juicy tidbit - "Long-time Tory angrily quits party over trusts".

Westmount-Ville-Marie Conservative Riding Association President Sean Ahern tore up his party membership yesterday, in response to the government's decision to tax income trusts.

"If the Liberals promise to leave things the way they are for existing unit holders, I'll vote for them. I've never voted for a Liberal in my life. But I will vote for them," said Mr. Ahern, a financial planner in his 60s who has been a Conservative Party member since he was 16.

Ouch!!!

I know for a fact that there are other bitter Tories out there. No doubt the party's fundraising efforts are going to take a hit.


However, the markets seem to be recovering. I would assume that if investors just wait it out, they can find an optimum time within the four year grace period to convert their investments to another area.


Conservative Party president Don Plett said Mr. Ahern is the only riding association president to take this kind of action over income trusts. He said he has received few complaints about the matter.

"I never want to downplay something like this," Mr. Plett said. But "the way I understand it, you've only lost money on paper if you don't sell out."


However financial planners and consultants must be taking a lot of heat over this from their clients.

It's rather ironic that the biggest backlash of all may come from the party membership.


* * * *

Dissonance and Disrespect has a little less sympathy... Gloria in Extremis: Shattered Trust.

24 comments:

Alberta Girl said...

Investors who decided to beat the tax system and put all their eggs in one basket are reaping the "rewards"??. This is paper money, they have not "lost" millions.

Heck - during the market downturn in the 90's, we watched our investments dwindle - where was the hew and cry over that. Our "investments" are still not at the paper levels they were in the heyday. But what exactly did we "lose"

Number one lesson - there are two certain things - death and taxes -

You NEVER beat those and if you try, you usually end up getting caught

Joanne (True Blue) said...

Alberta Girl, yep. It's one of the hard lessons in life. Death and taxes.

Also, if an investor put all their money in income trusts, they were either very stupid or very greedy.

Jason Bo Green said...

What the heck are people so sore about? Honestly, I thought this was like a page 3, one day item - I'm amazed I so misunderstood how big this was.

Joanne, if you feel comfortable, email your mailing address if you want my copy of that book I mentioned to you, "Selling Illusions: The Cult of Multiculturalism in Canada" by Neil Bissoondath, in which an immigrant attacks multiculturalism. No pressure - I'll just take it to Goodwill otherwise. :)

Joanne (True Blue) said...

Jason, that's very kind of you. I'll just order it from the library though, but thanks anyway. I usually have no trouble getting whichever book I request, and it's within walking distance.

Go ahead and donate the book to charity. I'm sure it will find a good home. ;)

Steve said...

...financial planners and consultants must be taking a lot of heat over this from their clients.

If their clients were not diversified and had most of their money in trusts, they deserve to take a lot of heat. I suspect this guy put his clients heavily into trusts and quit the party to save face.

Financial advisors and planners have a fiduciary duty to ensure their clients have diversified portfolios. If, as a result of their advice, their clients put too many eggs into the income trust basket, they probably deserve to have their licenses or professional accreditation removed.

Joanne (True Blue) said...

Excellent point, Steve.

A proper financial planner would be very reluctant to put all of a client's portfolio in anything one thing, even if he was ordered to do so. He would have to try to get the client to understand the extreme risk involved.

The golden rule is to assess the client's risk tolerance, and always diversify no matter what.

liberal supporter said...

Come on folks, the "you lost money because you were stupid or greedy" routine isn't going to help the CPC recover from this. Markets are pretty non partisan when it comes to thrashing any government that changes anything to do with financial markets. Breaking a clear campaign promise is bad form, not a mortal sin, so I'm sure you will give any future Liberal government a pass if it is something like this.

You should be talking up that the markets will overcorrect and punish any government, and accusing the previous government of being too scared of the bay street bullies to do the right thing, just before the last election.

I doubt that any future government will repeal this.

Joanne (True Blue) said...

L.S. - Wow, we sure did get off our 'talking points'!

You're absolutely right of course. Sean Ahern is crazy if he things a Liberal government would go and turn this around, considering that they were the ones that originally showed concern about income trusts.

The mistake that the CPC party made was to promise to leave them alone. But at the time there wasn't the trend in popularity that there was recently; especially with such big companies like BCE and Telus.

Swift said...

Alberta girl should do some digging. The only investors that were beating the tax system were non-Canadians. Why were they beating the system? The department of finance couldn't add the provincial crperate tax rate and the federal corperate tax rate to get the correct withholding tax for foreign investors. The rate for 2007 should be 13.5(provincial) plus 21(federal) giving a total withholding tax rate of 34.5%. The actual rate would have been 15%. No wonder there is a shortfall on revenue, especially for the provinces as the 15% went to the feds.

No Canadians were beating the system by avoiding taxes. Why did Canadians like the trusts? They paid out much more money to investors, both before and after taxes. It's not a matter of beating the tax system, but a different philosophy about how a business should be run. Normal companies say they are running the business for the benefit of the shareholders, but typically fall far short of that lofty goal. trusts came closer, which is why the conversion to a trust resulted in a fifteen to twenty percent increase in share value as soon as a conversion was annouced.

What would have happened to a ficticious pensioner who believed the conservative elecion promises about trusts?
October 31st 2006.
pension income and OAS
$15,000
investment income using trusts
$15,000
investments using trusts
$180,000
November 1st 2006
pension incme and OAS
$15,000
investment income using corporations
$6,000
investments after selling trust and buying common stocks
$150,000
This pensioner did nothing illegal, did not cheat the government of one cent. Yet will suffer a 30% drop in income because the government couln't add.
Doesn't seem fair to me.
it's not the trust or LLP structure that is the problem. The government didn't ban them. Acountants, lawyers, and many other professionals still can use them. Private companies can still use these stuctures. These have one thing in common. They are generally only available to high income high net worth individuals. Why can't the average person get the same advantages?

C. LaRoche said...

There's some good stuff on the income trust quandary in today's Globe business section. This quote in particular, from Simon Beck, is worth highlighting (in response to criticism from investors who lost money from the news, including one Mr. David Marshall, who lost $90,000 ina single day and was on the cover of Wednesday's Globe):

"It's probably fair to say that if Finance Minister Jim Flaherty were to venture anywhere near Cornwall in the coming days, Mr. Marshall and other outraged members of the Bingo Generation would be waiting for him with their sawed-off Ensure cans.

But the pensioner's plight raised some issues:

1. If you've lost $90,000 or more in one day, we're more likely to be envious of all the loot you haven't lost than the smidgen you have.

2. Does the word 'diversification' ring a bell?

3. There's always the NDP. You just know they'll leave all your hard-earned money alone."

Joanne (True Blue) said...

Swift, that is fascinating and frankly a bit beyond my comprehension of economics. I wonder what Garth Turner would say? On second thought forget that. He has selective hearing.

Swift said...

Quote from backgrounder available at department of finance website.
Click on WHAT'S NEW, then tax fairness Oct 31st. An FTE(flow though entity) is a trust or LLP

"In pinciple the tax that an FTE
does not pay is paid instead by those public investors, and there should be no tax reason for an investor to prefer FTE income to corperate dividends. This is indeed the case for taxable Canadian resident individuals."
The department of finance in the above admits that trust owners resident in Canada do not pay less tax than they should. CANADIAN TRUST INVESTORS DO NOT AVOID TAXES.


Why do investors like trusts? Because the average trust pays 8% a year. Without the Oil Sands trust this average is even higher.
The equivelant dividend for a regular company is 5.3%. The average dividend of a TSX stock is 1.5%. 5.3% is a lot larger than 1.5%. If you are looking for income the average trust will give you over three times the income of the average stock. the average trust gives you over twice the income of a GIC from a major bank.
And you don't have to rip off the goverment to get this extra income! The goverment admits this!

If you were retired and had $100,000 dollars to invest to supplment your income, where would you invest it? In the average stock and get $1,500. In GIC'S, and get $3,250 a year. Or in the average trust and get $5,280 a year. All figures before personal income tax. An added feature of both stocks and trusts is that your princeple and income will grow over time if wisely invested while GIC's will not.

Someday everybody will retire and be looking for extra income from their savings.Do you want to be liomited to the lowest returns or would you want to be able to improve yur retirement with trusts?
Again NO TAX IS AVOIDED BY CANADIAN RESIDENTS WHO OWN TRUSTS!

Swift said...

By the way, for those of you that think that 5.8% before tax return is greedy you havn,t been paying attention. What would you call 1000% return.

Nick said...

--
Someday everybody will retire and be looking for extra income from their savings.Do you want to be liomited to the lowest returns or would you want to be able to improve yur retirement with trusts?
Again NO TAX IS AVOIDED BY CANADIAN RESIDENTS WHO OWN TRUSTS!
--

Yup the tax certainly won't be avoided after last week's announcement. The real issue is why do Alberta energy companies think they are entitled to special rights - not having to pay any corporate taxes. Why wait until 2012 to lower the boom? The tax forms for year 2007 have not been printed yet...

Joanne (True Blue) said...

Swift, what can be done now anyway? Even if the Grits vote against it, do you think they'd really reverse all this if they got back in power?

liberal supporter said...

swift, thanks for explaining some of this.

I still don't feel I understand it though. You say:
"Normal companies say they are running the business for the benefit of the shareholders, but typically fall far short of that lofty goal. trusts came closer,"

What is it about trusts that make that happen? Why do they pay better? Is the company more obligated to cause the trust to pay out, or it can pay out more and on their side it costs the same?

Swift said...

First i'll try to xplain to nick, and anyone else who doesn't understand one of the differences between trusts and corperations, I'll get to liberal supporter's question later. It's a good one.

The trusts and LLP's are called flow throgh entities. The reason is things like profits and taxes flow through them. They don't keep profits, and they don't pay taxes. What happens is that the unit holders in a trust or the partners in an LLP get all the profits and pay all the taxes.

The way a regular company works is they make some profits doing bussiness(at least some of them do.) The government comes along and says, we heard you made some profits and we tax profits, pay up. So the company pays the taxes. The company then declares a dividend to its shareholders. Joe gets a hundred dollars in dividends. The government then comes to Joe and says, we heard you got some dividend income we tax dividends, pay up. But since the company has already paid some tax on this money you won't have to pay tax on the full hundred dollars. You can check on your tax form to see how they do this.

A trust works a little differently. The trust makes some profits and distributes them to it's unit holders. The government comes along and says, we heard you made some profits, we tax profits, pay up. The trust says, yes we made some profits, but we can't pay any taxes because we gave them all to the unit holders, go collect from them. So the government goes to Joe who got a hundred dllars from the trust, and says, we heard you got some distributions from a trust, we tax distributions, pay up. Because the trust didn't pay any taxes you won't get the dividend tax credit, so you will have to pay taxes on the full one hundred dollars. and joe pays up. The extra taxes that Joe pays for the distributions replaces the taxes the trust didn't pay. So if everything is set up properly the correct amount of taxes are paid. it is set up properly for Canadian tax payers now, but not for foriegn tax payers. They are not paying enough. Thus the tax leakage. This is simplified but should give you the idea. The company pays more than the trust but the reciever of the trust distribution pays more than the reciever of the dividend.

Swift said...

Now I can get to liberal supporter's excellent question. Why does a trust pay out more money and why does a trust come closer to the goal of running the company for the shareholders benefit.

Part of the answer to why the trust is better for the shareholder is that it does pay out more money.

But let's step back a little and make some general observations. If you have lots of money coming in most people will spend lots of money. They won't really examine each expenditure closely to make sure they are getting the most bang for the buck. However when the money is in short supply they examine each expendature much more closely.
Now ther are exceptions to this rule, and maybe you know some, or are one yourself.

What applies to individals also applies to organizations. Bussinesses and governments tend to spend much less wisely when they have a lot of money.

Let's look at a project that should cost one million dollars. It doesn't matter what it is, invent your own. In an enviorement where there is lots of money available, this project is likely to end up costing more than a million dollars. For examples of this in government, you just need to read the auditor generals reports.

In an enviorement where exspenses are closely monitored because money is scarce the project is likely to cost about a million dollars. If it costs more serious questions are asked, and if there are no good answers desks tend to be emptied out.

When there is simply not enough money to do everything that has to be done, there may be only eight hundred thousand available for the million dollar project. But it is amazing how many times somebody figures out how to do it for eight hundred thousand.

Now let's look at the difference between a company and a trust. Both the company and the trust make ten million dollars. The company pays the taxes declares a dividend and gets to keep two million.

A trust distributes all its profits to its unit holders. so it does not getr to keep the two million dollars. It doesn't pay taxes because it no longer has the profits, but the unit holders do pay taxes on the profits. it's only fair because the unit holders get all the profits.

The much bigger distributions of trusts can be explained by this. The profit made by the company is divided into three parts: taxes, dividends, and retained earnings. The trust distibutes all of this money to the unit holders.

This also explains another big advantage of trusts. In the example the company gets to keep two million dollars. This means it has lots more money than the trust. Remember what happens in organizations with lots of money? it gets spent. And often not wisely.

The trust does not get to keep the two million dollars so money is scarce. Money tends to be spent wisely and not wasted. There is lots of pressure to find better and cheaper ways of doing things.

Thus companies have a greater chance of becoming fat and lazy, whereas trusts have a better chance of being lean and mean. When lean and mean competes with fat and lazy in the marketplace lean and mean usually wins.

To recap the trust distributions are higher because the trust distributes all its pretax profits to the unit holder(and often even more.) The company dividend is much smaller because it's pretax profit is split three ways; taxes, retained earnings and dividends.

A further advantage for the trusts is that because they have much less money to spend they tend to spend it much more wisely. In the long run less money wisely spent generates much more profit than more money foolishly spent.

There are many more factors to consider than the two I have discussed here, some of them favouring the company model, but I hope I have given you enough to at least get a basic understanding of the points that you weren't clear on.

Joanne (True Blue) said...

Swift, thanks for the explanations. I think even I understood it this time.
;)

Questions:

#1. If what you're saying is true about the big tax leak being from foreign investors who don't have to pay taxes, why do you suppose the government didn't just address this issue and leave trusts as is for domestic investors?

#2. Your theory of Income Trust companies being wise spenders is an interesting one, but some would say it is more of an issue of not reinvesting at all in R&D, which can lead to big problems down the road unless I have interpreted this incorrectly:

"It's a positive step, what Flaherty is doing, but there's more problems to these than just the tax treatment," Rosen said.

He describes trusts like pyramids, warning most of the income distribution given to investors is a return of their own capital, and when the money runs out, the trust will collapse.


(From the Sun).


Thanks for your input. You have been providing a lot of interesting information here Swift, and certainly a deeper understanding of the implications than we are getting in MSM. I sure do hope you didn't take too much of a hit on Hallowe'en night.

Swift said...

Joanne, the Liberals were forced to back down on this issue. Flaherty has tried to defuse one of the most vigorous opposition groups by habdig out some goodies to retirees. The problem is most retirees who have more than ten thousand dollars of savings are loosers in the deal. The income splitting feature will mainly benefit the few couples where oe has a large pension income and the other has a small income. These couples either didn't bother saving or didn't take advantage of ways to equalize retirement income such as spousal RSPs.

If you read the backgrounder on the finance department website you will notice the following FTE's are not banned and who are the people who benefit from them.
LLP's by professionls such as accountants lawyers doctors and engineers. Private companies, all but the smallest are owned by millionaires.

For those of you that still can't figure out that it doesn't matter wether the company pays some of taxes and the individual pays some of the taxes or the individal pays all of the taxes both for himself and the trust, here are some things to think about.

By March 2012 the government will have 6.55 billion dollars less because of the tax changes. You will have to make up the differnce. This does not include the capital gains taxes lost because of the fall in price of existing trusts. Another 3 or 4 billion dollars you will have to pay. The fall of the stock prices of BCE and Telus will and the lost windfall taxes the government will have is over a billion dollars. You will have to pay.

The reason the oil patch is screaming? Trusts have a 15% to 20% higher price than regular stocks. This makes them much less likely to be taken over by foriegn companies. They feel that there are going to be many takeovers in the oil patch. For this you are really going to pay. I repeat again NO TAX WAS AVOIDED BY CANADIANS WNING TRUSTS. THE INDIVIDUALS PAYED THE PERSONAL TAX AND THE CORPERATE TAX THAT THE TRUST DIDN'T PAY. But what happens when a foriegn company takes over a Canadian company? They quickly put in measures to get money out of the Canadian company WITHOUT PAYING ANY TAXES! Unlike a trust where the unit holder pays personal taxes and then pays extra to make up for the taxes not paid by the trust, the foriegn company pays NO Canadian taxes on this money. Guess what, $400, million a year is chicken feed besides the money lost by this method. You pay to make up the difference.

Here's the thing I like best that trusts before Goodale were doing. American companies were coming up here and converting to trusts. Before the conversion they paid no Canadian taxes. There shareholders were mainly or totally US residents who paid no Canadian taxes. After the conversion the US unt holders were paying Canadian taxes. True, they were not paying enough Canadian taxes because the government goofed, but they were paying taxes in Canada. If you don't like the idea of US residents owning company doing no business in Canada starting to pay Canadian taxes which you will no longer have to pay then I wish you would replace the US money by paying the extra taxes i'm going to be paying.
Not much difference now, but it could have been huge. Take a look at the profits of one just one of the large US based companies and think 30% of that figure paid to the Canadian government.

I could go on about the non tax effects and the indirect effects of killing the trust but the main theme is the same. Even if you never would have owned a trust unit, still for the killing of the trusts YOU PAY!

Swift said...

Joanne, the Liberals were forced to back down on this issue. Flaherty has tried to defuse one of the most vigorous opposition groups by habdig out some goodies to retirees. The problem is most retirees who have more than ten thousand dollars of savings are loosers in the deal. The income splitting feature will mainly benefit the few couples where oe has a large pension income and the other has a small income. These couples either didn't bother saving or didn't take advantage of ways to equalize retirement income such as spousal RSPs.

If you read the backgrounder on the finance department website you will notice the following FTE's are not banned and who are the people who benefit from them.
LLP's by professionls such as accountants lawyers doctors and engineers. Private companies, all but the smallest are owned by millionaires.

For those of you that still can't figure out that it doesn't matter wether the company pays some of taxes and the individual pays some of the taxes or the individal pays all of the taxes both for himself and the trust, here are some things to think about.

By March 2012 the government will have 6.55 billion dollars less because of the tax changes. You will have to make up the differnce. This does not include the capital gains taxes lost because of the fall in price of existing trusts. Another 3 or 4 billion dollars you will have to pay. The fall of the stock prices of BCE and Telus will and the lost windfall taxes the government will have is over a billion dollars. You will have to pay.

The reason the oil patch is screaming? Trusts have a 15% to 20% higher price than regular stocks. This makes them much less likely to be taken over by foriegn companies. They feel that there are going to be many takeovers in the oil patch. For this you are really going to pay. I repeat again NO TAX WAS AVOIDED BY CANADIANS WNING TRUSTS. THE INDIVIDUALS PAYED THE PERSONAL TAX AND THE CORPERATE TAX THAT THE TRUST DIDN'T PAY. But what happens when a foriegn company takes over a Canadian company? They quickly put in measures to get money out of the Canadian company WITHOUT PAYING ANY TAXES! Unlike a trust where the unit holder pays personal taxes and then pays extra to make up for the taxes not paid by the trust, the foriegn company pays NO Canadian taxes on this money. Guess what, $400, million a year is chicken feed besides the money lost by this method. You pay to make up the difference.

Here's the thing I like best that trusts before Goodale were doing. American companies were coming up here and converting to trusts. Before the conversion they paid no Canadian taxes. There shareholders were mainly or totally US residents who paid no Canadian taxes. After the conversion the US unt holders were paying Canadian taxes. True, they were not paying enough Canadian taxes because the government goofed, but they were paying taxes in Canada. If you don't like the idea of US residents owning company doing no business in Canada starting to pay Canadian taxes which you will no longer have to pay then I wish you would replace the US money by paying the extra taxes i'm going to be paying.
Not much difference now, but it could have been huge. Take a look at the profits of one just one of the large US based companies and think 30% of that figure paid to the Canadian government.

I could go on about the non tax effects and the indirect effects of killing the trust but the main theme is the same. Even if you never would have owned a trust unit, still for the killing of the trusts YOU PAY!

Joanne (True Blue) said...

Even if you never would have owned a trust unit, still for the killing of the trusts YOU PAY!

Swift, have you seen anything in MSM exposing this wrinkle?

Swift said...

Your investment tip of the day; BUY TRUSTS. Remember there is more than one way to skin a cat.

Joanne, the MSM is no place to find the reasons for, or the results of, any thing. So I would guess not.

Joanne (True Blue) said...

Joanne, the MSM is no place to find the reasons for, or the results of, any thing. So I would guess not.

Very good point, Swift!