TORONTO, OTTAWA -- Finance Minister Ralph Goodale tried to put a lid on the messy income trust debate and placate angry investors yesterday by promising to lower taxes on dividends. But the surprise announcement was botched, creating momentary confusion in the business community and prompting some to suggest that Ottawa's policy-on-the-fly is a poor solution to the trust problem.
Mr. Goodale, whose ruling Liberal party is expected to be defeated next week, surprised many observers by announcing a change in tax policy before the next election. His review of the income trust sector, which rapidly snowballed into a heated political issue, was not expected to be completed until the end of this year.
"Quite frankly it's become clear in the last very few days that the Opposition is absolutely determined to bring Parliament to an end," Mr. Goodale told reporters, adding that the move will cost the government about $300-million a year.
"And in that context, while I would have preferred to have the full consultation process and have to the benefit of all of that . . . I decided that it was in the public interest to bring this to a definitive conclusion now."
The haste of this decision was readily apparent. Mr. Goodale's parliamentary secretary, John McKay, gave a television interview shortly before Ottawa formally announced the dividend tax cut, and mistakenly suggested the government also planned to levy a modest tax on income trusts.
Mr. Goodale denied that Ottawa was seriously considering a tax on trusts and suggested Mr. McKay was mistaken.
"We are not proposing any tax on trusts," Mr. Goodale said.
Sources said Ottawa was still debating this option hours before it made its decision, but opted not to meddle directly with the sector because of stiff opposition from both pension funds and trusts.
John Dielwart, president and chief executive officer of Arc Energy Trust, said Mr. McKay's error led to a half-hour scramble among senior trust executives, who had been expecting the government to announce a cut in dividend taxes.
"Obviously, there was a lot of consternation and confusion," he said, echoing the perplexed reactions in other brokerages across Canada.
Mr. Dielwart said he believes the Liberal government had been intending to impose a tax on trusts, but had abandoned that plan. He praised the government's final proposal. "The right answer did come out, from our perspective."
Banks, which have been urging better tax treatment of dividends for some time, were of course pleased with the ruling. They make lucrative fees from financing and underwriting income trusts, and as heavy issuers of dividends, their valuations are likely to jump today.
The government's proposal, which is scheduled to take effect in 2006, will effectively drop personal tax rates on dividends to roughly 21 per cent (for the highest marginal rate) from their current 32 per cent. This will be accomplished through a dividend "gross-up" of 45 per cent. The result is that total personal and corporate income tax paid on dividend income should be similar to the total taxes paid if that income were earned by a trust. Trusts have become popular because they pay out most of their cash to investors, thereby sidestepping the corporate tax.
But taxation expert Jack Mintz believes the government's political exigencies may have pushed them to act too fast. While he welcomed the move on dividends, which should bring them more in line with capital gains, he's not certain that Ottawa has attacked the root of the problem with trusts.
"It was absolutely rushed. You realize they haven't dealt with the issue," he said. He pointed out that pension funds, non-residents, and RRSP holders will continue to "prefer income trusts automatically," and said the government may very well have to revisit the issue if its moves yesterday do not slow down the pace of trust conversions and initial public offerings.
Mr. Mintz was also somewhat chagrined because he was in the midst of preparing a detailed tax paper for Ottawa's consultation process, which is now effectively over. "Did I waste my time writing this paper?" he asked. "Absolutely."
News that Mr. Goodale might address the trust situation, quite possibly by lowering taxes on corporate dividends, began to trickle into the markets late yesterday afternoon. Stocks with high dividend yields, like BCE Inc. and Rothmans Inc., gained roughly 5 per cent, while CI Fund Management Inc., a company that shelved its plans to convert to an income trust after Ottawa announced a review of the sector, jumped 4 per cent.
James Leech, senior vice-president of the Ontario Teachers Pension Plan, which holds $2.5-billion worth of trusts, was undeniably elated with the decision.
"We have been urging the federal government to end double taxation for some time, so we welcome the Finance Minister's move on dividend taxes," said Mr. Leech.
Mr. Goodale said most submissions during the consultations to the Department of Finance favoured a dividend tax cut.
"The one consistent idea [through] the vast majority of the representations was the elimination of double taxation with respect to dividends at the federal level," he said.
"At the end of the day I think what we're going to achieve here is greater fairness and balance over all."
The government tabled notice of a ways and means motion yesterday to give effect to the dividend tax cut. This means the Canada Revenue Agency will begin administering the reduction, which takes effect in Jan. 2006, even before legislation has been passed.
It's highly unlikely that the Liberal government, will be able to pass legislation before its expected defeat next week, but convention dictates that revenue collectors will begin treating it as law in the expectation that legislation will follow after the election.
© The Globe and Mail
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