Will fears of a hollowing out save income trusts?

OTTAWA — Recent research indicates that those who fear a “hollowing out” of the Canadian economy through foreign takeovers of domestic companies (InvestmentNews, Nov. 6) may have good reason. An April 5 report from CIBC World Markets Inc., part of the Toronto-based Canadian Imperial Bank of Commerce, counted 13 takeovers involving income trusts with a combined enterprise value of more than $7.2 billion (U.S.) since Oct. 31, when the taxation of income trusts was announced. Three more income trusts received offers April 16. Income trusts, investments similar in structure to U.S. real estate investment trusts, pay little or no income tax but instead pay out almost all their cash to unit holders, who are taxed individually. The minority Conservative government, faced with the possibility of an election, signaled last month that it might be backing off its stance of disallowing tax deductions for all income trusts. It isn’t takeovers of income trusts alone that raise the specter of jobs and decision-making power leaving the country, however. Algoma Steel Inc. of Sault Ste. Marie, Ontario, agreed April 18 to be acquired by Mumbai, India-based Essar Global Ltd. for $1.65 billion. BCE Inc., a Montreal-based telecommunications giant, also is in play. For years, such takeovers of Canadian companies were offset, or even outweighed, by Canadian firms making purchases abroad. That no longer is the case. During the past 10 years, foreign companies have acquired more of corporate Canada than Canadian companies bought of foreign companies. “Canada needs to find policies appropriate to a free-trade world but which don’t make Canada an easy mark for corporate giants created under the protection of their own governments,” Kenneth Smith, a Toronto-based managing partner with SECOR Consulting Inc. of Montreal, wrote in a March 30 op-ed article in the Financial Post, a national newspaper published in Toronto. “The sky is not falling,” he wrote. “The Canadian economy is strong, we have a boom in the West, and companies from around the world are investing in Canada,” Mr. Smith added. “However, the nature of the economy will change fundamentally if we continue to be the seller rather than the buyer in globally restructuring industries.” Some put the onus on Finance Minister Jim Flaherty. In response to the recent wave of announced acquisitions of income trusts, he said on April 2 that “trust buyouts are not my fault.” “Mr. Flaherty brings a new low to the concept of being accountable for one’s actions, be it in government or in any walk of life,” Brent Fullard, president and chief executive of the Ottawa-based Canadian Association of Income Trust Investors, said in a statement the following day. “Not only does Mr. Flaherty not understand the concept of ‘duty of care,’ he does not understand the concept of ‘duty of office.’ His actions are reckless,” Mr. Fullard said. The upshot of the income trust taxation decision and the removal of restrictions covering the ability of individuals to move the tax- sheltered retirement savings abroad will be “… a general decline in domestic-equity holdings by Canadians,” Peter Haynes, index analyst with TD Securities Inc., a subsidiary of The Toronto-Dominion Bank, wrote in a recent research report. “It’s Wall Street that will reap the benefits at the expense of Canadian jobs and Canadian families,” Stéphane Dion, leader of the opposition Liberal party, said in an April 16 speech, accusing the minority Conservative government of accelerating the process of hollowing out. “We are here today to condemn two destructive Conservative policies that prevent economic growth and leave Canadian businesses vulnerable to foreign takeovers,” he said. “First is the Budget 2007 decision to end the deductibility of interest on loans taken out by Canadian companies to finance overseas expansion. Second is the Conservative decision to break their election promise and tax income trusts at a punitive rate of 31% … This is the single biggest change to the corporate-tax system in 30 years, and the Conservatives failed to consult anybody about it and failed to calculate its cost to Canadian business.” Mr. Dion said. Although Mr. Flaherty said that the income trust tax will stay as long as the Conservatives remain in power, he signaled last month that he may be ready to narrow the deduction measure — so that it captures only those corporations seeking to evade Canadian taxes. “The goal has always been to get at the tax havens and the double dipping, as it’s called — the double deduction of interest,” Mr. Flaherty said during an April 2 webcast. That may be good for Canadian companies. But income trust investors will have to wait for the next election, which some political pundits think is imminent, to see a change in policies.