On October 31st, 2006, the TSX closed at 12,344.59 (if my math is right from this article). This was the last close before the Conservative government announced the plans to tax income trusts.
The S&P/TSX composite index fell 294.2 points or 2.4 per cent to 12,050.39 after the announcement late Tuesday that trusts will be taxed more like corporations — the biggest single one day drop in the index in two and a half years.
The market dropped dramatically the next couple of days as investers sold frantically.
Today, November 15th, 2006, the TSX closed at 12,425.37, over 80 points higher than it was before the announcement.
I know that the value did not come back in the same places, but it just goes to show you that if you are diversified enough in your portfolio, you probably are richer than you were the day before the announcement.
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Corporations lock up capital in their structures, do unproductive things with it and then “write off” the resulting losses against any applicable taxes. They try to merge and acquire each other and then finally get bought out by foreign companies. Smart investors no longer applaud this. Smart investors would prefer to receive the money before it is misspent.
Foreign takeover risk to tax base
“A surge in foreign takeovers of income trusts would mean the government’s attempt to stem a decline in tax revenue by taxing trusts may have the opposite affect, said Lee Goldman, a money manager at First Asset Funds Inc. in Toronto.”
“They get too cheap and they get taken out, so you have a whole stream of companies moving south of the border, and you lose the tax from that company anyway,” said Goldman, who helps manage $971 million at First Asset. “It could come back to bite the government.”
“Where you’ve seen a Canadianization of the energy industry, it will go the other way, there will be a lot of purchases,” William Andrew, 54, chief executive officer of Penn West said in a telephone interview from Calgary.
“The decline in Canadian energy income trusts will make them more attractive to foreign companies interested in acquiring natural gas and crude oil assets, BMO Capital Markets analyst Gordon Tait said. The new tax structure also removes a disadvantage foreigners faced when buying a Canadian trust. Under the current rules, a trust would lose its tax exemption if it were controlled by non-Canadians, meaning buyers would be paying for a benefit they couldn’t use.”
Takeovers
“As some of these assets get sold off and some of these good companies get sold down, you could see more foreign takeovers, in which case you could see a lot of income stripping coming out of Canada,” Andrew said.
link is here
Income stripping means that if these companies which were formerly Canadian Income Trusts become foreign owned, the income from these ventures will go to the foreign owners without any tax being paid in Canada.
It is mind boggling, but this is what this simple sounding “Tax Fairness” plan leads to.
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Exactly right!!!!!
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Red carpet for foreign investors
Flaherty seeks to boost welcome for capital from abroad
Review may include overhauling Investment Canada Act
Nov. 25, 2006. 01:00 AM
TARA PERKINS
BUSINESS REPORTER
After blindsiding foreign holders of Canadian Income Trusts and threatening to raise their tax from 15% to 41.5%, Flaherty now says,
“So, we need to attract more foreign direct investment. In some areas, some people feel Canada is not as attractive as other jurisdictions for foreign direct investment, so we want to make our business and tax climate more welcoming, just as we expect other countries to welcome Canadian business growing globally.”
Link is here
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Energy trust executives, finance minister to meet
By JUDY MONCHUK The Canadian Press
Saturday November 25, 2006
This article describes why the oil and gas royalty trusts should be exempt from the government’s blanket ruling on the income trust sector:
“Although the government has said it will not budge from its stance to eliminate the tax-free status of trusts, the oilpatch maintains it is a special case and Ottawa did not have all the facts before making its decision.”
“”We’re still suggesting radical surgery because many of the statements the government has made about our sector are wrong,” Dielwart said Friday.”
“The coalition wants to clear up what it calls Ottawa’s misunderstanding that the United States eliminated royalty trusts for energy — something Dielwart says never happened.”
“”The government says ‘the U.S. got rid of these things, so we have to, too.’ In fact, the U.S. government exempted the resource sector from that change that happened in 1987,” said Dielwart.”
“Master limited partnerships, the U.S. flow-through equivalent of Canada’s energy trusts, are “alive and well,” said Dielwart. “In fact, they had a lower cost of capital than we had and certainly lower than we have now.””
“If that American change was a key factor in Ottawa’s decision, the coalition believes Flaherty must take another look at how trusts are treated in the integrated North American energy market.”
“Oil and gas trusts lost more than $17 billion in market value in the days following Ottawa’s decision to tax income trusts.”
Click Here
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Unfortunately, the “traditional” corporate model discourages Canadian and foreign investment in publicly traded Canadian companies (Capital gains tax, dividend tax, interest tax, and now income trust distribution tax)to the extent that they become so undervalued that those that do hold them for the long term may only be rewarded by management selling them off to foreign interests at above market prices! The income trust model did not allow this to happen and now that this model is being destroyed by our own government, we are going to lose even more Canadian companies to foreigners and the federal and provincial tax base shall erode even further. Also, Flaherty shall have to explain why the US allows Master Limited Partnerships, which have substantially the same structure as Oil and Gas Royalty trusts to exist in the US, whereas he says that Canada needs to abolish them, justifying this decision by saying that the US abolished them. (awkward sentence I know 🙂