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The Canadian Income Trust Landscape: Insights and Implications

Explore the realm of income trusts in Canada: types, tax implications, international comparisons, revenue impact, efficiency matters, recent trends, and government responses. Learn about the debates, economic influences, and regulatory considerations shaping this investment space.

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The Canadian Income Trust Landscape: Insights and Implications

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  1. The Canadian Experience with Income Trusts

  2. Outline • What are income trusts? • Tax policy implications • Experience in selected countries • Revenue implications and economic efficiency issues • Recent developments • Questions

  3. Collective Investment Vehicles in Canada • Trusts widely used as a collective investment vehicle in Canada • Mutual funds are generally established as trusts • Mutual funds hold portfolio of public stocks and bonds

  4. What are Income Trusts? • Trusts governed by provincial laws • Ownership vehicle for a business • Ownership of a single company rather than shares of a portfolio of companies • designed to eliminate corporate income tax on the underlying business • Raise funds by selling units in the trust to public investors.

  5. REIT • Trust has a leasehold interest in properties held by the operating corporation • Trust receives lease income • Lease payments are deductible by the operating corporation

  6. Energy (Royalty ) Trust • Trust has a royalty interest in properties held by the operating corporation • Trust receives royalty payment • Royalty payments are deductible by the operating corporation

  7. Business Income Trust (First Generation) • Trust owns an operating corporation • Operating corporation issues subordinated debt to trust • Operating corporation pays interest to the trust and does not pay corporate tax

  8. Business Income Trust (Second Generation) • Operating corporation replaced by limited partnership (because of flow-through nature of partnership) • Operating trust sits in between limited partnership and income trust to avoid foreign property limit applying to Canadian pension plans (public and private)

  9. Business Income Trust(Third Generation) • Foreign property limit repealed in the 2005 budget • Operating trust not required

  10. Recent Growth • Energy trusts and REITs since mid 1980s • Business income trusts are more recent. • Market capitalization was $193 b at end of 2005 (11% of S&P/TSX); up from $18 b in 2000. • Could continue growing (listing on S&P/TSX and provincial limited liability laws)

  11. Types of Income Trusts

  12. Tax Policy Implications • Income trusts deduct distributions to investors (unit holders) in calculating taxable income of the trust • Trust pays income tax (top personal rate) on taxable income • Taxes paid depend on investor (Canadian retail, tax-exempt (e.g., pension funds), non-residents • Corporations pay corporate income tax and shareholders pay tax on dividends • Cases of over and under integration in Canada

  13. Experience in Selected Countries • U.S. generally treats flow-through entities as corporations • exceptions include REITs and certain partnerships • Since the mid-1980s, Australia has taxed certain publicly listed vehicles as corporations • However, Australian tax system fully integrates the personal and corporate tax systems. • The U.K. recently announced a tax regime for REITs

  14. Tax Revenue Implications • Estimated impact on federal tax revenues was $300 m in 2004 (approximately 1% of federal corporate tax revenues) • Business trusts accounted for $120 m • Estimate compares income tax under the corporate structure and income trust structure • Estimate sensitive to certain parameters (e.g. tax-exempts) • Provincial government implications as well • Estimate for 2005 is higher (60% growth since 2004)

  15. Economic Efficiency Issues • Some have said that income trusts lead to greater economic efficiency • Others have said that the tax system may reduce economic efficiency by distorting investment decisions

  16. Recent Developments • Canada recently carried out consultations on income trusts (and limited partnerships) • Important public policy issue in Canada • Views on both sides of the issue • Some see income trusts as positive development and low risk to government revenues • Others see potential risk to economic growth, investment, productivity and tax revenues

  17. Issues • Issues that were raised as part of the consultations were: • impact of their tax treatment on how businesses are organized in Canada • economic growth, investment and productivity • impact on government tax revenues • potential role tax-exempt investors may have in this market

  18. Government Response • Better integration of the personal and corporate income tax systems • Increase the dividend tax credit for dividends from large corporations to fully compensate investors for underlying corporate income tax • Takes into account recent proposals to reduce corporate income tax

  19. Questions • What is the experience in other countries? • What actions are being/have been taken? • Views on integration? • Views on pressures on the debt/equity borderline?

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