Canada's income trusts

Justice Litle - Fri 03 Nov, 2006

...The tax change regards a new plan to tax Canada's income trusts. Not only does it come out of the blue, it breaks a pledge made by Canada's Conservative government not to change the trust taxation rules...

 
 
- The term "political risk" usually brings to mind Third World countries. It's what you think of when mining companies take on projects in the Congo, or exploration and development guys get kidnapped in Nigeria.

- Russia has also been a poster child for political risk in recent years, as the Kremlin tightens its grip on the energy sector, plays up Cold War sentiments and destroys "uncooperative" players (like YUKOS) by any means available...including criminal ones.

- But now we are reminded of an unpleasant reality: Political risk applies to First World countries too.
Canada's "Conservative" government recently announced a surprise change in the tax laws that could have come straight from the Kremlin's playbook.

- As The Washington Post reports, "The total secrecy in Tuesday's announcement, as bankers and parliamentary staffers left early for Halloween, caught everybody off guard."

- The tax change regards a new plan to tax Canada's income trusts. Not only does it come out of the blue, it breaks a pledge made by Canada's Conservative government not to change the trust taxation rules.

- Canada's rationale for doing this is that they are missing out on too much revenue as the income trust sector expands. But this rationale is self-defeating; because of the message Canada's government sends with the arbitrary change: If you do business in Canada, you are liable to confiscatory changes in tax policy at government whim - even if we promise no such changes beforehand.

- I read The Economist every week. Frequently, I see business development ads for Ontario and Toronto, touting their advantage as desirable places for corporations to set up shop. Canada's new message rips that business-friendly ethos to shreds.

- Bill Holland, the CEO of the CI Financial Income Fund, calls this out-of-the-blue move "a bizarre, Third-World policy" and I agree. It is just plain stupid, and Canada's government could lose more from business foregone than it gains in tax revenues as a result. If so, the knuckleheads deserve it.

- For one thing, this "get me out of trusts" stampede is a blatant overreaction. Canada's finance minister has said that only new trusts will be immediately subject to the change, while existing trusts will get a four-year "transition period," whatever that means. So we don't even know how substantially, or how soon, Westshore's and Peyto's distributions will be affected.

- On top of that, there is still a possibility the idiots in Canada's government will get a clue and back off. This decision smacks of bureaucratic bungle - the colossal error of some pointy-headed bean counters with no understanding of business climates, and how important it is to maintain a consistent stance. A severe backlash could make them think twice.

- What's more, recall that natural gas is a SCREAMING long-term buy at these levels. Even if a hefty resource tax goes through - which it may not - and even if it were implemented immediately - which it won't be – there are still cheap natural companies when you consider the longer-term natural gas fundamentals.

- On a broader level, this is a good reminder. Political risk is no respecter of boundaries, and First World country politics could get increasingly ugly in the coming years as demagogues come to power and Western welfare regimes implode.

- That means some volatile swings could be on the cards...


Regards,

Justice Litle
for The Daily Reckoning