The trust issues continue

CanWest reports that predictably, the income trust issue has popped up again due to BCE's planned conversion. And the result could be both a major loss of federal revenue, and a transition by businesses toward a form of organization which further prioritizes cash payouts over long-term development:

BCE Inc.'s decision to go the income trust conversion route is ratcheting up pressure on Ottawa to find a way to put a stop to other large companies following suit, says a leading expert on trusts.

Jack Mintz predicted more corporate heavyweights are headed into the income trust structure with negative consequences for both government tax revenue and the ability of the economy to grow and innovate.

"The minister of finance has a big problem on his hands," Mintz, a business professor at the University of Toronto and former president of the C.D. Howe Institute, said.

"There is going to be tremendous pressure on the government to act...This has been going on for too long as it is.

"There are huge conversions down the road that could easily happen. We have to ask ourselves if this is how we want to allow corporate Canada to organize itself."

Income trusts pay almost all their cash to shareholders and pay little or no corporate tax. Last fall, Mintz estimated the tax hit to government revenues from earlier trust conversions was $500 million in 2004. Now, he says the bill is heading toward $1 billion and could go well past that depending on how many more companies convert...

As well, he said the tax advantages of the income trust structure are diverting capital to slow growth industries that are the most suitable to conversion to the income trusts.

Finance Minister Jim Flaherty told reporters in Vancouver Wednesday he's concerned about the issue and the government will continue to monitor the market...

Analysts have speculated other candidates for trust conversions include grocery chains, cable companies, mutual fund firms, and the wealth-management arms of the big banks.

"The onus is going to be on management to explain to shareholders why they aren't doing it," said Ian Nakamoto, research director at brokerage firm MacDougall, MacDougall & MacTier Inc.

The article suggests a carrot-and-stick solution which both applies a higher tax to foreign trust distributions, and offers yet another set of tax breaks on corporate dividends. But there's no more reason now than there was earlier to use a loophole as an excuse to lower other taxes, rather than simply closing the loophole to avoid encouraging similar problems in the future. And two moves (one by Goodale, one by Flaherty) based on more generous tax treatment of dividends have obviously failed to stop the shift.

Whatever one's preferred solution, there's no apparent reason aside from political optics why the Cons wouldn't try to take effective action where the Libs didn't. But unfortunately, it looks like those politics will win out over the substantive need for change:

David Perry, senior research associate at the Canadian Tax Foundation, said he believes the minority Conservative government will be in no hurry to tinker with income trusts given the controversy that erupted when the former Liberal government announced it was looking at the matter last year.

"I think there's a sense of urgency in the Department of Finance but it's a tough one to get into cabinet," Perry said. He noted there are "powerful interests" involved and adjusting tax laws to discourage trust conversions is a complex undertaking.

Which means that a substantial portion of Canada's economy could soon shift to the income trust model with little regard for its pitfalls, taking a significant amount of government tax revenue with it. And with the precedent set that both the Libs and the Cons are perfectly happy to let new tax avoidance measures expand indefinitely until it's too late to control them, the door is wide open for more and newer schemes to exacerbate those problems in the future.

(Edit: Fixed formatting.)