THE TAXING ISSUE OF ENERGY TRUSTS
by
Lesley Sun-Ju Kim
A thesis submitted in conformity with the requirements
for the degree of Master of Laws
Graduate Department of the Faculty of Law
University of Toronto
© Copyright by Lesley Sun-Ju Kim 2008 Library and Bibliotheque et 1*1 Archives Canada Archives Canada Published Heritage Direction du Branch Patrimoine de I'edition
395 Wellington Street 395, rue Wellington Ottawa ON K1A0N4 Ottawa ON K1A0N4 Canada Canada
Your file Votre reference ISBN: 978-0-494-45071-0 Our file Notre reference ISBN: 978-0-494-45071-0
NOTICE: AVIS: The author has granted a non L'auteur a accorde une licence non exclusive exclusive license allowing Library permettant a la Bibliotheque et Archives and Archives Canada to reproduce, Canada de reproduire, publier, archiver, publish, archive, preserve, conserve, sauvegarder, conserver, transmettre au public communicate to the public by par telecommunication ou par Plntemet, prefer, telecommunication or on the Internet, distribuer et vendre des theses partout dans loan, distribute and sell theses le monde, a des fins commerciales ou autres, worldwide, for commercial or non sur support microforme, papier, electronique commercial purposes, in microform, et/ou autres formats. paper, electronic and/or any other formats.
The author retains copyright L'auteur conserve la propriete du droit d'auteur ownership and moral rights in et des droits moraux qui protege cette these. this thesis. Neither the thesis Ni la these ni des extraits substantiels de nor substantial extracts from it celle-ci ne doivent etre imprimes ou autrement may be printed or otherwise reproduits sans son autorisation. reproduced without the author's permission.
In compliance with the Canadian Conformement a la loi canadienne Privacy Act some supporting sur la protection de la vie privee, forms may have been removed quelques formulaires secondaires from this thesis. ont ete enleves de cette these.
While these forms may be included Bien que ces formulaires in the document page count, aient inclus dans la pagination, their removal does not represent il n'y aura aucun contenu manquant. any loss of content from the thesis. Canada ABSTRACT
THE TAXING ISSUE OF ENERGY TRUSTS
Master of Laws
2008 Convocation
Lesley Sun-Ju Kim
Faculty of Law, Graduate Department
University of Toronto
The federal government announced the Tax Fairness Plan (the "Plan") on October
31, 2006. Under the Plan, income trusts are taxed in much the same manner as corporations, thereby losing the flow-through tax advantages previously associated with this structure. In this thesis I argue that energy trusts should be able to retain these tax advantages associated with the income trust form. In Part II, I describe these tax advantages, with a focus on foreign investors and tax exempt entities. In Part III, I explain the operation of the Plan and describe the way in which it interferes with these tax advantages. In Part IV, I explain tax expenditures and canvass the arguments for and against retaining these tax advantages for energy trusts. In Part V, I conclude that it is good public policy to exempt energy trusts from the Plan and retain the tax advantages of the income trust structure.
ii THE TAXING ISSUE OF ENERGY TRUSTS
TABLE OF CONTENTS
I. Introduction 1
II. The Tax Advantages of Income Trusts 8
A. Foreign Investors 18
B. Tax Exempt Entities 32
III. The "Fairness Plan" 35
IV. Are Tax Advantages for Energy Trusts Good Public Policy? 41
A. The Case in Support of Energy Trust Tax Advantages 44
B. The Case Against Energy Trust Tax Advantages 56
C. Weighing the Arguments for a Carve-Out for Energy Trusts 65
V. Conclusion 76
VI. Appendices a
VII. Bibliography e
iii LIST OF APPENDICES
I. Income Trust Buyouts After Income Trust Tax Announcement a
II. Income Trust Equity Financings d
iv 1
I. INTRODUCTION
On October 31, 2006 the Minister of Finance, Jim Flaherty (the "Minister") introduced the new "Tax Fairness Plan" (the "Plan") for Canadians. As a result, the tax benefits previously enjoyed by the income trust sector are expected to come to a close at the end of 2011.1 Income trusts essentially flow income through to their unitholders free of entity-level tax. However, under the Plan, the tax treatment of certain publicly traded flow through entities, also known as income trusts, will be more like that of Canadian public corporations, and their investors will be taxed more like shareholders. In announcing the Plan, the Minister stated that corporations converting to the trust structure
"don't pay their share of taxes" and if trusts were to continue to proliferate, "the tax burden will shift onto the shoulders of hardworking individuals and families."3 In this thesis, I argue that the federal government unwisely included energy trusts in its Plan to tax income trusts like conventional publicly-traded corporations.
In the 10 years leading up to the October 31, 2006 announcement, publicly listed income trusts, and the trust sector more generally, have gained popularity as investment vehicles. From 2000 to 2006 in particular, there had been sharp growth in the income trust sector. In 2005, prior to the Plan's announcement, the 227 income trusts trading on the Toronto Stock Exchange (the "TSX") represented 10 per cent or $176 billion of the quoted market value of all securities listed on the TSX (the quoted market value has been as high as $200 billion).4 By number of issuers, income trusts comprised 15 per cent of
1 Department of Finance Canada, New Release/Communique\ "Statement by the Honourable Jim Flaherty, Minister of Finance" (31 October 2006) online:
This asset class is comprised of energy trusts, business trusts, REITs and power and pipeline.7 In September 2005, income trusts represented 39 per cent of equity capital raised on the TSX, 31 per cent of initial public offering ("IPO") dollars, and 22 per cent of new listings.8 Energy trusts had contributed 46 per cent or $80 billion of the quoted market value in 2005, but of the 227 trusts that had been trading on the TSX, only 38 were energy trusts (17 per cent of all TSX traded trusts).9 Thus energy trusts proportionately raise more capital than other forms of income trusts. Compare these numbers to business trusts: in 2005, they contributed 31 per cent of the quoted market value but there were 144 business trusts which comprised 63 per cent of the 227 income trusts trading on the TSX.10 More recently, from the time of the Plan's announcement to
March 31, 2008, 47 income trusts have shut down leaving approximately 212 income trusts listed on the TSX.11
Income trusts are headquartered throughout Canada, but by quoted market value, before the Plan was announced, 63 per cent were based in Alberta. The rest were headquartered as follows: 21 per cent in Ontario, 9 per cent in Quebec, 6 per cent in other
5 Ibid. ° Deloitte, "Income Trust Buyouts: Lots of Activity, Little Tax Revenue" (December 2007) online:
As a result of this rapid growth in the income trust sector,14 the Plan, with its new income trust tax was announced. The Minister stated that the introduction of the income trust tax was in response to the growing trend towards corporate tax avoidance.15 The
2006 announcements by Telus Corp. and BCE Inc.16 of their intention to convert into income trusts appear to have been the catalyst for the Minister to announce this new tax.17
"[I]t goes almost without saying that to be effective a tax base must be politically acceptable." However, while a majority government can always force amendments to legislation,19 the Conservative Party currently forms the smallest minority government in
Canadian history. Therefore, the final fate of the income trust tax remains somewhat precarious, though as time goes on, the likelihood that the tax will be repealed by a
12 TSX, supra note 4 at 3. " J. Alex Tarquinio, "Not and oil baron? You can still get oil royalties" The New York Times (17 October 2004), online: New York Times < http://www.nytimes.com/2004/10/17/business/yourmoney/17ener.html>. 14 Department of Finance Canada, Consultation Paper, "Tax and Other Issues Related to Flow-Through Entities (Income Trusts and Limited Partnerships)" (September 2005) [Department of Finance, Consultation Paper] at 3. 15 Department of Finance, Flaherty, supra note 1. 10 Sinclair Stewart, Boyd Erman and Derek DeCloet "Faith Through Conversion" The Globe and Mail (14 October 2006) [Stewart]. " Department of Finance, Flaherty, supra note 1. 18 Kim Brooks, "Learning to Live with an Imperfect Tax: A Defence of the Corporate Tax" (2003) 36 U.B.C. L. Rev. 621-672 at 140 [Brooks]. 19 Lisa C. Phillips, "The Rise of Balanced Budget Laws in Canada: Legislating Fiscal Responsibility" (1996) 34 Osgoode Hall L.J. 681-740 atf 16 [Phillips]. 20 Wikipedia, "Minority Governments in Canada" (29 May 2008) online: Wikipedia
the income trust tax will be significant.
The Plan is especially relevant to Western Canada with its large, mature oil and
gas reserves. Exploiting these resources has produced benefits for the whole country
beyond simple royalty and tax revenues. For example, during the 1990s, the energy sector
91
contributed more than 65 per cent of Canada's merchandise trade surplus. In addition,
the oil and gas industry employs 334,000 people in Canada;22 in Alberta alone, it employs
directly and indirectly nearly one in every six workers, providing more than 275,000 jobs and oil and gas companies are among the largest employers of First Nations people
in the country.24 However, the oil and gas sector is extremely capital intensive and
investment is essential to keep it alive.
Income trusts or flow through entities ("FTE") are business structures that have
traditionally been used to raise capital through the public markets.25 Legally, income
trusts come within the Canadian Income Tax Act's (the "77M") meaning of "mutual fund 9f> trusts". There are three primary types of income trusts: business income trusts, energy
21 "Merchandise trade" means the export and import of goods (World Trade Organization, "Statistics: International Trade Statistics" (2006) online: WTO
Because investing in the oil and gas sector comes with some inherent commercial
risks, including the uncertainty related to exploration, large capital requirements for
development, and financial vulnerability due to price volatility and cyclically, energy trusts, which include royalty trusts, are commonly used business structures in the oil and
gas industry. Energy trusts tend to exploit mature reserves that are already producing
because this reduces some of the risks associated with maintaining the high distribution rates required of trusts (that serve to maximize tax savings. These are included in the
definition of a specified investment flow through ("SIFT")30 which under the new tax rules, are subject to the income trust tax.
The income trust tax is essentially equivalent to corporate level taxation. Because
much of the trust structure's popularity stems from their favourable tax treatment, the
taxation of energy trusts will have an adverse impact on this sector of the oil and gas
industry as it will have a negative capitalization effect (decrease in demand for trust
Department of Finance, Consultation Paper, supra note 14 at 4. 2° Department of Finance Canada, "Improving the Income Taxation of the Resource Sector in Canada (March 2003, updated 29 April 2008) at 11 [Department of Finance, Improving the Income Taxation of the Resource Sector]. 29 The term "energy trust" does not describe any one specific structure, but instead refers to the use of a trust in the oil and gas industry and includes other trust structures that may be more appropriate where royalty trusts are not. (Trudy Curran and Pat Maguire, "Navigating the Quagmire of Oil and Gas Transactions with Income Trusts" (2006) 44 Alta. L. Rev. 163-193 [Curran].) They are considered more flexible than a royalty trust structure and may own any kind of assets that produce revenue. Energy trusts that are not royalty trusts are generally more complex in structure and can be organized so that there are trusts on top of several subsidiaries and operating companies, trusts on trusts on partnerships, and other even more complex structures (Curran, ibid). Some trusts put in place a large debt obligation owing by the operating entity to the trust as any interest paid on the debt is deductible by the operating entity and is in turn deductible by the trust when those amounts are paid out to unitholders (Curran, ibid). 30 Kenneth J. McKenzie, "Income Taxes, Integration, and Income Trusts" (2006) 54, N° 3 Can. Tax J. 633 at 639 [McKenzie]. 6 units31). This will limit the energy trust sector's ability to raise capital for their
exploration and production projects and will most likely lead to the conversion of these trusts back to the corporate form by 2011.
Income trusts have benefited the Canadian securities industry by bolstering
earnings; however, while capital markets form a key part of Canada's financial system,
and make an important contribution to the welfare of Canadians33 the federal government
saw fit for various policy reasons to implement the Plan. The primary purpose of
Canada's tax system is to raise revenue, and in doing so, its objectives are to be equitable, neutral, simple, internationally competitive, and to stabilize the economy.34 However, because the oil and gas industry has large capital requirements for such commercially
risky activities as explorations, and because of the industry's importance to the country's
economy, there may be a public policy basis to allow it an exemption from the Plan.
31 Zhonglan Dai, Edward Maydew, Douglas A. Shakelford & Harold H. Zhang, "Capital Gains Taxes and Asset Prices: Capitalization or Lock-In?" (2006) Social Science Research Network Electronic Paper Collection online: SSRN
After the October 31, 2006 announcement of the income trust tax, the Small
Explorers and Producers Association of Canada ("SEPAC") released a statement claiming that with the introduction of the new income trust tax, the federal government was "killing the industry" because royalty trusts play a key role in the development of
Canada's oil and gas reserves.35 However, when balancing the concerns of the oil and gas industry with those of the federal government and the welfare interests of Canadian society at large, should the oil and gas industry be given an exemption from the Plan; or, would this be too great of a violation of the foundational principles of the ITAi36
Furthermore, would the cost in terms of lost revenues, regardless of the benefits the oil and gas industry bring to the country, be too great to justify such an exemption? As it stands, the Plan is to be implemented in three years and existing income trusts are facing the decision of whether to convert to the corporate form or to remain as trusts.37
Therefore, whether it is in the public interest to allow the oil and gas industry an exemption from the Plan is an important question that should be addressed.
In this thesis I argue that energy trusts should be able to retain the flow-through tax advantages associated with the income trust form. To this end, in Part II, I explain the essential structure of an income trust and describe these tax advantages; I pay particular attention to the tax advantages with respect to foreign investors and tax exempt entities.
In Part III, I explain the basic application of the Plan and then turn to a description of the way in which it interferes with these tax advantages. In Part IV, I describe why there are
35 Small Explorers and Producers Association of Canada, News Release (1 November 2006). 56 The ITA, supra note 26. 37 Jonathan Ratner, "Consolidation expected to continue among energy trusts" Financial Post (28 January 2008), online: FP Trading Desk
II. THE TAX ADVANTAGES OF INCOME TRUSTS
In its 2005 budget, the federal government spoke of four areas of concern with respect to the growing trend of corporations converting to income trusts.38 These included the impact of their tax treatment on how businesses are organized in Canada, their impact on federal tax revenues, the potential role tax-exempt investors (such as pension funds) may have in this market, and the impact of flow-through share tax treatment on the
Canadian economy. In the Minister's October 31, 2006 announcement, additional policy reasons were given for implementing the trust tax, including closing the tax gap between income trusts and corporations40 and preventing the erosion of the corporate income tax base associated with the conversion of corporations into trusts.41
While some of these concerns regarding income trusts may be valid, others are questionable. For example, it is not clear why companies can deduct interest payments in calculating their profits but not dividends when both are a cost of capital (the cost of borrowing or otherwise acquiring funds42). The cost of capital includes the cost of debt and the cost of equity,43 and the deduction of interest payments from debt financing also
"erode" the income tax base upon which tax is levied. Furthermore, the federal
38 Department of Finance, Consultation Paper, supra note 14. 39 Department of Finance, Consultation Paper, supra note 14. 40 Brian Laghi "Why now? It's about an election" The Globe and Mail (1 November 2006). 41 McKenzie, supra note 30. 42 Neil Brooks, "Flattening the Claims of the Flat Taxers" (1998) 21 Dalhousie L.J. 287. 43 Investopedia, "Cost of Capital" Forbes Media Company (2008), online: Forbes Media Company
"tax leakage" from income trusts of hundreds of millions of dollars in tax revenues.
Nonetheless, in considering the reasons behind businesses in the oil and gas industry choosing to operate as income trusts, are these revenue and business structure concerns of the federal government sufficient to justify the imposition of the income trust tax?
The IT A subjects taxable corporations to tax on all profits, regardless of whether those profits are distributed to shareholders in the form of a dividend or retained by the corporation to re-invest in the business.45 A significant feature of the corporate structure is that corporate income gets taxed twice, despite certain provisions, in the ITA (which will be discussed below) that partially integrate the corporate and personal tax rates. A simplistic description of double taxation is that an income stream is taxed once at the corporate level and again at the individual shareholder level. Another way to understand the double taxation concern is that the aggregate taxes paid at the entity level and at the investor level exceed the taxes that would have been paid if the income had been received directly by the investor.46 This double taxation of dividend income has been criticized as
Drew Hasselbeck, "Energy Trusts demand Auditor General investigate 'tax leakage' claim" Financial Post (10 March 2008) online: Financial Post
Currently, the personal income tax system provides partial relief from corporate income taxes to taxable individuals resident in Canada for dividends paid by Canadian corporations.48 These eligible shareholders are allowed the gross-up49 and dividend tax credit (the "DTC")50 which attempt to integrate the taxes paid at the corporate level.
These provisions assume a 20 per cent rate of corporate income tax. Because the combined federal-provincial income tax rate on most corporate income, other than small business income, is higher than 20 per cent (approximately 35 per cent51), dividends distributed to shareholders by large corporations can be subject to a higher combined corporate-personal income tax rate than that on other investments.52
The tax system is thus under-integrated for corporate income that is distributed as dividends (although corporations, unlike income trusts, rarely pay out all their income as dividends) to domestic shareholders of large public corporations. The excess amount of tax paid on dividends represents an absolute tax cost associated with the use of the corporate entity. (There are tax deferral advantages with respect to retained earnings of corporations which will be discussed later in this thesis.) Conversely, income trusts sell units in the trust to investors who are only taxed once when profits are distributed at the
Brooks, supra note 18 at 12. *8 Department of Finance Canada, News Release "Canada's New Government Announces Tax Fairness Plan" (31 October 2006) online:
An increased dividend tax credit was announced in the 2006 federal budget for dividends received from public corporations.54 The new DTC rate was based on a notional federal-provincial corporate income tax rate of 32 per cent (up from 20 per cent) for dividends received after 2005.55 This new rate was chosen to reflect the reduction in the corporate tax rate to 32 per cent, which will be implemented by 2010.56 Through these measures, the federal government is attempting to achieve full integration for tax paying public corporations by that date.
However, while the new corporate tax rates and enhanced DTC are effective at placing corporations on the same level as income trusts for eligible shareholders (taxable individuals resident in Canada) at the highest marginal tax rate, the enhanced DTC does not benefit tax exempt entities or foreign shareholders. Because tax is paid at the corporate level and the DTC is not refundable, tax exempt entities end up bearing tax when they invest in corporations.57 With respect to foreign shareholders, dividends they receive from Canadian companies have already been taxed at the corporate level and are also subject to a gross withholding tax under Part XIII of the ITA.5S Further, they are generally taxable in their country of residence and the tax credits they receive for taxes paid in Canada may not be sufficient for them to be offset.59 Thus, investment income
Department of Finance Canada, News Release, supra note 48. McKenzie, supra note 30 at 637. Department of Finance, News Release, supra note 48. McKenzie, supra note 30 at 638. The ITA, supra note 26 at ss. 212-218. McKenzie, supra note 30 at 638. 12 from corporate stocks may still be taxed at a higher rate than income from other investments.60
While corporations convert to the income trust structure for a variety of reasons, many say that the main reason why trust conversions were so popular is that they offer large tax incentives as compared with the conventional corporate model.61 Trusts operate in such a way as to not pay corporate tax.62 For a trust, a distribution of income to the trust beneficiaries is required to remove the tax liability from the trust, and so they pay out most of their income as distributions to unitholders who then pay tax on those distributions at their individual marginal tax rate.64
In very general terms, a trust is an arrangement under which a trustee holds property for the benefit of other persons (i.e. beneficiaries); the trustee's duties and powers under the trust are subject to fiduciary and statutory obligations.65 Trust property generally consists of shares and high-yield debt of an operating company. The operating company usually distributes the majority of its net cash flow to the trust in the form of interest or return of capital. In the simplest form, an operating entity is a single corporation wholly owned by a trust that owes the trust debt.66
Typically, a trust forms a subsidiary to acquire all the assets of the parent company. It does so by selling trust units to public investors (unitholders) and uses the
60 David Weisbach, "Line Drawing Doctrine, and Efficiency in Tax Law" (1999) 84 Cornell L. Rev. 1627 at 1637 as cited by Brooks, supra note 18 at f 6. 61 Stewart, supra note 16. 62 BMO Capital Markets, "Income Trusts: The Inconvenient Truth About Trusts, A Perspective on Ottawa's New Policy on Trusts" (4 December 2006) at 2. 63 Department of Finance, News Release, supra note 48. 64 CBC News, "Flaherty imposes new tax on income trusts" CBCNews (1 November 2006), online: CBC News
The income trust arrangement allows the operating company to reduce its taxable income. Dividends of a corporation are taxable; therefore, royalty or interest payments, which may be deducted from the corporation's income, must be created in order to move the corporation's operating revenue to the trust in a tax efficient manner.70 The prominent feature of an income trust (prior to the introduction of the Plan), which is considered a taxpayer for income tax purposes, is that the income earned is not subject to corporate income tax in the hands of the trust.71 Distributable cash or net cash flows generated by the operating entity's business are distributed to the income trust,72 which "flow through" income to investors so that corporate income taxes or capital taxes are not paid at the entity level. This maximizes cash distributions and unitholders then pay the applicable taxes on them.73.
Corporations distribute dividends to shareholders on a discretionary basis,74 but rarely do they pay out all their income. While retained earnings are reinvested after
67 McKenzie, supra note 30 at 639. 68 Chamber of Commerce, Submission, supra note 45 at 2. 69 National Policy 41-201, Income Trusts and Other Indirect Offerings (2004), s. 14 [NP 41-201]. 70 Curran, supra note 29. 71McKenzie, supra note 30 at 639. 72 NP 41 -201, supra note 69 at s. 2.1. 73 Chamber of Commerce, Submission, supra note 45 at 2. 74 King, supra note 33 at 8. 14 bearing only corporate level tax which leads to a tax deferral advantage, there are agency issues that may arise. Because the payment of dividends (which are taxable) is not mandatory, corporations are more inclined to retain earnings leaving large pools of capital in the hands of corporate managers.75 Retaining earnings may be efficient to the extent that they can be redeployed optimally to generate additional corporate income; however, investors do not have perfect information about a company's assets or the conduct of its managers.76 This can result in agency costs for shareholders which are
77 reflected in reduced dividends.
Income trusts on the other hand do pay out all their income as distributions thereby minimizing similar problems. Therefore, apart from the high, tax-free distributions, income trusts are attractive to investors who prefer to have management distribute cash from the business. The risk of leaving cash in the hands of managers who may reinvest the funds unwisely is reduced and the need to monitor management is also 7Jt thereby reduced. The regular payment of dividends imposes a useful discipline on management,79 and this applies even more so to income trusts that are required to distribute all their earnings and are managed by trustees that have fiduciary duties to the unitholders.
Another issue with the corporate structure is that the shareholder tax on dividends could lead to incentives for corporations to borrow instead of issue new stock to finance their operations. This can lead to highly leveraged companies, and thereby a "fragile 75 Brooks, supra note 18 at f 8. 76 Benjamin Alarie & Edward Iacobucci, "Tax Policy, Capital Structure and Income Trusts" (2007) 45 Can. Bus. L. J. 1 at 6 [Alarie]. 77 Brooks, supra note 18 at 18. 78 King, supra note 33 at 18. 79 Hayward, supra note 53 at 1535. 80 Brooks, supra note 18 at f 8. 15 economy" which is worrisome and highly relevant at present. The current shortage of cash known as the "Credit Crunch", caused at least in part by the subprime mortgage market in the United States, has led to corporate defaults on loans and the inability for corporations to access further financing. Thus the fact that interest payments are taxed only in the hands of the payee, which essentially gives interest "flow-through" treatment, is puzzling.
This anomaly or bias in favour of interest payments arguably presents a contradiction in the Minister's reasons for implementing the Plan; it is not clear why interest deductions are not targeted as eroding the tax base when distributions, which are now to be taxed as dividends, are. This is all the more perplexing, because corporations are now even more likely choose to finance through debt rather than equity; not only are interest payments deductible,85 but the gross withholding tax on interest paid to an
American payee has been reduced to zero.
It is thus, while extreme, a possibility that all income trusts revert back to the corporate form, retain highly leveraged structures, and continue to pay little tax.
Furthermore, when entrepreneurs issue debt rather than equity to raise capital, it signals that they have confidence in the business and will risk the loss of control in bankruptcy
Brooks, supra note 18 at f 8. 82 Drew Hasselbeck, "A guide to the credit crunch" National Post (16 August 2007) online: National Post
on proceedings if the company cannot make payments. This is particularly important in
DO current times where confidence in corporate management is low. However, the expected bankruptcy costs associated with high leverage may temper such actions.
In any event, this distinction between the tax treatment of dividends versus that of interest payments can help to explain oil and gas companies' prior inclinations to structure themselves as royalty trusts. While paying dividends is an opportunity cost of equity capital (compensation to shareholders),90 they are not deductible for corporations but trust distributions had, prior to the Plan, been deductible. Although trusts are "taxable entities" under the IT A and subject to the highest individual tax rate,91 they reduce their taxable income by making deductible distributions to their unitholders.92 It is this differential treatment of the two legal entities that income trusts exploit.93 "Tax can (and does in practice) bias financing choices"94 and thereby affects business' decisions with regards to their organizational form and capital structure.95
Oil and gas income trusts (royalty trusts) are owed a significant (usually 99 per cent) royalty or net profit interest ("NPI") by an operating entity.96 The trust purchases a royalty interest in the operating company, and since non-Crown royalties receive the same treatment as interest paid, they are deductible when paid to the trust and corporate
87 Alarie, supra note 76 at 6. 88 For example the Enron Corporation accounting scandal (CBC News, "From collapse to convictions: a timeline" CBC News (23 October 2006) online: CBC.ca
Furthermore, a royalty can only be granted on oil and gas property and not on other aspects of the oil and gas industry that might be generating income for the operating entity.99
This type of business organization has proven to be particularly attractive to tax exempt entities and foreign investors (the reasons for which will be discussed shortly) and it is these investors that will most feel the effects of the Plan. The federal government's efforts to alleviate double taxation of dividends (distributions from trusts will be deemed dividends) at the shareholder level with the new enhanced gross up and
DTC will not have any beneficial effects on foreign investors nor on tax exempt entities.
The DTC in effect primarily benefits high-income, Canadian resident individuals, and at any rate, it has been said that the DTC is completely unrelated to corporate tax paid.100
The DTC is granted to shareholders as compensation for the corporate tax paid on their dividends; however, tax exempt entities and non-residents are ineligible and furthermore, it is not refunded to individual taxpayers whose tax liability is less than the credit.101
Further, any tax credits a foreign investor may receive from their country of residence may be insufficient to offset the Canadian taxes paid.
It is estimated that 61 per cent of income trust investors are non-residents and tax exempt entities. These investors therefore comprise a considerable source of capital for
97 McKenzie, supra note 30 at 639. 98 Curran, supra note 29. 99 Curran, supra note 29. 100 Brooks, supra note 18 at f 79. 101 Brooks, supra note 18 at f 79. 18 companies operating as trusts. Because of the tax advantages of the trust structure particular to these two groups of investors, they were often a major consideration for a business when it decided to organize (or reorganize) itself as an FTE rather than as a corporation.103 In fact, even with the new tax provisions for corporate structures, including corporate tax cuts and enhanced dividend tax credits,104 this pool of potential investors was sufficient to compel two major telecommunications companies, BCE Inc. and Telus, to plan a conversion into income trusts. While there will be near to full integration of corporate taxes for Canadian residents that are individuals, there will be no such relief for tax exempt entities or foreign investors. The following discussion will clarify the important role of foreign and tax exempt investors in the Canadian economy, why such investors were attracted to income trusts and how the Plan disproportionately affects them.
A. Foreign Investors
The Plan raises many concerns in the financial markets,105 and these concerns are not restricted to Canada. Foreign jurisdictions, particularly the United States are affected by the Plan as well. Non-resident investors own about 22 per cent of all income trust units106 and some commentators have said that those most directly impacted by these changes are the non-Canadian resident trust unitholders.107 This is because the new
Jack Mintz, "Policy Forum: Income Trust Conversions - Estimated Federal and Provincial Revenue Effects," (2006) 54, N° 3 Can. Tax J 687. 103 Department of Finance, News Release, supra note 48. 104 Department of Finance, News Release, supra note 48. 105 CTy.ca News Staff, "Income trust investors suffer massive losses" CTV.ca (1 November 2006) online:
Prior to the Plan, foreign investors of Canadian income trusts were only subject to the gross withholding tax found in Part XIII of the IT A. With the new income trust tax, while
Canadian resident unitholders will be able to offset the corporate level taxes, non-resident unitholders will be subject to Canadian corporate tax in addition to Part XIII taxes. The impact of these new tax provisions will therefore vary depending on whether the unitholder is domestic or foreign.1
In any event, it seems equitable that the country in which business income is earned has a claim to impose the most substantial tax upon it.1 The foreign investor derives a benefit from the provision of government services that made the earning of the income possible and generally, in the context of international taxation, the return on
119 equity investment is taxed primarily in the source country. Thus, while foreign shareholders are not subject to Canadian income tax, dividends paid to them are subject to withholding taxes at a rate of 25 per cent.113 This general rate may be reduced by bilateral treaties such as the one Canada has entered into with the United States (the
"Canada-U.S. Convention") pursuant to which American shareholders are subject to only a 15 per cent withholding tax.114
Dividend payments received by U.S. residents are subject to U.S. domestic taxes as well, but Canadian withholding taxes are generally creditable against this U.S. tax liability. However, because U.S. tax is assessed on a global basis (income and foreign tax credits are aggregated into various "baskets"), U.S. foreign tax credits may not be enough to remove the Canadian taxes paid before the dividends were distributed if other foreign source income is highly taxed.115 Thus, it had been anticipated that to avoid the application of the Plan, a Canadian high-yield debt market would develop,116 particularly given the fact that under the Sixth Protocol of the Canada-U.S. Convention, the
117 withholding tax on interest payments to Americans has been reduced to zero.
High-yield debt or stapled shares work to stream off business income to investors where there is a deductible income stream to the operating entity.118 A stapled security structure would avoid the dividend distributions tax for an intermediary SIFT trust but would maintain the non-tax attributes of an intermediated investment by stapling securities held by investors directly with their interests in the trust. This modification to the income trust would involve the issuance of high-yield junk debt by a corporation directly to investors, who would otherwise acquire the debt of the corporate issuer
1 u Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital, Canada and United States of America, 26 September 1980 [Canada-U.S. Convention]. 115 McKenzie, supra note 30 at 638. 116 Deloitte, "Income Trusts: One Year Later" (October 2007), online:
The debt would be stapled to the units of the trust acquired by investors and the amounts advanced for these units of the trust would be used to buy shares of the operating corporation. l
The stapling of high-yield junk debt to the trust units would replicate the operation of a standard income trust and retain the tax free returns to investors.122
However, this high-yield debt market has not yet come to pass. Some suggest that this could be due to the accelerated buyout activity of income trusts following the announcement of the Plan123 or the recent liquidity crisis (the Credit Crunch) in the North
American debt market.124 In any event, the federal government released a statement threatening to shut down structures or transactions that are designed to circumvent the
Plan with new measures which may also be a contributing factor.
It is challenging for Canadian income trusts to raise capital; particularly for the oil and gas sector which has large capital requirements. Therefore, in order to meet these demands, foreign investors are important to the Canadian economy.126 Increasing amounts of capital are needed to develop Canada's maturing oil and natural gas reserves as well as large-scale projects such as open-pit mining of oil sands. It has been shown
120 Ibid. 121 Ibid. 122 Ibid. 123 Between the Plan's announcement on October 31,2006 and December 2007, there had been 40 announced or completed trust buyouts versus 14 deals over the equivalent year-ago period (Francis, Diane. "Harper, Carney, Flaherty income trust mistake: Deloitte" Financial Post (9 December 2007) online: FmancialPost
Foreign investors are essential to the energy trust sector in order to obtain the additional capital needed to sustain development in this area and the Canadian resource sector has a long history of foreign investment.130 However, the costs of finance that
Canadian firms must pay are set in international capital markets; therefore, providing
Canadian resident individual shareholders with the enhanced DTC to balance the income trust tax will not reduce the cost of capital in Canada and will not provide foreign shareholders with any beneficial incentives to invest in Canadian firms.131
The Canadian government has recognized that access to resident and non-resident investors is critical in today's capital markets and has made it an overriding public policy goal to promote domestic economic growth. It was estimated in an economic forecast prepared by Industry Canada and Foreign Affairs and International Trade that each $1 billion increase in new inward investment to Canada can generate up to 45,000 jobs and
$4.5 billion GDP over a five-year period.132 In a paper published by Industry Canada, it went so far as to say that policies that reduce or restrain foreign investment might even be
127 Canadian Association of Income Funds, "Draft Budget 2004 Legislation Submission" (15 October 2004) [CAIF, Draft Budget Submission]. 128 Ibid 129 Ibid. 130 Ibid. 131 Brooks, supra note 18 at f 79. 132 Foreign Affairs and International Trade Canada, The Importance of Investment and Investment Rules to Canada (Ottawa: Minister for International Trade, 2001), online: Minister of International Trade
"Foreign investment helps ensure Canadian firms have the capital they need to succeed and grow in the highly-competitive global economy. Investment creates jobs and spurs innovation through bringing new ideas and technologies to our companies. It provides Canadians access to the capital and expertise that make our country stronger. It should be further noted that a large proportion of profits from new investments is reinvested in Canada, contributing to a higher growth rate and a rise in Canadian living standards."135
Given the federal government's policy statements regarding the promotion of foreign investment in Canada and the need to be internationally competitive for those foreign dollars,136 the decision to implement the new income trust tax seems counterintuitive. Canada has to be more attractive and do better than its international competition in order to attract foreign investment.137 Because of the DTC (though it is insufficient for full integration at present), it has been said that the only beneficiaries of the royalty-trust structure before the announcement of October 31,2006 were tax-exempt investors and non-residents. As such, it has been argued that the new tax really targets
U.S. investors. ° It appears that energy trusts in particular, will face considerable hurdles with the implementation of this new tax rule as a great portion of their foreign investors
133 Industry Canada, Working Paper Number 24: Canadian Government Policies Toward Inward Foreign Investment by Steven Globerman & Daniel Shapiro, (Ottawa: Strategic Investment Analysis 1998). 134 CAIF, Draft Budget Submission, supra note 127 at 3. 135 Minister of International Trade, supra note 132. 136 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 11. 137 Paul Kastner, "Tax Credit Aspects: Tax Climate for R & D: A Canadian Perspective (1995) 21 Can.- U.S. L.J. 289. 138 Barrons, "Whoa, Canada! Royalty Trusts Take Tax Hit" (3 November 2006) online: MarketWatch from DowJones < htrp://www.marketwatch.com/news/story/whoa-canada-royalty-trusts- take/story.aspx?guid=%7B2C8E79CB-DA33-49AC-B63B-6AAED7F6109E%7D> [Barrons]. 24 are American. This is because the Canadian energy trust environment is even more competitive than the U.S. market.139
U.S. investors have been putting their money into Canadian energy trusts for years and these investors have helped keep unit prices high, even when oil prices have dropped.140 Furthermore, this American activity has kept other investors willing to ride out the lows in the market; historically unit prices only dipped less than 10 per cent during times when oil prices were low.141 Part of the reason for American investment is because unlike Canadian trusts, U.S. trusts are "wasting assets" (an asset that has a limited lifespan and loses its value over time). 42 U.S. trusts aren't allowed to borrow money or raise cash to fund the purchase of new reserves or to undertake new drilling and exploration programs; because they cannot replace their existing reserves, every U.S. energy trust will eventually deplete its oil & gas reserves and the trust will be dissolved.143
Canadian royalty trusts on the other hand are actively managed just like normal corporations and can borrow money or issue new shares.144 This money is then used to fund new exploration efforts or to acquire additional oil & gas reserves (usually mature assets from senior companies or junior companies looking to exit the market). Because they had been able to continuously purchase new reserves to make up for the depletion of their existing fields, Canadian trusts had more easily been able maintain their
139 Oil and Gas Investor, Special Report "Canadian Investment Opportunities" (June 2004) [Oil and Gas Investor].. 140 Brent Jang, "A Matter of Trust" (26 June 2003) online: globeandmail.com
Another significant reason for their popularity is that under the old tax rule, income (distributions) received by foreign trust unitholders are subject only to a general withholding tax of 25 per cent which may be reduced by bilateral treaties. American shareholders, by virtue of the Canada-US Convention, are subject only to a 15 per cent withholding tax, and would therefore find decreased distributions a disincentive for investing in Canadian income trusts. There is a real danger therefore, that foreign investment will be negatively impacted by the new tax rules. With distributions being subject to corporate taxes in addition to withholding taxes, in essence, Canada will withhold as much as 41.5 per cent from the income going to Americans.150 When trust distributions are taxed at the trust level at corporate tax rates, non-resident shareholders that receive these distributed earnings from Canadian corporations will bear a heavier
Canadian income tax burden than residents.151
Foreign investors, particularly American investors have been keeping oil and gas trust unit prices steady but with the tax incentives gone, they could look elsewhere for investment opportunities, which may in turn impact other investors' decisions when
145 Ibid. 146 Deloitte, Income Trusts: One Year Later, supra note 116. 14/ Deloitte, Income Trusts: One Year Later, supra note 116. 148 McKenzie, supra note 30 at 638. 149 Canada-U.S. Convention, supra note 114. 150 Fred E. Foldvary, The Progress Report, "Canada Commits Economic Suicide" (2007) online:
In the Finance Minister's announcement, he alleged a loss of tax revenue associated with non-resident unitholders of FTEs.152 However, there is currently a 25 per cent withholding tax on all distributions to foreign investors (subject to bilateral treaties).
Industry groups argue that this level of taxation is sufficient for the federal government to recover any perceived or actual "tax leakage" to non-resident Canadian unitholders. The corporate structure has so many deductions and credits available to it that really, no restriction on the holdings of units in a trust should apply.153
Even if the withholding tax was insufficient to cover the "tax leakage", it may not be a problem associated only with income trusts. There will always be some lost tax revenue when a non-resident makes an investment in Canada rather than a Canadian, whatever corporate organization is used. Just as Canadians pay less tax than the locals in foreign countries when they invest there, Canada should reciprocate; it is a means of encouraging the flow of international capital.155 Moreover, in the oil and gas sector, foreign capital is vital; there simply is not enough domestic capital to effectively operate the industry and a tax regime that encourages foreign investment is to be pursued not abandoned.
Department of Finance, Flaherty, supra note 1. 153 Curran, supra note 29 at f 97. 154 Department of Finance Canada, "The 15% Solution" (23 November 2005) online:
On a different note, the World Bank and its member countries, including Canada,
supported the development of enabling legislation which would assist World Bank members with petroleum potential in attracting foreign direct investment and risk capital
into the critical petroleum sector of their economies.156 The project is called the "World
Bank Funded Petroleum Exploration Program" and it has suggested what an appropriate petroleum taxation framework should include. The following broad objectives were
some of those recommended: to provide for a fair and equal tax regime, regardless of the
nationality of the investor (i.e., domestic or foreign), without any significant
discrimination; to avoid the double taxation of foreign investors by ensuring that profit taxes paid to the host country will qualify for foreign tax credits under the tax laws of the
investor's country of origin; to provide for tax stability for a reasonable time period as
investors are accustomed to benefiting from such stability, even though the host country
has the sovereign right to amend tax legislation regularly.158
While these objectives were developed to help encourage foreign investment into
third world countries, it is somewhat ironic that Canada, as one of the developed nations
involved with the World Bank program, is implementing the income trust tax which
would violate the very tax objectives that they had recommended. Distributions received
for example by U.S. investors will be comprised of Canadian corporate tax paid money
with the additional withholding tax deducted off them. While Canadian withholding taxes
are generally creditable against U.S. tax liability, because U.S. tax is assessed on a global
basis, U.S. foreign tax credits may not be enough to remove the Canadian taxes paid
156 William T. Onorato & J. Jay Park, "World Petroleum Legislation: Frameworks that Foster Oil and Gas Development" (2001) 39 Alta. L. Rev. 70-126 at |1 [Onorato]. 157 World Bank Industry and Energy Department, An Evaluation of World Bank Funded Petroleum Exploration Promotion Programs, Energy Series Paper No. 59 (1992) at 1. 158 Onorato, supra note 156 at |23. 28 before the distributions if other foreign source income is highly taxed.159 In addition, the federal government had made election promises not to tax income trusts,160 and investors made decisions on faith of those promises. Imposing the Plan thereafter certainly does not provide for the tax stability that investors had come to expect. Furthermore, the tax regime of a host country should not discriminate against investors whether domestic or foreign; however, the Minister is on record that energy trusts were included because of their high U.S. ownership.161
This has given rise to another issue with respect to foreign investors and Canada's obligations under the North American Free Trade Agreement (the "NAFTA"). The
NAFTA is "a set of rules governing trade, investment, and related legal issues that require a degree of harmonization of domestic business regulation in the member nations." It imposes legal obligations upon the governments of Canada, Mexico, and the United
States to ensure that the content and application of their domestic laws conform to the agreed-upon rules.164
Chapter Eleven of the NAFTA contains provisions designed to protect cross- border investors and to facilitate the settlement of investment disputes.165 Specific standards of treatment of investors and their investments are provided for as well as a direct right of action by an investor against a NAFTA government for transgressions of
159 McKenzie, supra note 30 at 638. 160 Wikipedia, "Income Trust" (9 May 2008) online: Wikipedia
("UNCITRAL Rules") or the Arbitration (Additional Facility) Rules of the International
Centre for Settlement of Investment Disputes ("ICSID Additional Facility Rules").167
Therefore, individual and corporate investors have some power against NAFTA governments.168
The Government of Canada has recently been named in an arbitration claim under
Chapter Eleven of the NAFTA.169 Article 1102 of Chapter 11 provides that each NAFTA
Party must accord investors from the other NAFTA party national treatment; i.e., treatment no less favorable than that it accords, in like circumstances, to its own investors.170 Therefore, under the NAFTA, Canada cannot target other NAFTA citizens when they impose new measures. The Gottliebs are an American couple that filed a
"Notice of Intent to Submit a Claim to Arbitration" pursuant to this and other Chapter 11 provisions of the NAFTA. They claim that thousands of U.S. investors lost a total of $5 billion from the federal government's decision to implement the Plan.
There have been successful Chapter 11 claims in the past, and S.D. Myers is an example of a successful claim against the Canadian government for disadvantaging an
Mark A. Luz & Marc Miller, "Globalization and Canadian Federalism: Implications of the NAFTA's Investment Rules" (2002) 47 McGill L.J. 951-997 at f 2 [Luz & Miller]. 167 USA.gov, supra note 165. 168 Luz & Miller, supra note 166 at f 2. 169 Gottlieb Investors Group v. The Government of Canada [Gottlieb]. 170 NAFTA, supra note 162 at Art. 1102. 171 Gottlieb, supra note 169 at 14. 30
American business as compared to like Canadian businesses.172 In that case, the NAFTA
Tribunal (the "Tribunal") partially granted S.D. Myers' claim determined pursuant to the
UNCITRAL Arbitration Rules. S.D. Myers is an Ohio based waste disposal company that charged that Canada's fifteen-month temporary ban on exporting polychlorinated- biphenyls ("PCBs") from Canada violated the NAFTA by prohibiting S.D. Myers from conducting its PCB remediation business in Canada.
The Tribunal found that Canada's PCB exportation ban was "shaped to a very great extent by the desire and intent to protect and promote the market share of enterprises that would carry out the destruction of PCB's in Canada and that were owned by Canadian nationals".174 Further, the Tribunal found that there was no legitimate environmental reason, contrary to the arguments presented by the Canadian government, for implementing the PCB ban.175 Instead, it was found that the ban was introduced to protect the Canadian PCB disposal industry from U.S. competition.17 The Tribunal awarded damages in the amount of $6.05 million plus interest for the contravention of
Article 1102177 and Canada was unsuccessful in its appeal of the Tribunal's decision to the Federal Court of Canada.178
172 S.D. Myers v. Government of Canada (13 November 2000) NAFTA Tribunal [S.D. Myers]. 173 Ibid, at 1131. mIbid. at "ft 162. 115 Ibid, atf 195. 176 Ibid, at 1194. 177 Foreign Affairs and International Trade Canada, News Release: NAFTA Tribunal Awards Damages in S.D. Myers Case (Ottawa: Foreign Affairs and International Trade Canada, 21 October 2002) online: Foreign Affairs and International Trade Canada
In assessing whether a measure (which includes any law, regulation, procedure, requirement or practice17 ) is contrary to a national treatment norm under Article 1102 of the NAFTA, the Tribunal will consider "whether the practical effect of the measure is to create a disproportionate benefit for nationals over non-nationals" and "whether the measure, on its face, appears to favour its nationals over non-nationals who are protected
1 SO by the relevant treaty." Therefore, the Gottlieb claim which proceeds in part pursuant to Article 1102, will be determined based on this analysis.
With respect to the first part of an analysis under Article 1102, one reason the
Minister included energy trusts in the Plan was because of the high levels of American ownership; conversely, it is noteworthy that REITs, which are owned mostly by
Canadians, were excluded. The Gottliebs are in fact seeking compensation under the
NAFTA against the Canadian government for what essentially amounts to the banning of investment by U.S. investors in energy trusts.182 With respect to the second part of the analysis under Article 1102, Canada's tax treaty with the U.S. states that trust income will not be taxed at more than 15 per cent,183 however, under the Plan, trust distributions will bear corporate tax as well as the gross withholding tax. In addition, the NAFTA provides that investors are entitled to rely upon Canadian government promises and
Prime Minister Harper had repeatedly made public promises that his Government would 184 not tax trusts.
179 The NAFTA, supra note 162 at art. 1101. 180 S.D. Myers, supra note 172 at J 252. 181 Canada, Standing Committee on Finance, 39th Parliament, Is' Session (30 January 2007) online:
In S.D. Meyers, the Government of Canada was unable to rebut the evidence that the protection of the Canadian PCB disposal industry was its intent behind the PCB exportation ban.185 Thus, whether the Canadian government can do so with respect to the
Gottlieb claim will be determinative in part of the outcome (the Gottlieb claim proceeds on more than one Chapter 11 provision, however a discussion of each claim is beyond the scope of this paper). The results of the Gottlieb claim may have far reaching consequences; the Gottliebs are also calling for other American investors that are in a similar situation as themselves to join the action.186 If they can prove their claim, and depending on the number of investors to come forth, then the cost of compensating claimants, whose losses are estimated to total $5 billion, could completely offset the hundreds of millions of dollars of tax leakage that the federal government was attempting to prevent.
B. Tax Exempt Entities
Tax exempt entities, which include pension funds and registered retirement savings plans ("RRSP") as well as educational, religious and other charitable organizations, invest in businesses and are an important source of corporate capital.
Tax exempt entities help to finance the activities of Canadian businesses, and their preference for debt as opposed to equity has played a role in the rising popularity of income trusts.188 In Canada, tax-exempt investors are not subject to tax on flow-through entity income nor on dividend income.189 However, because the DTC is not refundable,
S.D. Meyers, supra note 172 at f 194. The Gottliebs have set up a website detailing their claim at
Under the tax system prior to the Plan, there was no equivalent tax on the earnings of an FTE, and so, tax exempt entities generally preferred those earnings to dividends.191
Tax exempt entities have been attracted to energy trusts because such investments were tax efficient and the distribution pay outs from energy trusts had been very high compared to other investment vehicles in Canada.192 The Plan removes these advantages to investing in trusts. Distributions will decline after taxes are paid at the trust level and
"tax exempt" entities will in effect be taxed as they cannot access the DTC. RRSP holders and pension funds are said to be among the most seriously affected by the Plan.193
When the Plan was announced, they suffered a permanent capital loss in the range of
$11-15 billion and in addition, the new tax will negatively impact their investment income and rate of return.194 While the enhanced DTC more closely approximates full integration of corporate level tax, as stated above, it is not refundable. Therefore, taxes paid at the corporate level on distributions cannot be offset by the dividend tax credit.195.
The Minister, in his October 2006 announcement expressed concern about tax leakage because some unitholders, such as pension plans and RRSPs, are tax exempt and tax revenues associated with flow-through entities were thus excessively reduced.196
However, this statement is not accurate; tax exempt entities will be obliged to distribute the distributions received from trusts to their beneficiaries in due course and that income
190 McKenzie, supra note 30 at 638. 191 Department of Finance, News Release, Canada's New Government, supra note 108. 192 Acuity Investment Management, "Income Trust Benefits to the Canadian Economy" (2006) at 5, available online: < http://www.acuityfunds.com/assets/income_trust_benefits.pdf>. 193 Fortin, supra note 106 at 218. 194 Fortin, supra note 106 at 218. 195 McKenzie, supra note 30 at 638. 196 Department of Finance, Flaherty, supra note 1. 34 will be fully taxable.197 Therefore, while the Plan treats these entities as "tax exempt", in reality they are not "tax-exempt" but "tax-deferred".198 With Canada's aging population, the money in these tax exempt entities will have to be paid out eventually, and that will in fact happen sooner rather than later.199
Ultimately all capital and income accumulated in such accounts is taxed at personal tax rates when the monies are withdrawn in the future.200 This income will be locked in and a guaranteed source of tax revenue for years to come. Furthermore, the income held in the tax exempt entity will be reinvested thus creating economic activity and generating tax revenues. It is argued that the root of the issue is whether there is a difference between the present value of future taxes and the value of foregone tax
90^ revenue in the short run; however, such a study has not yet been done. A determination of these values would nonetheless seem appropriate before policy measures affecting
Canadians' retirement saving are decided.204
The policy behind the tax-exempt status of savings such as RRSPs, registered pension plans ("RRP") and registered retirement income funds ("RRIF") is to allow individuals to accumulate wealth such that the income earned in the plan is not subject to 90S tax. Taxation at the income trust level on income paid by a trust to these entities taxes the income accruing to pension plans and retirement savings accounts and this is contrary
197 Department of Finance, The 15% Solution, supra note 154. 198 Fortin, supra note 106 at 2. 199 Fortin, supra note 106 at 2. 200 Fortin, supra note 106 at 2. 201 Department of Finance, The 15% Solution, supra note 154. 202 Department of Finance, The 15% Solution, supra note 154. 203 No study of this nature could be found at the time of this thesis. 204 Fortin, supra note 106 at 2. 205 Mintz & Richardson, supra note 151 at 374. 35 to the policy.206 The market value of income trusts has fallen between $20 billion and $25 billion since the Plan was announced.207 A large portion of this amount represents the retirement saving owned by Canadians and in effect, it was lost in an attempt to collect approximately $1 billion208 in additional tax revenue starting in 2011. This market loss is unfortunate as retirement and the adequate funding of one's retirement is an important social issue facing Canada and its aging population, however, 70 per cent of Canadians are not members of defined benefit retirement plans and many who are, find that their plans are under-funded.209 Thus sentiments about the Plan's effects on retirement savings have been strong.
"Hard working Canadians with significant amounts of retirement saving invested in income trusts will be losers for the rest of their lives not only in terms of the permanent decimation of their capital and saving but also in terms of a lower flow of investment income, and ultimately retirement benefits."210
III. THE "FAIRNESS PLAN"
The new system of taxation is intended to bring the taxation of income trusts and
91 1 other flow-through entities in line with that of corporations. For income trusts that begin trading after the announcement, the new measures would apply beginning with their 2007 taxation year.212 However, not only have there been no new conversions
(Telus and BCE dropped their proposed trust conversions), but there has been an 18 per 206Mintz & Richardson, supra note 151 at 374. 207 CBC News "Dodge says income trust changes "level the playing field" (1 February 2007) online: cbc.ca
91 ^ • • cent decline to the number of existing income trusts since the announcement. Existing income trusts and limited partnerships will not be subject to the new measures until their
2011 taxation year allowing a four year grace period.214 The proposed new rules are meant to apply to a clearly defined set of FTEs to be known as "specified investment flow-throughs" (SIFTs).215 Essentially, all of the entities typically known as "income trusts" are SIFTs and will generally include a publicly traded Canadian resident trust or a publicly traded Canadian resident partnership that holds one or more "non-portfolio properties".216 The proposed definition of non-portfolio properties includes significant investments in Canadian resident entities such as corporations, trusts and partnerships,
Canadian resource properties, timber resource properties and real properties situated in
Canada.217
Under these tax rules, distributions from publicly traded FTEs are subject to tax at corporate income tax rates in the FTE, pursuant to certain exceptions. Those distributions are no longer deductible by an FTE that is a trust, and are taxed in the hands of an FTE that is a partnership. Investors are further taxed on the distributions as though they were taxable dividends from a taxable Canadian corporation.218 Before a SIFT trust distributes non-portfolio earnings to its unitholders, it must first deduct taxes at a rate equivalent to the federal general corporate tax rate, plus approximately 13 per cent for the provincial tax.219
213TSX, Canadian Income Trusts, supra note 11. 214 Department of Finance, News Release, supra note 48. 215 Department of Finance, News Release, supra note 48. 216 Grant Thornton, supra note 211. 217 Grant Thornton, supra note 211. 218 Department of Finance, News Release, supra note 48. 219 KPMG, supra note 2 at 3. 37
Non-portfolio earnings include income of the SIFT trust directly or indirectly attributable to: income from businesses carried on in Canada, income (other than dividends) from its non-portfolio properties, and taxable capital gains from its dispositions of non-portfolio properties.220 Subject entities include corporations resident in Canada, trusts resident in Canada, and certain partnerships.221 Thus the Canadian assets of most business trusts, royalty trusts and REITs are non-portfolio properties and subject to the new tax regime (though REITs have been specifically excluded from the
Plan).222
Amounts distributed by a SIFT trust to a unitholder that would have been deductible by the trust but for the new regime are now treated as though the distribution was a taxable dividend from a taxable Canadian corporation.223 An individual resident in
Canada now applies to these deemed dividends the eligible dividend "gross-up" and may claim the eligible dividend tax credit to reduce the amount of personal tax the individual would otherwise have paid.224 A corporation resident in Canada may deduct the amount of the distribution from its income, subject to Part IV tax.225 As before, a tax-exempt entity such as an RRSP is not taxed on the distribution, but it will receive an amount less the equivalent of corporate-level tax within the SIFT.226 A unitholder who is not resident in Canada is taxed, in addition to the corporate level tax, pursuant to Part XIII of the IT A
220 KPMG, supra note 2 at 4. 221 KPMG, supra note 2 at 4. 222 KPMG, supra note 2 at 4. 223 KPMG, supra note 2 at 5. 224 KPMG, supra note 2 at 5. 225ITA, supra note 26 at Part IV. 226 KPMG, supra note 2 at 5. 38 on the distribution at a 25 per cent rate of tax, subject to a reduction of this withholding
997 tax rate under a relevant tax treaty.
Many publicly traded oil and gas companies were operating as energy trusts or royalty trusts to alleviate the inherent risks that come with running a business in their industry. The principal outputs from oil and gas production companies; namely, oil, gas, and natural gas liquids, are fungible commodities whose prices are largely determined by world markets. Because a producer is unable to determine the price for its products, profitability will fluctuate with the market price for its commodities; this cyclical nature of the markets for oil and gas products renders it difficult for producers to plan, budget, and implement growth strategies.229 The lack of stable and predictable commodity prices, which is exacerbated by an uncertain energy policy (carbon taxes will be discussed later), can make lenders and equity investors nervous as the market price for oil and gas affects companies' total returns.230
Until recently, the availability of the income trust structure to the oil and gas industry, with its tax incentives (especially with respect to tax exempt entities and foreign investors) and regular cash distributions had rendered the risks more acceptable for investors. Two key theoretical elements to determining the "intrinsic" value of corporate shares include the determination of the expected value of all future free cash flows (net of tax) attributable to the shares and the variability of the cash flows.231 Thus, the intrinsic fair value of shares depends not only upon the accuracy of the total future free cash
227 KPMG, supra note 2 at 5. 228 Mark R. Smith, "Basic Derivatives for the Oil and Gas Company" (2001) 39 Alta. L. Rev. 152-179 at 1 1 [Smith]. 229 Ibid at ^ 1. 230 Oil and Gas Investor, supra note 139. 231 Vern Krishna, "The valuation of stocks: an uncertain art" 24 The Lawyers Weekly No. 27(19 November 2004) (Vern Krishna). 39 flows, net of tax, that one expects to receive from the shares, but also some consideration
919 of the volatility of one's estimates and the accuracy of predictions. This is because in valuing trust units for investment, their intrinsic fair value depends not only upon the accuracy of the total future free cash flows that an investor expects to receive from the units, but also on the stability of the cash flow; the more stable the cash flow, the lower 9H the risk of volatility and, therefore, the lower the risk that those flows will not be met.
Generally, the pre-tax cash flows of stable companies, unlike oil and gas companies, can be predicted with more confidence because their prices are less cyclical and somewhat less dependent on global geopolitical and economic conditions.234 The acceptable level of cash returns for investors varies across sectors depending on their relative risks; riskier business models would need to offer higher cash returns within a given industry and across industries.235 In an empirical study conducted by Klassen on the valuation of income trust units, it was demonstrated that the earnings of income trusts is highly valued.236 Income trusts have features that make them appealing to investors, including high annual payouts relative to both stock and bond investments and a monthly payment, in addition to the tax efficiency of their distributions.237
Thus, whether the double taxation of trust distributions arising from the Plan are the only reason for the over $20 billion loss in market value the day after the tax announcement, which has increased to $35 billion loss over the course of a year,238 is
23questionable2 Ibid. . Nonetheless, without the tax benefits of the energy trust arrangement, 233 Ibid. 234 Ibid. 235 King, supra note 33 at 14. 236 Kenneth Klassen, "Valuation of Income Trusts: An Exploration of Clienteles and Implicit Taxes" (2006) School of Accountancy, University of Waterloo at 18. 231 Ibid, at IS. 238 Francis, supra note 123. 40 unitholders in trusts are facing reduced distributions; the double taxation on their distributions will cut the amount of cash flow that can be distributed to them. This is relevant because high distributions had been a factor in investment decisions.
However, it should be remembered that shareholder taxes are deferred when a corporation reinvests its profits which results in shareholders paying roughly the same level of tax as a trust unitholder when shareholders sell their shares and realize a capital gain. While corporate dividends are subjected to double taxation, for those eligible shareholders (taxable Canadian residents), the integration rules lower the effective tax rate on dividends (in the range of 24 per cent in Alberta to 37 per cent in Nova Scotia, and Newfoundland and Labrador240). In addition, only half of realized capital gains are included in income for both individuals and corporations.241 These features of the tax system act together so that the overall tax rate applicable to a corporate form depends not only on the tax rate of the investor, but also on when the investor realizes the dividend or capital gains.242 The following example from Klassen illustrates this point:
"For investors with a one-year horizon, if the company and investor reside in Ontario and all after-tax income is retained, so the investor receives a capital gain, the after-tax value to a maximum-tax-rate individual investor is $0.49 for each dollar of pre-tax income of the corporation. The dollar of pre-tax earnings is taxed at 36% in the corporation. Assuming the remaining $0.64 is passed to the shareholder through appreciation, it is taxed at a rate of 23%, or $0,147 more tax. Thus, the after-tax amount is $0,493. If the $0.64 of earnings are distributed as a dividend, rather than retained and taxed as a capital gain, then the tax on the dividend is 31%, or $0,198, leaving only $0,442. However, if the business had been operating in an income trust form, the individual would have received $0.54 since the trust pays no tax and the individual pays tax at 46% on the full $1 received. As the investor's horizon increases, the present value of the tax cost on the capital gain falls. At a 10% after-tax discount rate, the aftertax
Klassen, supra note 236 at 7. Klassen, supra note 236 at 6-7. Klassen, supra note 236 at 7. Klassen, supra note 236 at 6-7. 41
return on the corporation is the same as the income trust if the investor does not sell the stock for 4 years."243
Therefore, tax levels can be the same for shareholders of a corporation and unitholders of a trust if the deferral advantages of the corporate form are considered. In any event, agency issues with respect to the reinvestment of retained earnings still persist.
The deferral advantage is one that requires shareholders to wait a certain amount of time to see a return on their investments while trusts must distribute their profits regularly and it is the tax efficient high distribution rates before the Plan that had made them a popular investment vehicle. It should therefore be considered whether energy trusts should be granted an exemption from the Plan. IV. ARE TAX ADVANTAGES FOR ENERGY TRUSTS GOOD PUBLIC POLICY?
Canadian governments are faced with the difficulty of balancing the desires of their citizens that their economic, social, and tax policies reflect their expectations with the reality of international economic competition which affects Canadians' ability to pay their way in the world and to improve the standard of living and quality of life of the nation. 4 As a result, the Canadian tax system's principles, including equity and neutrality, are often compromised for other goals and the tax system is in part, the product of a political marketplace in which politicians, interest groups, citizens and businesses all try to maximize the benefits they derive from governments and minimize their costs, including taxes.245 It seems most people would rather minimize the taxes they pay than have a "good tax system."246 Therefore, tax levels reflect in part the political
243 Klassen, supra note 236 at 6-7. 244 Geoffrey Hale, The Politics of Taxation in Canada (Peterborough: Broadview Press, 2002) at 17 [Hale]. 245 Ibid, at 17. 246 Ibid, at 26. 42 demands governments face and their perceptions of what their citizens are willing to pay in addition to underlying objectives such as equity.247
The federal and provincial governments can achieve their social and economic policies and goals as well as satisfy pressures from various groups either directly, through grants and subsidies covered in their annual budgets, or indirectly through their tax systems.248 A tax system can include tax incentives such as deductions, exemptions, credits and deferrals to advance particular initiatives or activities.249 The costs for these exemptions are called "tax expenditures" and represent a loss of revenue that would otherwise be available to a government if it had a "benchmark" tax system.250
A "benchmark" tax system is a normative system that measures income without reference to special incentives to achieve social, economic, and other policy objectives.
It determines only net income so that its tax base has some relationship to a taxpayer's ability to pay and a particular class of deductions or exclusions is necessary to prevent the taxing of gross receipts.252 Tax expenditures are designed to provide a benefit to a specified activity or class of taxpayer. Thus, if the federal government granted a special exclusion for oil and gas companies from the income trust tax, but taxpayers in other businesses are denied a similar exclusion, it could be regarded as a tax expenditure.
Tax expenditures are used as an alternative to direct expenditures in order to provide favourable tax treatment for particular activities, entities, transactions, or
247Ibid. 26. 248 Vern Krishna, The Fundamentals of Canadian Income Tax Law, 9* ed. (Toronto: Thomson Carswell, 2006) at 39 [Krishna]. 249 Ibid, at 39. 250 Ibid, at 39. 251 Ibid, at 40. 252 Bernard Wolfinan, Book Review of Tax Expenditures by Stanley S. Surrey & Paul R. McDaniel, (1985) 99 Harv. L. Rev. 491 [Wolfinan]. 43 investments. Canadian politicians frequently use the ITA to subsidise various sorts of activities,254 and in many areas, due to political realities, the tax system is a primary
source of government funding.255 This is in part because budgetary expenditures are
scrutinized more closely whereas tax expenditures, while representing real costs, are not clearly visible in annual budgets and are often hidden in the details of the HA.
Conversely, budgetary subsidies implemented through direct expenditure such as explicit subsidies, rebates and grants are usually the easiest to identify because governments often report the existence and magnitude of these subsidies in annual budget papers.
In addition, while the lower figure on the revenue side of a budget reflects the cost of tax expenditures, these costs are not accounted for as they would be with direct program spending. However, "tax expenditures are often criticized as a form of invisible spending that is frequently dispensed to more affluent sectors whose claims for public subsidization may not attract much sympathy among the wider body of voters."259
Furthermore, tax concessions are open-ended subsidy programs. Thus, the total cost of tax concessions cannot be easily predicted or controlled and there is no predetermined budget limit.260
Regardless of the criticisms, there is currently a proliferation of business sector tax expenditures.261 Often they arise in the context of competition with other countries for
253 Christopher Riedy, "Subsidies that Encourage Fossil Fuel Use in Australia" (Extended version of a working paper presented to the Australia New Zealand Society for Ecological Economics (ANZSEE) 2002 Conference on Ecologically Sustainable Development, January, 2003) at 4 [Riedy]. 254 Claire F.L. Young, "Child Care - A Taxing Issue?" (1994) 39 McGill L.J. 539 [Young]. 255 Ibid. 256 Krishna, supra note 248 at 40. 257 Riedy, supra note 253 at 4. 258 Phillips, supra note 19 at 125. 259 Phillips, supra note 19 at 125. 260 Phillips, supra note 19 at \ 25. 261 Phillips, supra note 19 at 125. 44 foreign investment dollars. The growing globalization of the Canadian economy and the associated mobility of capital imposes certain limits on Canadian sovereignty in
9rV? determining its tax policy, especially in areas affecting investment. In fact, some argue that tax competition between countries for foreign investment dollars leads to better tax
systems that help ensure economic growth.
It should however be noted that there is a hidden cost to all other taxpayers of a tax expenditure that may benefit a concentrated minority.264 Furthermore, there are certain potentially harmful consequences that can arise if they are extensively used.
These include the erosion of the tax base (because many investments would have occurred without tax incentives or through abusive or improper use of provisions), the distortion of resource allocation because some activities are encouraged over others, and the opportunity for corruption and socially unproductive rent-seeking activities.
Nonetheless, whether from political lobbying or for policy reasons to keep Canada's oil
and gas industry competitive, there are specific tax incentives for the oil and gas sector
currently available in the ITA. It stands to reason that there may also be legitimate reasons to allow energy trusts to continue accessing the tax efficiencies of the trust structure
before the Plan was announced.
A. The Case in Support of Energy Trust Tax Advantages
The Canadian government has acknowledged the importance of developing the
country's natural resources to its economic well being. 262 Benjamin J. Richardson, "Financing Environmental Change: A New Role for Canadian Environmental Law" (2003) 49 McGill L.J. 145 [Richardson]. 263 Daniel J. Mitchell, "The Moral Case for Tax Havens" (Paper presented at the colloquium, "Perspectives on International Tax competition" by the Liberal Institute of the Friedrich-Naumann-Stiftung, Potsdam 3, December 2005), The Liberal Institute of the Friedrich Naumann Foundation at 3-4 [Mitchell]. 264 Wolfman, supra note 252. 265 Howell H. Zee, Janet G. Stotsky & Eduardo Ley, "Tax Incentives for Business Investment: A Primer for Policy Makers in Developing Countries" (2002) 30 World Development No. 9 1497-1516 at 1498 [Zee]. 45
"The extraction of a non-renewable resource can produce substantial income and jobs in Canada. Since development of such resources can create significant economic and social benefits, there is a strong incentive for governments to design a sound economic and fiscal framework for the required large capital investments. Economic activity generated by resource industries has been important to Canada's emergence as an advanced economy. Resource activity is an important generator of investment, exports, and jobs for Canadians."266
A strong competitive position for oil and gas exploration and development in Canada
supports investment, innovation, productivity, economic growth, and jobs for
Canadians. Thus, in order to attract investment into the exploration and production of
Canada's oil and gas resources, there are a variety of tax incentives already in existence,
some specific to the oil and gas sector.
These tax incentives include four provisions relating to Canadian exploration expenses ("CEE"), Canadian development expenses ("CDE"), Canadian oil and gas property expenses (the "COGPE"), and capital cost allowances ("CCA") that determine the timing of the deduction of capital expenditures. The CEE allows oil and gas
corporations to write-off all exploration expenses in Canada which include any expense
incurred in determining the existence, location, and extent of a non-renewable resource.268 The COGPE provides for the ability to write-off the cost of acquiring oil and
gas leases and wells at a declining balance rate of 10 per cent;269 the foreign resource
expense ("FRE") allows for a partial deduction for foreign exploration and the CDE
allows for the partial deduction of development expenses if the company is a Canadian resident.270
266 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 10. 267 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28. 268 Robert W. Broadway & Harry M. Kitchen, Canadian Tax Policy. 3rd ed. (Toronto: Canadian Tax Foundation, 1999) at 195 [Broadway]. 269ftW.atl95. 210 Ibid, at 196. 46
Another provision, the resource allowance, allows a deduction equivalent to 25 per cent of net "resource profits" (before deductions of interest and exploration and development expenses) from resource production. 71 There is in addition a provision that allows corporations in the non-renewable resource sector that issue "flow-through shares" to renounce deductions in respect of exploration and development expenditures in favour of investors who may apply such deductions against their income for tax purposes.
This gives oil and gas companies the ability to finance exploration and development by issuing flow through shares which essentially allows the company to sell their losses to
97^ shareholders who may then deduct these losses off their own personal income.
The federal government acknowledges that there are specific risks and benefits inherent in the oil and gas business including uncertainty related to exploration, large capital requirements for development, and financial vulnerability due to price volatility and cyclically.274 The tax treatment that the sector receives is therefore recognizing that oil and gas companies are operating in a distinct business environment. In addition, international capital has been a critical factor in the development of Canada's resource industry; however, competition for this capital is getting increasingly intense.276
Therefore, tax treatment for the resource industry is also a response to the competition for foreign investment dollars in an international market.277
The specific provisions currently included in the ITA (including the CEE, the
CDE, the FRE, and the COGPE) and the CCA are meant to recognize the risks inherent
271 Ibid, at 196. 272 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 8. 273 Broadway, supra note 268 at 197. 274 Department of Finance, Improving the Income taxation of the Resource Sector, supra note 28 at 11. i75 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 11. 276 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 11. 277 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 11. 47 to the large investments required for oil and gas exploration and extraction and play an important role in ensuring a competitive business environment. However, the oil and gas sector is a cyclical industry which has losses some years and in those years, these special provisions may not advance the policy objectives behind them because companies may not be able to use them. Making oil less profitable to produce means producers have that much less incentive to find more278 and the Plan, which imposes corporate level taxation on a trust will among other things, make oil production less profitable for those trusts.
Therefore, it stands to be considered whether the policy reasons behind the special provisions for the oil and gas industry would also apply so as to grant the same industry an exemption from the income trust tax.
While the effect of a concession on government revenue is the same as if the government had made a direct expenditure of the cost of the concession to the industry;279 it has been argued that it is not appropriate to criticize them as violating tax equity or tax neutrality or eroding the tax base.280 Tax expenditures should instead be analyzed on their merits as if they were a separate assistance program by asking the questions: How much does it cost? Does it fulfill its objectives? Who benefits from the expenditure?281
Canada's tax system is not just about revenue raising; in addition it is actually "a massive spending program and should be evaluated as such".282 Therefore, in order to determine whether there are valid policy reasons for granting the oil and gas industry an exemption from the Plan, perhaps the role of the income trust should be reviewed on its own.
8 John W. Schoen, "Honestly, how come oil prices are jumping?" MSNBC (26 March 2008), online: MSNBC
The oil and gas industry is probably the most capital intensive sector of the economy, whether it is a major oil sands project or in the conventional oil and gas sector where smaller exploration and production players operate. Investment into the sector is also uncertain and high risk because of commodity, production and reserve risks, as well as operating risk.284 However, energy trusts may be considered to be less exposed to the risks because they tend to purchase longer life assets. Further, energy trusts acquire already producing reserves in order to replace the reserves being depleted thereby reducing exposure to exploration risks, though energy trusts may indirectly conduct significant exploration and development activities.286
The high cash distributions trusts make also serve to ease some of the risks for investors because at times, distributions are higher than a trusts taxable income, and that amount over represents a return on capital.287 Thus energy trusts appeal to investors seeking regular cash distributions and have given the oil and gas sector its biggest boost to capital formation. This capital has gone into increased exploration and development which has helped to enhance the sector's efficient operation.289
Energy trusts account for nearly a third of the activity in the Canadian oil and gas sector.2 This financing form has been shown to be an effective means of attracting investment into the energy industry because they have provided investors with a predictable, low-risk and tax efficient revenue stream that is derived from mature,
283 Department of Finance, The 15% Solution, supra note 154. 284 Bold Generation Financial Inc., "Income Trusts" (2006) online: BGF
909 maturing reserves of the Western Canadian Sedimentary Basin (the "WCSB"). The
WCSB is a vast sedimentary basin underlying 1.4 million km2 of Western Canada including southwestern Manitoba, southern Saskatchewan, Alberta, northeastern British
Columbia and the southwest corner of the Northwest Territories.293 The WCSB, which supplies much of the North American market, contains one of the world's largest reserves of petroleum and natural gas, of which Alberta has most of the oil and gas reserves and almost all of the oil sands.294
Because the WCSB is considered a mature area for petroleum exploration, recent development by the major oil and gas companies has tended toward natural gas and oil 9Q^ sands rather than conventional oil. Conventional light oil is a mature industry with 64 per cent of the recoverable oil reserves already produced and production is declining by 90fi three to four per cent per year. However, only about 27 per cent of light oil is recovered which still leaves large opportunities for improvement.297 About 46 per cent of conventional heavy oil resources have already been produced and is thought to have a future of long-term production decline. Nonetheless, only 15 per cent of heavy oil is currently being recovered, and this too leaves a large volume for future recovery.299 In 291 PricewaterhouseCoopers, "Oil and Gas Taxation in Canada" (May 2004) at 9 [PWC]. 292 Curran, supra note 29. 293 Wikipedia, "Western Canadian Sedimentary Basin" (3 February 2008) online: Wikipedia
Conventional finding and development costs have increased substantially in the last five years, and operating costs have more than doubled.300 The combination of higher costs (which could get even higher if, as discussed later, carbon taxes are implemented nationwide) and lower production and reserve expectations has made it more difficult for energy producers to invest profitably in the WCSB.301 While this may seem counterintuitive given the fact that oil prices are setting records at over $140 a barrel, there comes a point where rising oil prices threaten rather than help the profits of oil and gas companies because high oil prices could lead to reduced demand. Furthermore, the high Canadian dollar is further detracting from profits. Approximately four out of five
(78 per cent) companies in Canada's oil and gas sector were negatively impacted by the higher value because it is costing companies more money to pursue oil and gas activities in Canada.304 In addition, conventional oil and gas royalties, which energy trusts pay, automatically increase with higher prices and oil prices have been rising at a record pace. These factors have driven senior producers to look for their growth opportunities
300 Coalition of Canadian Energy Trusts, "Canadian Energy Trusts: An Integral Component of the Canadian Oil and Gas Industry" (December 2006) at 5 [CCET]. 301 Ibid, at 6. 302 CTV ca News staff. «Tory "fueicast" ads UTget Liberal carbon tax" CTV.ca (8 June 2008) online: CTV.ca
In fact, the major explorers and producers have been abandoning conventional production in Canada. However, smaller exploration companies, which have lower operating costs and access to improved seismic and drilling technology, are maintaining levels of conventional oil production in the WCSB with higher recoveries from existing pools through infill drilling, and efficient, cost-effective exploration and development of smaller pools. Senior producers have been selling their mature WCSB properties to energy trusts, which have become adept at maximizing the resource recovery out of these
•5AQ mature reservoirs. With their lower cost structure and lower cost of capital, energy trusts are able to exploit and extend mature property opportunities that would be uneconomical to other producers.309
Many smaller traditional exploration and development companies have thus converted to the royalty trusts structure to cope with the maturity of oil and gas exploration in Western Canada. The cost of exploring and developing in these mature areas is significantly higher and therefore more capital intensive.310 Several existing trusts arose to underpin conventional oil and gas production in the WCSB. In fact the trust structure was initially developed to facilitate production from mature assets in the oil patch.311
306 Ibid, at 6. 307 Wikipedia WCSB, supra note 239. 308 CCET, supra note 300 at 6. 309 CCET, supra note 300 at 6. 310 PWC, supra note 291 at p. 9. 311 Hayward, supra note 53 at 1533; The Oil Drum: Canada, "Income Trusts and the Canadian Energy Sector" (21 November 2006) online:
A typical Canadian energy trust directs the majority of its investment dollars toward the acquisition of producing oil and gas properties from senior producers as well as junior companies.312 This is because they distribute the bulk of their cash flow to unit holders.313 Energy trusts thus have a limited ability to finance internal growth and tend to grow through acquisition of additional oil and gas properties or producing companies with proven reserves of oil and gas instead (which they fund through the issuance of additional units).314 Once the major oil and gas companies have fully developed a large field and produced most of the reserves, they no longer have any incentive to hold it. In the past, junior companies, due to their size, generally could not purchase these assets and so they were often sold to non-resident interests. As the popularity of royalty trusts gained however, they have become the largest buyers of properties from the majors and play a very important role in making sure that properties, which are no longer of interest to the majors, are fully produced.317
Smaller or minor oil and gas exploration and production companies set up a trust in their business structure which allows virtually all income generated from these assets to flow through to trust unit-holders on a monthly or quarterly basis. As this arrangement alleviates or eliminates corporate taxes and has stable cash distributions, trust units have been an attractive investment. Energy trusts have a lower cost of capital because distributions had been deductible before the Plan and this has resulted in a general increase in capital development activities that has allowed the development of what
312 The Oil Drum, ibid. 3.3 BGF, supra note 284. 3.4 BGF, supra note 284. 31i Department of Finance, The 15% Solution, supra note 154. 316 Department of Finance, The 15% Solution, supra note 154. 317 Department of Finance, The 15% Solution, supra note 154. 53 would have been unexploited opportunities due to inadequate rates of return. The sale of trust units allows companies to raise sufficient capital to continue acquiring and producing mature assets as well as to pursue the exploration of these reserves.
Explorations are high risk in that they could lead to nothing. However, investors in the resource sector want a safe investment vehicle. To render the risks more acceptable to investors, energy trusts are commonly used. A group of assets or businesses that already have either a current income stream or potential for a current income stream is attractive to a trust and so mature oil and gas assets have been better suited to the trust sector. This is because there was an existing stream of cash flow from wells already in production.
Because trusts need to create income, they typically value exploration plays lower. This is because their investors tend to value high risk plays lower than those with known asset values.323 However, those trusts that have an established base of income or production are willing to look at potential exploration opportunities.324
Exploration is of key importance if the WCSB's production potential is to be met.325 Not only does the trust sector in the oil and gas industry ensure that mature reserves are produced, they have also been tending towards more exploratory work into areas not profitable for the major players.326 Energy trusts therefore appear to be particularly well suited to maximize Canada's depleting oil and gas reserves.
318 The Oil Drum, supra note 311. 319 The Oil Drum, supra note 311. 320 Curran, supra note 29 at f 45. 321 Oil and Gas Investor, supra note 139. 322 Curran, supra note 29 atf 47 323 Curran, supra note 29 at % 47. 324 Curran, supra note 29 f 47. 325 Brian A. Toal, "Calgary Start-Ups" (June 2004) Oil and Gas Investor [Toal]. 326 lb id. 54
Trusts can distribute cash flows in a manner that achieves full integration of the personal and corporate income tax systems, removing an impediment to distributions.
With the new income trust tax, energy trusts would need to deal with lower distributions because they will have borne the equivalent of corporate tax. This will make them less attractive as investment vehicles, particularly to tax exempt entities and non-resident investors because they will not be able to access the DTC to offset the trust level tax.
Furthermore, before the Plan, the adoption of an income trust structure may have acted as a signal to investors, possibly even more so than a stated dividend policy of a corporation, that managers intended to distribute cash to investors.328 Even where a corporation makes high dividend payments, it is done with money that has already borne corporate tax therefore it lacks the same incentive as an income trust to pay out earnings.
Because income trusts will be liable to tax at the highest marginal rate if they do not pay out distributions, investors may feel trusts are even more committed to making cash distributions.329
The clientele effect can be seen where a company attracts a set of investors to whom its dividend policy is attractive,330 and the concept of tax clienteles arises when two assets of similar economic characteristics are taxed differently.331 This can help to explain why investors with low tax rates prefer to invest in the income trust structure and receive regular distributions on their investments rather than realize a capital gain from the sale of corporate shares, despite the deferral advantage that may arise when
327 Department of Finance, Consultation Paper, supra note 14 at 5. j28 Alarie, supra note 76 at 16. 329 Alarie, supra note 76 at 17. 330 Thomson, "Glossary of Finance Terms" online:
ill tax rate, the greater after-tax value the income trust organizational form provides. Tax exempt investors receive a higher return under the income trust structure, but the advantage is much less than when no return is earned through capital gains.334 Thus tax clientele effects help explain some of the reason why income trusts are more attractive to non-taxable or tax-deferred Canadian resident investors.
Accessing capital is a key challenge for Canadian income trusts but the Canadian capital markets can only absorb finite quantities of securities in any form.335 The oil and gas industry is already heavily dependent on capital for investment, and because income trusts need to pay out all their income in order to avoid taxation at the highest marginal rate, they constantly need (even more so than corporations which do not tend to pay out all their earnings) to seek new capital. There is in fact evidence that demonstrates that income trusts do seek new capital when needed for additional investment.336 However, since the Plan was announced, many trusts have reduced liquidity and have stopped their acquisition engines due to the lack of available cash to finance acquisitions and other growth initiatives. The ability to raise equity financing is now significantly impaired,
Klassen, supra note 236 at 1. Klassen, supra note 236 at 1. Klassen, supra note 236 at 1. CAIF, Draft Budget Submission, supra note 127. Klassen, supra note 236 at 11. Deloitte, Income Trusts: One Year Later, supra note 116. 56 as seen by the overall decline in equity offerings (see Appendix II: Private Equity
Financings). This decline is more pronounced when REIT activity is excluded.338
The decline in interest for secondary trust unit offerings and the recent illiquid debt market has even caused some trusts to pull back on distribution increases or to cut distributions altogether.339 This will hurt the energy trust structure even more as high distributions is part of their appeal for investors. Another obstacle for meeting its capital intensive needs is that the domestic demand for capital exceeds the domestic supply and the residual had been provided for by foreign investors.340 However, the Plan has had a negative impact on foreign investors as well.
B. The Case Against Energy Trust Tax Advantages
While the tax treatment of energy trusts prior to the Plan has helped that sector raise the capital it needed for its development and production activities, it should be remembered that the main purpose of an income tax is to raise revenue. In addition the
Canadian tax system also has subsidiary objectives. These include equity, neutrality, simplicity, economic stabilization and international competitiveness which all powerfully influence the design of a tax system.341 Some have welcomed the Minister's decision to tax income trust distributions on the basis that it closes a loophole that was purportedly unfair and contrary to the objectives of the ITA.342 In announcing the new trust tax the
Minister is focusing in on meeting the objectives of an equitable tax system based on the
Deloitte, Income Trusts: One Year Later, supra note 116. 339 Deloitte, Income Trusts: One Year Later, supra note 116. 340 McKenzie, supra note 30 at 650. 341 Hogg, supra note 34 at 34. 342 Lee, Ian. "Two Bad Reasons for the Tax on Income Trusts" (8 November 2006) University of Toronto, Faculty of Law, online:
According to the Minister, if the proliferation of income trusts were allowed to continue, and if Telus Corp. and BCE Inc.344 had proceeded with their plans to convert to the trust structure, the federal government would stand to lose billions of dollars in tax revenue.345 "We were going to see the two largest telecommunications companies in the country not pay corporate taxes. That's a clear and present danger to fairness in the
Canadian tax system. I thought we had to act." While the loss of tax revenues is a fair argument, the Minister has not provided information to demonstrate how the government came to the conclusion that income trusts had been costing it hundreds of millions of dollars in tax revenues.347
The new tax rules will apply to amounts earned and distributed by a SIFT and will have far reaching consequences for these business structures.348 Under the Plan in its current form, there will be few reasons to remain a SIFT trust, other than the cost of converting back to the corporate structure.349 One of the policy reasons given by the federal government for imposing the trust tax is to level the playing field between SIFTs and public corporations so that our tax system is more neutral. Neutrality in this context
343 Hogg, supra note 34 at 26. 344 Stewart, supra note 16. 345' ,Departmen t of Finance, Flaherty, supra note 1. 346 Stewart, supra note 16. 347 Hasselbeck, supra note 44. 348 Borden Ladner Gervais LLP, Tax Law Group, Tax Law Bulletin, "Income Trust Proposals - All Trick, No Treat" (9 November 2006) [BLG]. 349 Deloitte Canada, "Impact of Changes to Trust Taxation" (December 2006) online: It has been argued however that the tax policy bias will have swung in favour of public corporations by 2011.351 While true that the combined entity and investor level tax burden for SIFT trusts and public corporations will be similar, the SIFT trust will be required to distribute its non-portfolio earnings in order to achieve that neutral result. Because retained earnings in a trust are taxed at the highest individual rate (which can be as high as 49 per cent depending on the jurisdiction), a SIFT trust will be forced to distribute its non-portfolio earnings or instead incur this 49 per cent trust-level tax on retained income. If a trust has significant taxable income in relation to cash distributions, forced distributions could impede management's ability to run the business. There may be situations where a SIFT trust wants to reduce its cash distributions in order to maintain a sustainable payout ratio but the forced distribution feature of trust taxation would hamper management's ability to do so.354 Public corporations however, have the flexibility to retain its income to invest in its business and grow naturally; with respect to income that would have been distributed to taxable Canadian resident shareholders, an added tax deferral benefit arises because the corporate income tax rate is significantly less than the highest individual tax rate on ordinary income. The Minister's objective therefore to have a neutral tax system may not be met. The Plan does not act to level the playing field between the corporate 350 Hogg, supra note 34 at 28. 351 Deloitte Canada, supra note 349. 352 Deloitte Canada, supra note 349. 353 Deloitte Canada, supra note 349. 354 Deloitte Canada, supra note 349. 355 Deloitte Canada, supra note 349. 59 structure and the income trust structure; it goes further and seems to actually discourage if/ the use of income trusts as high yield structures. In fact, businesses operating as trusts or planning to convert to trusts have actually been converting back to the corporate structure and canceling plans to convert to income trusts.357 The new tax rules are actually skewing business decisions to the direction of corporate structures when in a truly neutral tax system tax considerations would not drive decisions one way or another. This is even more so for oil and gas companies which are for the most part based out of Alberta where the corporate income tax rate is 10 per cent. In order to eliminate any possible distortive advantages where a SIFT trust is not subject to full provincial income taxation, the Plan imposed a compensatory proxy for the provincial income tax that would apply if the SIFT trust had been corporation rather than a trust.359 This 13 per cent is to be collected by the federal government and distributed to the provinces. However, the proxy rate is 13 per cent which creates an incentive, all other things being equal, to use a corporate model in Alberta. The other argument that the Minister presented to support the Tax Fairness Plan is that corporations operating as trusts do not pay their share of taxes and that "the tax burden will shift onto the shoulders of hardworking individuals and families".362 According to this argument, allowing trusts to continue with their tax free status would be 356 Alarie, supra note 76 at 3. 357 See for example Steven Chase, "Income trust tax long overdue, David Dodge says" The Globe and Mail (2 February 2007) online: It has also been argued that the federal government's tax subsidies to the oil and gas industry indirectly promote green house gas ("GHG") emissions. This would be contrary to Canada's environmental protection policies which include its commitments under the Kyoto Protocol (the "Kyoto"). When Canada became a signatory to the Kyoto, it committed itself to reducing its GHG emissions to 6 per cent below 1990 levels by 2008-2012. Further, Canada is a member of the International Energy Agency (the "IEA") which acts as energy policy advisor to its member countries. The IEA has balanced energy policy making as its mandate which includes energy security, economic development and environmental protection. For Canadian energy policy, the biggest challenge in recent years has been balancing the need to reduce emissions, while maintaining energy production and 363 Fair Tax Commission (Ontario), Fair Taxation in a Changing World (1993), 44-68 [Fair Tax Commission]. 364 Lee, supra note 342. 365 Lee, supra note 342. 366 Ron Duek, "Generating a Green Tax Policy for Renewable Electricity in Canada" (2007) 12 Appeal 90- 111 at K 37 [Duek] citing Petition from Mr. Charles Caccia, c/o Institute of the Environment, Friends of the Earth Canada, Pembina Institute for Appropriate Development and Sierra Legal Defence Fund to the Auditor General of Canada, "respecting federal tax and other subsidies to the oil and gas industry that undermine government spending and regulations aimed at complying with the Kyoto Protocol and fighting climate change", October 3, online: Sierra Legal One method by which an IEA country may attempt to fulfil its obligation to reduce GHG emissions is through its tax system. Environmental tax measures include environmental taxes or tax expenditures.375 Environmental taxes have been defined as "a tax whose base is a physical unit (or a proxy for it) of something that has a proven specific negative impact on the environment, when used or released".376 Conversely, environmental tax expenditures are "deliberate departures from otherwise applicable taxes in order to encourage the (environmentally positive) activity at which the incentive is directed".377 There has in the past been a disparity between tax expenditures made to the oil and gas industry versus climate change action programs. For example, between 1996 and 2002, the federal government provided nearly $8 billion in tax expenditures to the oil and 370 ibid. 371 Duek, supra note 366 at f 7. 372 Duek, supra note 366 at f 7. 373 Duek, supra note 366 at f 8. 374 Duek, supra note 366 at f 9. 375 Duek, supra note 366 at f 13. 376 Duek, supra note 366 at 113 citing David G. Duff, "Tax Policy and Global Warming" (2003) 51(6) Can. Tax J. 2063-2118 at 2068 [DuffJ. 377 Duek, supra note 366 at f 13 citing Duff, ibid, at 2078. 62 37ft gas industry while allocating less than $6 billion to environmental programs. However, 370 it is difficult to integrate environmental policy into financial markets regulation; particularly if one considers that investment returns in environmentally problematic industries and companies, such as the oil sector, would be less profitable if they paid for their full environmental impacts through pollution charges. Nonetheless, the province of British Columbia, the first jurisdiction in North America to do so, has implemented a "carbon tax". A "carbon tax" is a tax levied by governments on emissions of GHGs; it is a policy that can be used to put a price on GHG pollution.382 Oil and gas companies pay a carbon tax based on the level of pollution from their production processes such as tar sands mining, processing and refining.383 British 384 Columbia has started taxing virtually all fossil fuel emissions as of July 1, 2008. Quebec has also introduced a smaller-scale carbon tax affecting a limited number of companies in the fall of 2007. There is a possibility that other provinces, including Ontario, may implement a carbon tax. Conversely, the federal government will not likely adopt a broad-based carbon tax because they affect the price of fossil fuels and it has in the past rejected 378 Duek, supra note 366 at «| 37. 379 Richardson, supra note 262 at 162. 380 Richardson, supra note 262 at 172. 381 Jonathan Fowlie & Fiona Anderson, "B.C. introduces carbon tax" The Vancouver Sun (19 February 2008), online: The Vancouver Sun 386 Liberal Party, supra note 383. 63 energy taxes. Higher energy costs would likely have an adverse effect on the competitiveness of Canadian manufacturers and producers on international markets and •500 certain energy-intensive regional economies would be disproportionately affected. Instead, Canada's proposed Clean Air Act (the "CAA"), was introduced in 2006; it is designed to set in motion the country's first comprehensive and integrated approach to tackling air pollution and GHG emissions.389 The CAA does not include a carbon tax but it does include a notice of intent to discuss reducing GHGs between 45-55 per cent by 2050.3 ° Additionally, the CAA includes guidelines to "maintain Canadian competitiveness and reflect the opportunities offered by the capital investment cycle." However, the effectiveness of the CAA has been challenged by the opposition parties, which state that it does little to prevent climate change392 and B.C.'s Finance Minister believes that a carbon tax is necessary in order to reach target GHG reductions.393 Prime Minister Stephen Harper therefore agreed to send the CAA to a special committee for review; the bill has gone through the unusual step of being reviewed by an all-party committee and has had its second reading but is not yet in force. 4 It remains to be seen whether the CAA will be effective in promoting reductions in GHG emissions in Canada. Thus, there is still the potential for a federal carbon tax. 387 Richardson, supra note 262 at 189. 38g Duek, supra note 366 at f 45. 389 Office of the Prime Minister, "PM Announces Canada's Clean Air Acf (10 October 2006), online: Stephen Harper Energy trusts could therefore be facing further reduced profits, and while oil prices are setting records at over $140 per barrel, rising oil prices pose a threat because at some point, various substitutes become economical.396 In fact, it was rising oil prices that had made oil sands development economically feasible.397 Furthermore, oil and gas royalty revenues in Alberta, the centre of the oil and gas industry in Canada, have already peaked in 2005-2006 at $14.3 billion; they have since been declining with revenues at $12.3 billion in 2006-2007 and a forecast of $11 billion for 2008-09.398 Oil and gas revenues in Alberta have also been extremely volatile and were as low as $4.7 billion in 1999-2000. In any event, along with environmental concerns, an economic slow-down is also threatening Canada.400 If environmental harms such as waste emissions and resource depletion are to be taxed, to be politically viable, these "eco-taxes" would need to be offset by reductions in other types of corporate taxes.401 With the Plan's implementation however, energy trusts could be facing a double blow; they would be subject to corporate level taxation as well as a potential federal carbon tax which would lower profits and thereby distributions to unitholders. Their ability to compete for capital would thus be severely hindered. Furthermore, the non-commercial policy goals of energy policy could result in the increasing intervention by Canadian governments in the market in areas such as carbon pricing and strategic reserve requirements.402 Thus it is not surprising that one study 395 CTV ca Tory fyelcast supra note 302 396 Geoff Kirbyson, "Balancing on "Risky" Revenue Source" (June 2008) 24 The Bottom Line No.7 [Kirbyson]. 397 Ibid. ™Ibid. ""ibid.i 400 Liberal Party, supra note 383. 401 Richardson, supra note 262 at 173. 402 Ernst & Young, "Strategic Business Risk: Oil and Gas" (2008) at 10 [Ernst & Young]. 65 listed energy policy as one of the biggest business risks to oil and gas companies.403 This uncertainty is a factor when investors are choosing where to put their money and hurts the oil and gas industry's ability to raise capital. C. Weighing the Arguments for a Carve-Out for Energy Trusts Considering the foregoing concerns with foreign investment, tax exempt entities and environmental issues, a review of the possibility of an exemption from the Plan for energy trusts is appropriate. The United Nations Environment Programme (the "UNEP") and the International Energy Agency (the "IEA") state that: "Any subsidy can be justified if the gain in social welfare or environmental improvement that it brings exceeds the net economic cost."404 This suggests subsidies to oil and gas producers should be retained if they do sufficient good for the country so as to outweigh the economic cost.405 The Minister's recent accusations against Premier McGuinty's Liberals of showing a "lack of leadership and vision" by not giving tax breaks to businesses supports this conclusion. The Minister claimed that the lack of tax concessions has hurt the Ontario's manufacturing sector406 and he thereby appears to acknowledge that at times, tax breaks or incentives are appropriate and sometimes necessary in order to help and encourage business. In the case of the oil and gas sector, there does seem to be many policy reasons, including international competition for capital and the exploitation of Canada's natural resources, to provide it with tax incentives. m Riedy, supra note 253 at 6 citing UNEP and IEA "Reforming Energy Subsidies", (2002) Oxford, UK, United Nations Environment Programme - Division of Technology, Industry and Economics, International Energy Agency, First Edition at 19 [UNEP and IEA]. 405 Riedy, supra note 253 at 6. 406 CTV.ca News Staff, "Flaherty calls on Ontario to cut business taxes" CTV.ca (20 February 2008) onlme:CTV.ca When considering subsidies that are administered through the taxation system, it is important to also consider any special taxes, such as royalties and excise taxes that are imposed on fossil fuel (oil and gas) producers and consumers. Subsidies granted to the energy sector can be more than offset by these special taxes.407 According to the UNEP and the IEA, most OECD (Organization for Economic Co-operation and Development) countries more than offset any gross energy subsidies with special taxes and duties on fossil fuels.408 Fossil fuel subsidies were defined by the UNEP and IEA's as "any government action, concerning primarily the energy sector that lowers the cost of fossil fuel production, raises the price received by fossil fuel producers or lowers the price paid by fossil fuel consumers."409 Because an exemption from the income trust tax would lower the cost of production for oil and gas companies by lowering the taxes they must pay, it would be considered a subsidy. Therefore, according the UNEP and the IEA, Canada, as an OECD country may be able to offset any costs of allowing the oil and gas industry an exemption from the income trust tax with other taxes and duties. In Canada, the oil and gas sector is one of the most heavily taxed sectors;410 income from Canadian oil and gas operations are subject to the federal income tax, provincial income taxes, and in addition, there are duties or royalties levied on the production of oil and gas.411 Furthermore, conventional oil and gas royalties, which energy trusts pay, automatically increase with higher prices412 and currently, oil prices have been setting record highs. Royalties are a combination of Crown royalties on the 407 Riedy, supra note 253 at 2. Riedy, supra note 253 at 5 citing UNEP and IEA, supra note 404. 409 Riedy, supra note 253 at 2. 410 Canada, Department of Finance, Improving the Income Taxation of the Resource Sector in Canada, supra note 28 at 5. 41' PWC, supra note 291 at 1. 412 CAPP, Alberta Oil, supra note 305 at 2. 67 one hand and payments provinces receive from oil and gas companies for the production of conventional crude oil, natural gas and oil sands on the other. Companies are granted the right to explore for and develop petroleum and natural gas resources, in exchange for the value to provinces that flows from development in the form of royalties.414 As previously stated, in Alberta alone in 2005-2006 non-renewable energy royalty revenue amounted to $14,347 billion.415 Furthermore, in its 2008 budget, Alberta increased the overall royalty rates from a maximum of 30 per cent and 35 per cent for old and new tiers to a range up to 50 per cent for conventional oil, and rate caps will be raised to $120 per barrel. Thus while the Minister argues that the entire income trust sector leads to hundreds of millions of dollars in tax leakage (though he has failed to demonstrate how this amount was calculated),417 certainly the oil and gas sector on its own more than makes up for this. It appears therefore that the cost of granting the sector an exemption from the Plan may be offset in other ways. The demand for fossil fuels is growing faster than the world's oil producers can find new sources to satisfy that demand and replace the oilfields that are used up. Canada's energy policy includes energy security and therefore it has an obligation under the IEA to exploit its resources; further, as a net exporter of energy resources, Canada is one of the few industrialized countries that benefits from the current record breaking world energy prices.419 Alberta's 2005-06 provincial budget estimated that the impact of 413 CAPP, Alberta Oil, supra note 305 at 1. 414 Government of Alberta, Department of Energy, "Royalty Information Briefing #1: What are Royalties" (2007) online: < http://www.energy.gov.ab.ca/Org/pdfs/InfoSeries-Reportl-Royalty.pdf>. 415 Ibid. 416 Alberta Finance, Alberta Advantage: Budget 2008 (Alberta: Alberta Finance, 22 April 2008). 417 Hasselbeck, supra note 38; CTV.ca, Ottawa won't show income trust figures, supra note 38. 418 Schoen, How come oil prices are jumping, supra note 278. 419 John W. Schoen, "Oil price spike has economic impact" MSNBC (22 May 2008), online: MSNBC Energy is an extremely important contributor to Canada's economy. During the 1990s, for example, the energy sector contributed to more than 65 per cent of Canada's merchandise trade surplus (the export and import of goods424).425 Energy trusts have a significant role in the oil and gas sector and while there has been a recent proliferation of income trusts that had prompted the federal government to react with the Plan, historically, the use of royalty trusts and income trusts was largely confined to the real estate and oil and gas sectors.426 They complement the efforts of small and large corporations and, in addition, contribute almost half of the quoted market value of all income trust trading on the Toronto Stock Exchange.427 There are already the special provisions such as the CEE, COGPE and the CDE in the ITA that allow oil and gas companies deductions for capital costs and for other types of taxes paid. Another example is flow through shares; the federal government has acknowledged that junior oil and gas companies need special tax treatment to survive. Therefore, flow-through shares may be used by these companies as a targeted vehicle to 420 CAPP, Alberta Oil, supra note 305 at 2. 421 Paul Brandus, "Oil's Vicious Circle" Forbes.com (28 May 2008) online: Forbes.com 423 CTV ca News Staff. «LiberalS; Tories trade shots over carbon tax" CTV.ca (9 June 2008) online: CTV.ca However, despite these provisions, the industry pays higher taxes in other areas that may offset some of this favourable tax treatment. The federal government imposed an export tax on oil and gas to keep domestic prices down, another tax as part of the national energy program, and disallowed the deduction of provincial royalties.430 Because the existence of resource taxes can have a considerable influence on decisions by firms to explore for natural resources, and to exploit natural resources once they have been acquired, ' the federal government should review the costs of allowing the oil and gas industry an exemption from the new income trust tax scheme. Particularly as reducing corporate income taxation levels will improve the Canadian economy which would in turn improve the country's competitiveness and thereby boost Canada's economic performance.432 The exploitation of Canada's oil and gas reserves are essential to the economy and tax factors may play a role in companies endeavouring to do so. The energy industry is a heavy driver of Canadian growth,433 and Western Canada and Newfoundland, with their reserves of crude oil and the economic activity generated by the various aspects of 428 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 14. 429 Department of Finance, Improving the Income Taxation of the Resource Sector, supra note 28 at 9. 430 Broadway, supra note 268 at 197. 431 Broadway, supra note 268 at 20. 432 Donalee Moulton, "Tax use of resources, says Mintz" 23(14) The Bottom Line (November 2007) [Moulton] citing Kevin Dancey, Canadian Institute of Chartered Accountant's president and CEO. 433 Sydney Sharpe, "A Century of Growth and Energy" (June 2005) Oil and Gas Investor. 70 the energy industry, are prospering.434 Conversely, high oil prices have been said to have contributed to the steady decline of Canada's manufacturing sector.435 It may be argued that with the high oil prices, oil and gas companies have higher profits and that they should use those profits to explore for oil and "leave the tax breaks for companies that need them".436 However, the manufacturing sector has its own sector specific tax incentives as well, including an allowance that reduces its applicable rate of tax.437 "Dutch disease" is the theory that an increase in revenues from natural resources will de-industrialise a country's economy by raising the exchange rate, which makes the manufacturing sector less competitive and public services entangled with business interests.438 In any event, it is difficult to determine a national policy that does not punish one at the cost of another.439 Furthermore, it cannot definitively be said that Dutch disease is the cause of the ailing manufacturing sector; there are too many other factors at play in the very complex global economy.440 The Finance Minister has blamed Ontario's slumping manufacturing sector on high provincial business taxes and suggested its Premier's "out-of-control spending is threatening the economy".441 The Minister's concerns are echoed by others who agree that the Liberal Party's economic policies like "higher taxes, runaway spending and the 434 Deirdre McMurdy, "What soaring oil prices mean for Canada" Sympatico MSN Finance (19 April 2008) online: Sympatico MSN Finance Others argue that surging hydro rates and employment laws make it "cheap, easy and quick" to shut down factories and that this is the factor driving manufacturers out of Ontario.443 The Minister also stated on June 14, 2008 that the weak U.S. dollar has hurt Canadian manufacturing exports to the U.S. He said that "we've borne one-third of the brunt of the depreciation of the U.S. currency" due to the size of Canada's trade with the U.S.444 There are thus many arguments as to the cause of the declining manufacturing sector and whether it is the energy sector is not clear. It is clear however that oil has been trading at record highs.445 The Bank of Canada governor recently stated that unlike most industrialized countries, Canada benefits from rising oil and natural gas prices and that this effect is not confined to Alberta and other producing provinces.446 He went on to say that "[t]here are variety of industries that feed into the energy industry, including manufacturing industries in Ontario and other areas of Central Canada; there are wealth effects in portfolios; there are wage effects for secondary and tertiary industries spread across the country."447 Therefore, as a net exporter of energy, it appears to be the time for Canada to capitalize on its reserves because with the volatility of oil and gas prices, this level of profitability may not last. 442 ibid. 443 Ibid. 444 Associated Press, "G-8 raises alarm over rising oil prices" MSNBC (14 June 2008), online: MSNBC In an effort to prevent tax leakage after the announcement of the BCE and Telus income trust conversions, the Minister announced the Plan; however, these were not traditional income trust offerings. Oil and gas (and real estate) companies have sound economic reasons for structuring themselves as income trusts and it appears as though energy trusts may have been caught by the Plan because of the proliferation of trust conversions of other businesses, which do not properly fit within the income structure. The use of trusts was historically confined to the oil and gas and real estate sectors 5 and the oil and gas sector argues that the federal government inappropriately targeted energy trusts; those in that sector argue that the government should take into consideration energy trusts' role in the maximization of production of the WCSB's reserves so as to grant it a sector specific solution to the general income trust tax.451 If tax leakage was a concern of such great magnitude that the Canadian government acted contrary to election promises, then all income trusts, including energy trusts and REITs should be subject to the Plan. However, it excluded REITs and in doing so, the federal government wanted to recognize the important role they play in the economy. Like REITs, energy trusts have a 20 year history of value creation in Canada and they compete internationally for capital.452 The government has addressed the historical importance of REITs, however, historically royalty and income trusts were most often associated with the oil and gas as well as the real estate sectors.453 448 Zetzsche, Dirk. "The Need for Regulating Income Trusts: A Bubble Theory" (2005) 63, No. 1 U.T Fac. L. Rev. 45 at 77 [Zetsche] citing Jeffrey Rubin, "Why feds clamped down on income trusts" The Globe and Mail (29 March 2004) B7. 449 Zetzsche, ibid, at 77. 450 Hayward, supra note 53 at 1533. 451 Diane L.M. Cook, "Tax Fairness Plan" Oil and Gas Network (February 2008) [Cook]. 452 CAIF, Draft Budget Submission, supra note 127. 453 CAIF, Draft Budget Submission, supra note 127. 73 Most established energy trusts are "wasting businesses", in that there is a significant return of capital element to the cash distributions and the underlying asset is depleted.454 REITs also own capital assets, i.e., real estate, the value of which is depleted by time, according to the estimated time of use.455 Both energy trusts and REITs have risks with respect to finding customers (in marketing activities) and receiving a sufficient sale price for the product and distributions provide a good indication of sales success. 5 The federal government's purported desire to ensure income trusts pay their "fair share" of the tax burden is inconsistent with the decision to exempt REITs from the Plan.457 If the federal government is concerned with preventing the loss of corporate taxes, then excluding REITs from the Plan is counterproductive. The Minister acknowledged that energy trusts have a high U.S. ownership while REITs have primarily ACQ Canadian resident ownership. With the new gross-up and enhanced DTC, eligible unitholders of REITs will not bear any corporate level tax on their distributions while the American investors of energy trusts will not be able to access the DTC to offset corporate taxes. Thus, because REIT units are for the most part by Canadian residents, the federal government's reasoning in exempting REITs is unsound; by doing so, it ensures that REITs pay no corporate level tax. In any event, even if REITs were justifiably exempted from the Plan, the Canadian Association of Income Trust Investors ("CAITI") commented in a press release Zetzshe, supra note 448 at 77. Zetsche, supra note 448 at 77. Zetsche, supra note 448 at 78. Department of Finance, News Release, Canada's New Government, supra note 108. Standing Committee on Finance, 39th Parliament, supra note 181. 74 that allowing the energy rather than the real estate sector to retain the tax advantages of the trust structure would have greater utility.45 "REITs differ quite substantially when viewed from the perspective of their contribution as engines of economic growth and employment and their overall strategic importance to the country, given the passive fixed asset nature of their assets. When evaluated on these bases, other asset classes within the broader income trust market would have scored considerably higher on the "endangered species" list. Subsectors that immediately come to mind would be the energy subsector or resource subsector in general.'''' While the tax advantages of the energy trust model are a clear incentive for investors, it has also proved to be useful for managing assets efficiently, for example by mitigating sector risks and agency costs because of its high distributions.461 There are other indicators that show that tax purposes alone are not the reason for oil and gas companies to structure into an income trust. The high level of underwriters' and legal fees for the issuance of income trust units (which are higher than that for corporate initial public offerings because income trust issues involve complex restructuring) offset a portion of the tax savings.462 In addition, while corporations accumulate a large amount of their returns within the firm and investors must sell their shares in order to realize these returns, income trusts regularly pay returns to its investors. This helps to address the information asymmetry between investors and entrepreneurs of a company; when distributions are made, investors do not have to worry that managers may invest cash flows of the company 459 Canadian Association of Income Trust Investors, "Concerns with the "Tax Fairness Plan"" (5 January 2007) [CAITI, Concerns with the TFP]. 460 Ibid. 461 Brooks, supra note 18 at 18. 462 Zetzsche, supra note 448 at 59. 75 inappropriately.463 Where a company distributes its profits to its investors, management is forced to return to the market in order to raise additional capital; this gives management an incentive to perform well in order to maintain and improve the market value of the firm's securities.464 While the distribution of free cash flows signals to investors that managers will act in their best interest, it can be more costly than financing operations with internally generated funds.465 Nonetheless, the avoidance of double taxation of trust distributions reduced the cost of this "signaling device" for trusts in the past while the double taxation of distributed corporate profits imposes a further cost that may have deterred corporate managers from doing the same.466 In any event, while the costs of securing new financing by issuing trust units may have been somewhat offset by the savings of agency costs by disciplining management, it is not clear whether the investor's peace of mind from the distribution of earnings was sufficient for them to invest in income trusts.467 This is evident by the lack of trust conversions and increased trust buy-out activity since the Plan was announced. Corporate level tax and the double taxation that ensues may have rendered the excess costs of returning to the market in order to raise capital prohibitive, despite any savings from agency costs. The Plan has therefore restricted energy trusts' ability to raise the capital it needs to operate in the inherently risky oil and gas sector. Alarie, supra note 76 at 8. 464 Mark Gillen, "A Comparison of Business Income Trust Governance and Corporate Governance: Is There a Need for Legislation or Further Regulation?" (2006) 51 McGill L.J. 327-383 at 1125 [Gillen]. 465 Ibid. 466 Ibid. 467 Zetzsche, supra note 448 at 62. 76 V. CONCLUSION There was a loss of over $20 billion in market value of income trusts the day after the Plan was announced and this amount has increased to over $35 billion over the course of a year.468 Thus the tax efficiency of investing in income trusts prior to the Plan's announcement was undeniably an important consideration to investors. While the Plan was introduced to ensure income trusts pay their "fair share" of taxes,469 the fall out from the Plan is far greater than had been expected. It has implications for pensioners and foreign investors who invested in trusts on faith of the federal government's promise not to tax them; it has implications for Canada's international obligations as the Canadian government may be in violation of certain NAFTA provisions; it has implications for foreign investment in Canada; and it has implications for the oil and gas industry in Canada. Furthermore, the Plan has set off accelerated trust buy-out activity (40 in one year) and has reduced the liquidity of existing income trusts which has hurt their ability to make capital acquisitions.471 The oil and gas sector in Canada faces many risks such as a dependence on commodity prices, costly explorations that could lead nowhere, depleting reserves, and the constant shadow (for the industry at least) of an uncertain energy policy and a national carbon tax. It is also a very capital intensive sector and it is essential to its survival that it is able to raise new capital for its exploration and production operations. Some companies therefore had turned to the energy trust structure as a means of coping and have found them to be the ideal business structure. This is particularly true for 468 Francis, supra note 123. 4K* Department of Finance, News Release, Canada's New Government, supra note 108. 470 Deloitte, Income Trusts, One Year Later, supra note 116. 471 Deloitte, Income Trusts, One Year Later, supra note 116. 77 smaller companies developing the mature reserves of the WCSB. In fact, the energy trust structure has given the whole oil and gas sector its biggest boost to capital formation.472 In addition, given the fact that Canada is currently one of the few industrialized countries benefiting from the record high oil prices, it is apparent that the country should exploit its reserves. Energy is an important component of the Canadian economy. In 2007, the energy industry accounted for 5.6 per cent of Canada's gross domestic product and 19.7 per cent ($90 billion) of the total value of Canadian exports. That same year, the energy industry's capital and repair expenditures totalled $68.9 billion and accounted for about 35 percent of total private sector investment. 7 The tax efficiency of energy trusts had been a considerable factor in their attractiveness to investors; particularly to foreign and tax exempt investors. However, because of the Plan, the tax advantages are gone and energy trusts will soon be taxed in the same manner as corporations, but without the flexibility of being able to retain earnings for reinvestment because retained earnings in a trust are taxed at the highest individual marginal rate. Thus business will likely move away from the income trust structure. While there had been expectations that the high-yield debt market would take off after the Plan and offer the same tax advantages as the trust structure, the Credit Crunch, and possibly the federal government's announcement that measures would be introduced to prevent attempts to structure businesses in a way to avoid the policy behind the Plan, it still has not. The federal government has stated that it and the provincial and territorial governments have policy responsibilities to help ensure the competitiveness of the Department of Finance, The 15% Solution, supra note 154. National Energy Board, An Energy Market Assessment (May 2008) at 3 [NEB]. 78 Canadian fiscal regime that applies to the resource sector. Thus while the whole Canadian tax system is based on the notions of fairness and equity, given the federal government's policy reasons underlying the tax incentives in the IT A (international competitiveness, job creation, etc.) for the oil and gas sector and given the fact that many of these policy objectives may be defeated by the Plan, a carve out for energy trusts from the new income trust tax appears to be warranted. Oil and gas producers were the groups for which trusts were first created; the first energy trust, Enerplus Resources fund, was established in 1986.475 The trust structure encouraged development of marginal and depleted wells and has proven to be a very effective model for doing so; consider that Enerplus Resources' initial public offering was worth $9 million and by 2007, it had an enterprise value of $7.6 billion. Just prior to the income trust tax announcement, the flow of capital into royalty trusts has been helping to preserve Canadian development of its natural resources, enabling efficient redevelopment of existing oil and gas fields, and contributing to increased productivity and longer reserve life. 7 Much of these benefits were achieved because royalty trusts buy up from major producers, properties that are no longer profitable for them. This sets off a chain reaction of favourable economic activity in the country. It keeps the revenues in Canada whereas in the past, because junior domestic oil and gas companies were unable to purchase these mature resource plays, foreign companies were purchasing them. When junior oil and gas companies purchase these mature reserves, it allows the majors to raise capital to fund new ventures such as oil sands work and puts the assets in the hands of a party who has a 474 Minister of Finance Improving the Income Taxation of the Resource Sector, supra note 28 at 10. 475 Enerplus (2007) online: It is a significant benefit of energy trust activity that these trusts had been purchasing many Canadian assets back from foreign companies which returns the management of these assets, as well as the revenues, back into Canada.477 In 2004 alone, Canadian trusts have purchased assets from U.S. companies such as Chevron/Texaco, Murphy Oil, Calpine Corp., Williams, Anadarko Petroleum Corp. and El Paso Energy. Canadian royalty trusts had also begun to acquire international production which has the effect of bringing more income into the Canadian tax system479 because Canadian residents are taxed on their worldwide income.480 The royalty trust structure allows these Canadian businesses to make competitive bids for these international assets.481 However, since the Plan, many trusts are suffering from illiquidity and are unable to continue making acquisitions. This has in turn reduced earnings and distributions which makes trust as investment vehicles less attractive to investors. Where a company's stock price is lowered, it becomes more vulnerable to a takeover attempt, and the Plan has acted to greatly lower the stock prices of energy trusts. It is predicted that the Plan will have significant consequences in terms of control of Canadian energy resources. While energy trusts had been able to compete on a global basis because they had a cost of capital advantage over corporations, they are 477 Canadian Association of Income Funds, "Presentation on Foreign Ownership Restrictions" (September 2004). 478 Ibid. 479 Department of Finance, The 15% Solution, supra note 154. 480 The ITA, supra note 26 at s. 2(1). 481 Department of Finance, The 15% Solution, supra note 154. 482 The Oil Drum, supra note 311. 483 The Oil Drum, supra note 311. 80 now vulnerable to foreign takeover.484 In fact, after the Plan was announced, 47 income trusts have collapsed485 and 70 per cent of the purchasers of Canadian income trusts were tax exempt pension/private equity funds or foreign buyers who pay little if any tax in Canada.486 It therefore appears that the Plan may not be in keeping with the federal government's stated obligation to ensure Canada's resource regime remains competitive. In addition, it cannot be denied that it was a Conservative election promise that income trusts would retain its status as a flow-through entity. Neither can it be denied that the Plan has had very significant effects on the oil and gas sector in particular. Among other things, the tax will deter the development of smaller resource plays, jeopardize supply in the declining Western Canadian Sedimentary Basin and alienate foreign investors. Furthermore, the Plan has hurt pensioners who rely on monthly distributions to boost their retirement incomes,488 which contravenes the federal government's own policy to • • 489 promote retirement savings. While energy trusts form only a part of the income trust sector, they interact with and are integral to the whole oil and gas industry in ensuring the mature, depleting reserves of the WCSB are produced. The Minister has pronounced that the government is committed to producing Canada's natural resources and that tax expenditures in the oil 484 The Oil Dram, supra note 311. 485 ygj^ Canadian Income Trusts, supra note 11. 486 Francis, supra note 123; see Appendix I: "Income Trust Buyouts After Income Trust Tax Announcement" for a complete list of income trust buyouts after the Plan was announced. 487 Gottlieb, supra note 169. 488 Stewart, supra note 16 at 3. 489 Mintz & Richardson, supra note 151. 81 and gas industry are essential to meeting that end.490 For the foregoing, allowing energy trusts to retain the tax advantages of the income trust structure appears to be justified and this would help to ensure that Canada is able to maintain its status as a net energy exporter and contribute to a stronger Canadian economy. Office of the Auditor General of Canada, "Petition No. 158 - Subsidies to the oil and gas industry and federal efforts to address climate change" (31 May 2006) online: Income Trust Buyouts After Income Trust Tax Announcement1 1. $2.28 billion -- Sunrise Senior Living REIT (SZR.UN) by U.S REIT Ventas, Inc. (VTR, NYSE), annual distribution 61.2 million. 2. $173 million — Halterm Income Fund (HAL.UN) by private equity firm Macquarie Infrastructure Partners, annual distribution $7.8 million. 3. $786 million -- Great Lakes Carbon Income Fund (GLC.UN) by U.S. private company Oxbow Carbon & Minerals Holdings Inc., annual distribution $65.3 million. 4. $87 million ~ Norcast Income Fund (NCF.UN) by private UK Pala Investment Holdings Ltd., annual $8.7 million. 5. $210 million -- Lakeport Brewing Income Fund (TFR.UN) by Belgium's Labatt Brewing Company Ltd., annual $11.3 million. 6. $880 million ~ Calpine Power Income Fund (CF.UN) by U.S. vulture fund Harbinger Capital Partners, $60.6 million a year. 7. $177 million ~ Entertainment One Income Fund (EOF.UN) by UK private equity Marwyn, $9.2 million a year. 8. $131 million - Amtelecom Income Fund AMT.UN by U.S. private equity Bragg Communications Inc., $8.8 million a year. 9. $1 billion -- Alexis Nihon REIT AN.UN by N.S. Homburg Invest Inc., no distribution annually. 10. $419 million — Clean Power Income Fund CLE.UN by private Australian Macquarie Power Income Fund (MPT.UN), zero. 11. $51 million - Associated Brands Income Fund ABF.UN by private equity TorQuest Partners, zero. 12. $826 million -- KCP Income Fund KCP.UN by NYC Caxton-Iseman Capital Inc., $51.8 million. 13. $886 million - Gateway Casino Income Fund GCI.UN by two Australian privates, zero and pending as of Dec. 07. 1 Diane Francis, "Income trust takeovers and values of tax losses" Financial Post (8 December 2007) online: Financial Post a 14. $222 million — Liquor Barn Income Fund LBN.UN by Canadian Liquor Stores Income Fund (LIQ.UN), zero. 15. $164 million - VOXCOM Income Fund VOX.UN by UE Waterheater Income Fund (UWH.UN), zero. 16. $1.74 billion - UE Waterheater Income Fund UWH.UN by NY Alinda Capital Partners LLC , $47.5 million. 17. $419 million -- Thunder Energy Trust THY.UN by Canadian PSPIB/Overlord Financial, zero. 18. $222 million — Custom Direct Income Fund CDI.UN by U.S. private equity EdgeStone Capital Partners, $26.5 million. 19. $254 million -- Canada Cartage TRK.UN by U.S. private equity Nautic Partners, $18.5 million. 20. $120 million — Stephenson's Rental Services Income Fund RNT.UN by U.S. private equity EdgeStone Capital, $10.1 million. 21. $686 million -- private - CanWest MediaWorks Income Fund CWM.UN by CanWest MediaWorks LP, zero. 22. $107 million ~ Arriscraft International Income Fund AIN.UN by U.S. General Shale Brick Inc., $4 million. 23. $1.08 billion — Versacold Income Fund ICE.UN by Iceland's Eimskip Holdings Inc., $42.9 million. 24. $584 million - Osprey Media Income Fund OSP.UN by Quebecor Media, $39.8 million. 25. $207 million — Countryside Power Income Fund COU.UN by Canadian Fort Chicago Energy Partners LP (FCE.UN), $21.6 million. 26. $291 million - E.D. Smith Income Fund JAM.UN by U.S. TreeHouse Foods Inc., zero. 27. $239 million — Movie Distribution Income Fund FLM.UN by US. EdgeStone Capital, $45.8 million. 28. $3.5 billion - CCS Income Trust CCR.UN by Goldman Sachs Capital, $102.9 million. b 29. $455 million - Sound Energy Trust SND.UN by Canadian Advantage Energy Trust (AVN.UN), zero. 30. $2.47 billion -- Legacy REIT LGY.UN by Canadians, InnVest REIT, Caisse de depot, $60 million. 31. $1,265 billion -- CHIP REIT by Vancouver private, $44.4 million. 32. $237 million -- Golf Town Income Fund GLF.UN by OMERS Capital Partners, $13.1 million. 33. $1,474 billion — IPC US Real Estate Investment Trust pending with Harvard University private equity, zero. 34. $80 million ~ Spinrite Income Fund SNF.UN by U.S. private equity Sentinel Capital Partners, zero. 35. $183 million — Gienow Windows & Doors Income Fund GIF.UN by H.I.G. Capital, LLC, zero. 36. $205 million — Oceanex Income Fund OAX.UN by private equity South Coast Partners LP, zero. 37. $5 billion - PrimeWest Energy Trust / SHN.UN PWI.UN by Abu Dhabi National Energy Company, $440.5 million. 38. $380 million - Vault Energy Trust VNG.UN by Penn West Energy Trust (PWT.UN), zero. TOTAL: $29.54 billion and $1.2 billion annual distributions as of Dec. 10, 2007. c APPENDIX II Income Trust Equity Financings2 Nov-06 to Oct-07 Nov-05 to Oet-06 Change Change% $millions# $millions# $mtllions# $millions business Trusts 29 1,888.6 51 5.188.7 (22) (3,300.1) 4~% -64% Energy Trusts 33 4,900.4 41 5.321.8 (8) (421.4) 2~% -8% REITs 44 3,769.8 36 2,488.2 8 1,281.6 22% 52% ower & 2 165.0 6 562.1 (4) (397.1) -71% ipelines 6?% 108 10,723.8 134 13,560.8 (26) (2,837.0) 19"% -21% xcl. REITs 64 6,954.0 98 11,072.6 (34) (4,118.6) 35% -37% 2 Deloitte. "Income Trusts: One Year Later" (October 2007), online: d BIBLIOGRAPHY Legislation/Policies/Treaties Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital, Canada and United States of America, 26 September 1980. Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1. Kyoto Protocol to the United Nations Framework Convention on Climate Change, 4 June 1992. National Policy 41-201, Income Trusts and Other Indirect Offerings (2004). North American Free Trade Agreement Between the Government of Canada, the Government of Mexico and the Government of the United States, 17 December 1992, Can. T.S. 1994 No. 2, 32 I.L.M. 289 (entered into force 1 January 1994) Department of Finance Canada. Protocol Amending the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital Done at Washington on 26 September 1980, as Amended by the Protocols Done on 14 June 1983, 28 March 1984, 17 March 1995 and 29 July 1997 (21 September 2007, Ottawa: Department of Finance). Government Documents Alberta Energy. "Our Business" (2008) online: Government of Alberta Alberta Finance. Alberta Advantage: Budget 2008 (Alberta: Alberta Finance, 22 April 2008). Bank of Canada. Income Trusts - Understanding the Issues by Michael R. King (Ottawa: Financial Markets Department, 2003). Canada, Standing Committee on Finance, 39th Parliament, 1st Session (30 January 2007) online: The Canadian Chamber of Commerce. "Canada's Clean Air Act Summary" (19 October 2006). Canadian Chamber of Commerce. "Submission to the Department of Finance Canada Re: Tax and Other Issues Related to Flow-Through Entities (Income Trusts and Limited Partnerships)" (November 2005). e Department of Finance Canada. Consultation Paper, "Tax and Other Issues Related to Flow-Through Entities (Income Trusts and Limited Partnerships)" (September 2005). Department of Finance Canada. "Improving the Income Taxation of the Resource Sector in Canada" (March 2003, updated 29 April 2008). Department of Finance Canada. News Release "Canada's New Government Announces Tax Fairness Plan" (31 October 2006) online: Department of Finance Canada. New Release/Communique, "Statement by the Honourable Jim Flaherty, Minister of Finance" (31 October 2006) online: Department of Finance Canada. "The 15% Solution" (23 November 2005) online: Europa, European Commission, Environment, The Kyoto Protocol (Brussels, Belgium: The European Commission) online: The European Commission Fair Tax Commission (Ontario), Fair Taxation in a Changing World (1993), 44-68. Foreign Affairs and International Trade Canada, News Release: NAFTA Tribunal Awards Damages in S.D. Myers Case (Ottawa: Foreign Affairs and International Trade Canada, 21 October 2002) online: Foreign Affairs and International Trade Canada Foreign Affairs and International Trade, Canada, Office of the Chief Economist. "Canada's Energy Trade from a Global Perspective" (2002) online: Foreign Affairs and International Trade Canada, The Importance of Investment and Investment Rules to Canada (Ottawa: Minister for International Trade, 2001), online: Minister of International Trade Government of Alberta, Department of Energy. "Royalty Information Briefing #1: What are Royalties" (2007) online: Industry Canada, Working Paper Number 24: Canadian Government Policies Toward Inward Foreign Investment by Steven Globerman & Daniel Shapiro, (Ottawa: Strategic Investment Analysis 1998). f International Energy Agency, online: IEA Liberal Party of Canada, The Green Shift (2008), online: The Green Shift M.N.R. Interpretation Bulletin IT-533, "Interest Deductibility and Related Issues" (31 October 2003). National Energy Board, An Energy Market Assessment (May 2008). National Energy Board, Canada. "Canada's Energy Future: Supply and Demand Scenarios to 2025" (23 October 2003). Office of the Auditor General of Canada. "Petition No. 158 - Subsidies to the oil and gas industry and federal efforts to address climate change" (31 May 2006) online: Office of the Prime Minister. "PM Announces Canada's Clean Air Acf (10 October 2006), online: Stephen Harper Ontario Ministry of Finance. "Proposed Enhancement to Dividend Tax Credit" (3 August 2006) online: Parliament of Canada. 39th Parliament - 1st Session (3 April 2006 - 14 September 2007) online: LEGISinfo Statistics Canada. "Labour Force Survey" (5 January 2007) online: UNEP and IEA "Reforming Energy Subsidies", (2002) Oxford, UK, United Nations Environment Programme - Division of Technology, Industry and Economics, International Energy Agency, First Edition. U.S. Department of State, "NAFTA Investor-State Arbitrations", online:USA.gov World Bank Industry and Energy Department, An Evaluation of World Bank Funded Petroleum Exploration Promotion Programs, Energy Series Paper No. 59 (1992). World Trade Organization. "Statistics: International Trade Statistics" (2006) online: WTO g Case Law/Pending Litigation Canada (Attorney General) v. S.D. Myers Inc. (F.C.), [2004] 3 F.C.R. 368. Gottlieb Investors Group v. The Government of Canada. S.D. Myers v. Government of Canada (13 November 2000) NAFTA Tribunal. Journal Articles Alarie, Benjamin & Iacobucci, Edward. "Tax Policy, Capital Structure and Income Trusts" (2007) 45 Can. Bus. L. J. 1. Avi-Yonah, Reuven, Edgar, Tim & Shaheen, Fadi. "Stapled Securities - "The Next Big Thing" for Income Trusts? Useful Lessons from the U.S. Experience with Stapled Shares" (2007) 55(2) Can. Tax J. 247-88. Boadway, Robin, & Bruce, Neil. "Problems with Integrating Corporate and Personal Taxes in an Open Economy" (1992) vol. 48, no. 1 Journal of Public Economics 39-66. Brooks, Neil. "Flattening the Claims of the Flat Taxers" (1998) 21 Dalhousie L.J. 287. Brooks, Kim. "Learning to Live with an Imperfect Tax: A Defence of the Corporate Tax" (2003) 36 U.B.C. L. Rev. 621-672. Condon, Bradley. "Proceedings of the Canada-United States Law Institute Conference: NAFTA Revisited: NAFTA at Three-and-One-Half Years: Where Do We Stand and Where Should We be Headed? A Cross-Cultural Analysis of North American Legal Integration" (1997) 23 Can.-U.S. L. J. 347. Curran, Trudy & Maguire, Pat. "Navigating the Quagmire of Oil and Gas Transactions with Income Trusts" (2006) 44 Alta. L. Rev. 163-193. Dai, Zhonglan, Maydew, Edward, Shakelford, Douglas A. & Zhang, Harold H. "Capital Gains Taxes and Asset Prices: Capitalization or Lock-In?" (2006) Social Science Research Network Electronic Paper Collection online: SSRN Duff, David G. "Tax Policy and Global Warming" (2003) 51(6) Can. Tax J. 2063-2118. Duek, Ron. "Generating a Green Tax Policy for Renewable Electricity in Canada" (2007) 12 Appeal 90-111. Gillen, Mark. "A Comparison of Business Income Trust Governance and Corporate h Governance: Is There a Need for Legislation or Further Regulation?" (2006) 51 McGill LJ. 327-383. Kastner, Paul. "Tax Credit Aspects: Tax Climate for R & D: A Canadian Perspective (1995)21Can.-U.S.LJ.289. Klassen, Kenneth. "Valuation of Income Trusts: An Exploration of Clienteles and Implicit Taxes" (2006) School of Accountancy, University of Waterloo. Hayward, Paul D. "Income Trusts" A "Tax-Efficient" Product or the Product of Tax Inefficiency?" (2002) 50, No. 5 Can. Tax J. 1529-1569. Luz, Mark A. & Miller, Marc. "Globalization and Canadian Federalism: Implications of the NAFTA's Investment Rules" (2002) 47 McGill L.J. 951-997 McKenzie, Kenneth J. "Income Taxes, Integration, and Income Trusts" (2006) 54, N° 3 Can. Tax J. 633. Mintz, Jack M. "Policy Forum: Income Trust Conversions - Estimated Federal and Provincial Revenue Effects," (2006) 54, N° 3 Can. Tax J 687. Mintz, Jack M. & Richardson, Stephen R. "Income Trusts and Integration of Business and Investor Taxes: A Policy Analysis and Proposal" (2006) 54(2) Can. Tax J. 359. Mitchell, Daniel J. "The Moral Case for Tax Havens" (Paper presented at the colloquium, "Perspectives on International Tax competition" by the Liberal Institute of the Friedrich-Naumann-Stiftung, Potsdam 3, December 2005), The Liberal Institute of the Friedrich Naumann Foundation. Onorato, William T. & Park, J. Jay. "World Petroleum Legislation: Frameworks that Foster Oil and Gas Development" (2001) 39 Alta. L. Rev. 70-126 at f 1 [Onorato]. Phillips, Lisa C. "The Rise of Balanced Budget Laws in Canada: Legislating Fiscal Responsibility" (1996) 34 Osgoode Hall L.J. 681-740. Richardson, Benjamin J. "Financing Environmental Change: A New Role for Canadian Environmental Law" (2003) 49 McGill L.J. 145. Riedy, Christopher. "Subsidies that Encourage Fossil Fuel Use in Australia" (Extended version of a working paper presented to the Australia New Zealand Society for Ecological Economics (ANZSEE) 2002 Conference on Ecologically Sustainable Development, January, 2003). Smith, Mark R. "Basic Derivatives for the Oil and Gas Company" (2001) 39 Alta. L. Rev. 152-179 i Weisbach, David. "Line Drawing Doctrine, and Efficiency in Tax Law" (1999) 84 Cornell L. Rev. 1627 Wolfman, Bernard. Book Review of Tax Expenditures by Stanley S. Surrey & Paul R. McDaniel, (1985) 99 Harv. L. Rev. 491. Young, Claire F.L. "Child Care - A Taxing Issue?" (1994) 39 McGill L.J. 539. Young, Claire F.L. "(In)visible Inequalities: Women, Tax and Poverty (1995) 27 Ottawa L. Rev 99, Zee, Howell H., Stotsky, Janet G. & Ley, Eduardo. "Tax Incentives for Business Investment: A Primer for Policy Makers in Developing Countries" (2002) 30 World Development No. 9 1497-1516. Zetzsche, Dirk. "The Need for Regulating Income Trusts: A Bubble Theory" (2005) 63, No. 1 U.T Fac. L. Rev. 45. Books Broadway, Robert W. & Kitchen, Harry M. Canadian Tax Policy. 3rd ed. (Toronto: Canadian Tax Foundation, 1999). Hale, Geoffrey. The Politics of Taxation in Canada (Peterborough: Broadview Press, 2002) 17. Hogg, Peter W., Magee, Joanne E. & Li, Jinyan. Principles of Canadian Income Tax Law, 5th ed. (Toronto: Thomson Carswell). Krishna, Vern. The Fundamentals of Canadian Income Tax Law, 9 ed. (Toronto: Thomson Carswell, 2006). Industry Documents Acuity Investment Management. "Income Trust Benefits to the Canadian Economy" (2006), available online: Blake, Cassels & Graydon LLP, Business with Canada. "Canadian Minister of Finance Announces a Proposed New Regime for Income Trusts and Limited Partnerships' (1 November 2006) online: BMO Capital Markets. "Income Trusts: The Inconvenient Truth About Trusts, A Perspective on Ottawa's New Policy on Trusts" (4 December 2006). J Bold Generation Financial Inc., "Income Trusts" (2006) online: BGF Borden Ladner Gervais LLP, Tax Law Group. Tax Law Bulletin, "Income Trust Proposals - All Trick, No Treat" (9 November 2006). Canadian Association of Income Funds, "Draft Budget 2004 Legislation Submission" (15 October 2004) Canadian Association of Income Trust Investors, "Concerns with the "Tax Fairness Plan"" (5 January 2007). Canadian Association of Petroleum Producers. "Alberta's Oil and Gas Royalties" (2006). Canadian Association of Petroleum Producers. "Policy Direction for Canada's Oil and Gas Industry" (December 2003). Canadian Association of Income Funds, "Presentation on Foreign Ownership Restrictions" (September 2004). Canadian Institute of Chartered Accountants, "Industries Hardest Hit by High Canadian Dollar Differ on How to Stay Competitive" (31 January 2008) online: CICA Coalition of Canadian Energy Trusts. "Canadian Energy Trusts: An Integral Component of the Canadian Oil and Gas Industry" (December 2006). Cook, Diane L.M. "Tax Fairness Plan" Oil and Gas Network (February 2008). Deloitte. "Income Trust Buyouts: Lots of Activity, Little Tax Revenue" (December 2007), online: Deloitte. "Income Trusts: One Year Later" (October 2007), online: Deloitte Canada, "Impact of Changes to Trust Taxation" (December 2006) online: Ernst & Young. "Strategic Business Risk: Oil and Gas" (2008). Fortin, Yves L. "Taxation of Income Trusts: Is it Worth the Cost and the Turmoil?" (November 2006) available online: k Friedman Michael & Miller, Todd. "Income Trusts Cope with Upheaval" (February 20007) internationaltaxreview.com. Goodman's LLP. "Canada: Department of Finance Releases Conversion Rules for Income Trusts" by Carrie Smit, Jon Northup & Mitchell Sherman (16 July 2008) online: Grant Thornton. "Government's Tax Fairness Plan changes the taxation of income trusts" (2006) online: Investopedia. "Cost of Capital" Forbes Media Company (2008), online: Forbes Media Company KPMG. "Current Developments: Income Trusts and Real Estate Investment Trusts" (November 2006) online: KPMG < http://www.kpmg.ca/en/services/audit/documents/itreitNov2006.pdf>. Oil and Gas Investor. Special Report "Canadian Investment Opportunities" (June 2004). The Oil Drum: Canada. "Income Trusts and the Canadian Energy Sector" (21 November 2006) online: The Pembina Institute, Sustainable Energy Solutions, "Carbon Taxes: Key Issues, Key Questions" (29 May 2008) David Suzuki Foundation. Petition from Mr. Charles Caccia, c/o Institute of the Environment, Friends of the Earth Canada, Pembina Institute for Appropriate Development and Sierra Legal Defence Fund to the Auditor General of Canada, "respecting federal tax and other subsidies to the oil and gas industry that undermine government spending and regulations aimed at complying with the Kyoto Protocol and fighting climate change", October 3, online: Sierra Legal PricewaterhouseCoopers. "Oil and Gas Taxation in Canada" (May 2004). RBC Capital Markets. Industry Comment, "Business and Royalty Trusts" (15 January 2007). Sharpe, Sydney. "A Century of Growth and Energy" (June 2005) Oil and Gas Investor. 1 Small Explorers and Producers Association of Canada. News Release (1 November 2006). Toal, Brian A. "Calgary Start-Ups" (June 2004) Oil and Gas Investor. Toronto Stock Exchange. "Income Trusts on Toronto Stock Exchange (TSX)" (2005). Newspaper Articles Associated Press, "G-8 raises alarm over rising oil prices" MSNBC (14 June 2008), online: MSNBC Barr, Alistair. "Corporate Defaults to Surge" The Wall Street Journal, Market Watch (11 September 2007), online: The Wall Street Journal Digital Network Barrons, "Whoa, Canada! Royalty Trusts Take Tax Hit" (3 November 2006) online: MarketWatch from DowJones Brandus, Paul. "Oil's Vicious Circle" Forbes.com (28 May 2008), online: Forbes.com Buckstein, Jeff. "Exhausting topic: B.C. has carbon tax" 24(4) The Bottom Line (April 2008). The Canadian Press, "Economy remains robust, Bank of Canada Governor Carney says" The Canadian Press (18 July 2008) online: The Canadian Press The Canadian Press. "McGuinty wishes for help in the manufacturing sector" CTV.ca (17 February 2007), online: CTV.ca CBC News, "BCE drops plans for income trust conversion" CBC News (12 December 2006) online: cbc.ca CBC News "Dodge says income trust changes "level the playing field" (1 February 2007), online: cbc.ca m CBC News. "Flaherty imposes new tax on income trusts" CBC News (1 November 2006), online: cbc.ca CBC News, "From collapse to convictions: a timeline" CBC News (23 October 2006), online: CBC.ca CBC News. "Harper agrees to send Clean Air Act to committee" cbcnews.ca (1 November 2006), online: cbcnews.ca Chase, Steven. "Income trust tax long overdue, David Dodge says" The Globe and Mail (2 February 2007) online: CTV.ca News Staff. "Flaherty calls on Ontario to cut business taxes" CTV.ca (20 February 2008), online: CTV.ca CTV.ca News Staff. "Income trust investors suffer massive losses" CTV.ca (1 November 2006), online: CTV.ca CTV.ca News Staff, "Liberals, Tories trade shots over carbon tax" CTV.ca (9 June 2008) online: CTV.ca CTV.ca News Staff, "Ottawa won't show details of income trust figures" CTV.ca (24 January 2007), online: CTV.ca CTV News Staff. "Tory "fuelcast" ads target Liberal carbon tax" CTV.ca (8 June 2008) online: CTV.ca De Souza, De Souza. "Carbon tax gaining support across Canada: poll" Canwest (25 May 2008), online: canada.com n Foldvary, Fred E. The Progress Report, "Canada Commits Economic Suicide" (2007), online: Fowlie, Jonathan & Anderson, Fiona. "B.C. introduces carbon tax" The Vancouver Sun (19 February 2008) online: The Vancouver Sun Francis, Diane. "Harper, Carney, Flaherty income trust mistake: Deloitte" Financial Post (9 December 2007), online: Financial Post Francis, Diane. "Income trust takeovers and values of tax losses" Financial Post (8 December 2007), online: Financial Post Hasselbeck, Drew. "Energy Trusts demand Auditor General investigate 'tax leakage' claim" Financial Post (10 March 2008), online: Financial Post Hasselbeck, Drew. "A guide to the credit crunch" National Post (16 August 2007), online: National Post Jang, Brent. "A Matter of Trust" The Globe and Mail (26 June 2003), online: globeandmail.com Kirbyson, Geoff. "Balancing on "Risky" Revenue Source" (June 2008) 24 The Bottom Line No.7 Laghi, Brian. "Why now? It's about an election" The Globe and Mail (1 November 2006). McMurdy, Deirdre. "What soaring oil prices mean for Canada" Sympatico MSN Finance (19 April 2008), online: Sympatico MSN Finance o Moulton, Donalee. "Tax use of resources, says Mintz" 23(14) The Bottom Line (November 2007). MSNBC, "Oil and Energy" MSNBC (15 June 2008), MSNBC online: Ratner, Jonathan. "Consolidation expected to continue among energy trusts" Financial Post (28 January 2008), online: FP Trading Desk Rubin, Jeffrey. "Why feds clamped down on income trusts" The Globe and Mail (29 March 2004) B7. Schoen, John W. "Honestly, how come oil prices are jumping?" MSNBC (26 March 2008), online: MSNBC Schoen, John W. "Oil price spike has economic impact" MSNBC (22 May 2008), online: MSNBC Stewart, Sinclair, Erman, Boyd & DeCloet, Derek. "Faith Through Conversion" The Globe and Mail (14 October 2006). Street Authority, "Northern Beauties" (2005), online: Tarquinio, J. Alex. "Not and oil baron? You can still get oil royalties" The New York Times (17 October 2004), online: New York Times Turchansky, Ray. "Canadian Investors No Longer Insulated from Oil Price Pinch" The Vancouver Sun (18 July 2008) online: The Vancouver Sun Internet Sites Coalition of Canadian Energy Trusts (2006) online: Enerplus (2007) online: Lee, Ian. "Two Bad Reasons for the Tax on Income Trusts" (8 November 2006), University of Toronto, Faculty of Law, online: P Thomson. "Glossary of Finance Terms" online: TSX Group. "Listings: Canadian Income Trusts" (5 June 2008) online: Wikipedia. "Cost of Equity" (3 May 2008) online: Wikipedia Wikipedia. "Dutch Disease" (23 February 2008) online: Wikipedia Wikipedia, "Income Trust" (9 May 2008) online: Wikipedia Wikipedia, "Minority Governments in Canada" (29 May 2008) online: Wikipedia Wikipedia. "Western Canadian Sedimentary Basin" (3 February 2008) online: Wikipedia q