The NDP: why is Jack Layton selling out Canada's Resources?
The short answer is in exchange for support for his pet projects like lowering ATM fees. Do you think it's worth giving up Canada's oil and gas energy sector to save $1 at the bank machine? The NDP does. Without their support this misguided Conservative policy wouldn't be passed into law. Here's what the NDP doesn't get.
Income Trusts and Canada's Energy Sector: Past
Before Income Trusts came along, many of Canada's medium-sized oil and gas companies were being bought out by foreign corporations, mainly from the U.S. The growth of Canadian energy trusts didn't just end the tide of foreign takeovers, it actually reversed the trend. In the 5 years ending with 2005, trusts purchased over $8.9 billion of oil and gas properties from foreign-owned corporations. Pengrowth's recent acquisition of assets from ConocoPhillips will push this total close to $10 billion. This has been made possible by income trusts' competitive cost of capital and income trusts' ready access to capital markets: capital provided by Canadians, "made in Canada" capital.
Income Trusts and Canada's Energy Sector: Present
Canada's 31 oil and gas trusts currently produce 20% of Canada's oil and gas: more than 1 million barrels per day and its 10 infrastructure trusts handle approximately 80% of Canada's oil and gas transmission. In 2005, the oil and gas trust sector generated over 30% of the tax revenue collected from publicly traded Canadian entities in the oil and gas sector even though they reported 16% of its revenues. Tax leakage? In 2006 the energy trust sector will generate payments of an estimated $5.7 billion to governments in Canada including royalties, property and capital taxes, and the estimated $2.4 billion in personal taxes to be paid on distributions. In 2006, energy trusts reinvested approximately $7 billion of capital into Canada's Western Sedimentary Basin and operating and administrative expenditures are expected to total almost $6 billion annually.
Income Trusts and Canada's Energy Sector: Future
Flaherty's new tax regime is designed to shut down Income Trusts. His actions have left all 250 income trusts highly vulnerable to hostile foreign takeover. We are going back to the bad old days of foreign owership of our precious resources and vibrant businesses.
These takeovers have already begun and will turn into a feeding frenzy if Flaherty's trust-killing tax is passed into law. His announcement has created what is called an "event driven" buying opportunity. This is where an arbitrary event (Flaherty's tax policy announcement) artificially lowers the value of a publicly traded Income Trust to a level below its true worth. US private equity is flush with capital scouring the world looking for just such assets to buy. Flaherty has handed them a $200 billion bonanza. Canada's incredibly lax takeover rules and the 8% decline in the Canadian dollar since Halloween just makes the situation even easier and more lucrative for them.
Upon purchasing these vulnerable Income Trusts, foreign owners will simply convert them back into corporations. This provides foreign buyers with two advantages. 1) As corporations they will now be free of the arbitrary growth restrictions that Flaherty imposed on the trusts as the second leg of his misguided "central planning" trust crackdown. 2) These foreign investors will structure their investments in the form of debt in order to take full advantage of the corporate deductibility of interest. Interest payments will be made from pre-tax cash flows and will flow to foreign tax jurisdictions free of anyCanadian taxation. This is a strategy known as "income stripping".
The consequence of this inevitable outcome is that it will create tax leakage. That's right. The very policy that was supposed to stem (imaginary) tax leakage will actually cause tax leakage through a hollowing out of a growing and vibrant sector of the Canadian economy. Taken to the max, this strategy would result in a loss of the $1.2 billion in annual taxes paid by the 126 trusts referenced above. More than double that amount if you look at all 250 income trusts. Prior to becoming income trusts, most of these companies were private companies and were therefore protected from this opportunistic vulture takeover that has been induced by Flaherty. The combination of Flaherty and the fact that these businesses are now are public makes them highly vulnerable. Takeover will precipitate the $35 billion loss in savings well before Flaherty's 4 year phase in, which is nothing more than a mirage. Making 4 years into 10 years is simply another mirage as it will only marginally slow down the inevitable takeout of these trusts.
The preceding is an excerpt from the article ATMs or BTUs. Click here to download the full article.