(September 22, 2004) The federal government’s move to restrict non-resident ownership of income trusts is an unnecessary measure that will severely hamper Canadian trust access to equity capital, according to a group representing income funds.

According to a study commissioned by the Canadian Association of Income Funds (CAIF), the current rules laid out in the 2004 federal budget are already sufficient to minimize tax leakage associated with foreign ownership.

The finance department has attempted to create new rules, which would alter the definition of “taxable Canadian property” to include resource and timber based trusts, making them subject to foreign ownership restrictions. Structured as mutual fund trusts, these income funds were given until January 2007 to reduce their foreign ownership levels to below 50%.

The study, entitled Analysis of Proposed Budgetary Tax Changes Related to Non-Resident Taxation and the Definition of Taxable Canadian Property and written by HLB Decision Economics, determined that the actual tax-leakage caused by distributions made to foreigners totalled $83 million a year.

The report suggests the government recover this loss by increasing the current withholding tax on return of capital distributions, rather than reducing foreign access to ownership.

CAIF says it is vital to maintain the long history of foreign investment in the resource sector, since Canadian investors alone cannot fully fund such undertakings as the exploitation of Alberta’s Athabasca oil sands.

“The reality today is that Canadian capital markets can only absorb finite quantities of trust resource product and cannot supply the capital needed to fully exploit our reserves over the long term,” the report concludes. “The needed capital must therefore come from foreign investors.”

The report goes on to claim trusts are superior to corporate structures in terms of tax revenues generated.

“The calculations showed that two corporate structures were almost equivalent from a taxation perspective, prior to the [2004] budget, with income trusts generating slightly more taxes than the corporations from non-residents,” the report said. “Once the budget measures regarding the withholding tax on the return of capital were taken into effect, the income trust generated significantly higher taxes from non-residents.”