The federal government slapped a levy Tuesday on income trusts - which pay little or no corporate tax - to stem a growing revenue bleed and curb the growth of a vehicle it says threatens Canada's economy.
The surprise move breaks a major Conservative campaign promise to avoid taxing trusts.
Finance Minister Jim Flaherty said he had no choice because he feared that increasing numbers of corporations were preparing to convert to trusts - a trend he said threatened Ottawa's tax base.
"Quite frankly, things changed a great deal this year and we're faced with a situation where Canada was moving to an income trust economy," Mr. Flaherty said, noting that in 2006 alone, the market value of companies converting to trusts was approaching $70-billion.
"Left unchecked, such corporate decisions would result in billions of dollars in less revenue for the federal government to invest in the priorities of Canadians."
Federal officials said they were also concerned about the prospect of financial institutions such as banks - or portions of bank assets - converting to trusts.
Income trusts pay little or no corporate tax, instead shovelling out the bulk of earnings to investors, who are taxed individually. Critics said Ottawa and the provinces never recouped all the lost revenue and ended up losing hundreds of millions of dollars in revenue each year.
Mr. Flaherty announced that Ottawa will start taxing trusts in the same manner as corporations, effective immediately for new trusts and starting in the 2011 tax year for existing trusts.
He acknowledged this will force Telus and BCE to reconsider their plans to convert to trusts that would have ranked as the largest in Canadian history.
The measure is expected to roil markets today, driving down the unit prices of most trusts and hammering the shares of Telus and BCE.
Tax expert Jack Mintz, with the University of Toronto's Rotman School of Management, predicted that Ottawa's actions will spell the end of conversion plans for both companies.
"I would not expect the trust conversions to go ahead. That's for sure," he said.
The tax rate on trust distributions will start at 34 per cent - to mirror federal and provincial taxes on companies - and will drop to 31.5 per cent by 2011. Ottawa will remit to the provinces a 13-percentage-point share of the revenue.
This effectively ends any tax advantages for investors in trusts over corporations.
Finance watchers said they expect the measure to stop almost all corporate conversions to trusts - and may encourage some that have already converted to rethink the move.
"Perhaps over the next four years, some who have already converted may go back to a corporate structure," Toronto Dominion Bank chief economist Don Drummond said.
Mr. Flaherty said this will restrain a wave of conversions that he said threatens corporate productivity, because pressure on trusts to distribute all profits cramps Canadian productivity by eroding trusts' ability to reinvest and innovate.
The trust tax is certain to hammer the retirement savings of millions of Canadians who've come to rely on trusts for hefty returns, including many seniors, whom the Tories consider a key voting group.
The Conservatives tried to cushion the blow of the trust tax by unveiling more than $1-billion in annual tax breaks for seniors and enacting a half-percentage-point rate cut in the general corporate tax rate, to take place in 2011.
The corporate tax cut will "ensure there will not be more government revenue generated from the corporate sector," Mr. Flaherty said.
The senior-targeted tax relief, which goes into effect in 2007, takes two forms. Ottawa will allow senior couples to split their pension income and thereby reduce their income tax bill. It's also boosting a tax credit for low-and middle-income seniors called the Age Credit Amount by $1,000, to $5,066.
Concern over income trusts spiked in mid-October when Mr. Mintz estimated that Ottawa and the provinces stood to collectively lose $1.1-billion in annual revenue after Telus and BCE converted.
Yesterday, Mr. Flaherty said federal government losses alone were about $500-million annually and would have climbed to $800-million after Telus and BCE converted.
The Tories are tackling what the Liberals left unfinished last year. The Liberals considered everything from a trust tax to lightening the tax burden on corporations. They eventually decided to cut the effective rate of tax on corporate dividends. This reduced the tax advantages of trusts, but critics considered it a half measure.
Liberal finance critic John McCallum accused the Conservative Party yesterday of hurting Canadians' retirement savings by breaking their campaign pledge.
"I think Canadians who invested in income trusts secure in the belief that the government will keep its word will have a real shock," Mr. McCallum said. "There's absolutely no doubt there's going to be some big losers out there as a consequence of this broken promise."
The New Democrats, however, praised the Tories for closing the tax gap between income trusts and corporations.
With reports from Simon Tuck and Alex DobrotaReport Typo/Error