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The Vancity Savings Credit Union branch in Lynn Creek, North VancouverJOHN LEHMANN/The Globe and Mail

Credit unions across Canada are stunned by an unexpected change in the federal budget that will increase their taxes, and may ultimately imperil the ability of some of the smallest ones to operate.

The federal government has decided to eliminate a long-standing tax benefit for credit unions, introduced in 1972 to compensate for their inability to use the markets to raise capital by issuing shares, since they are owned by their members. That puts credit unions at a disadvantage compared to the country's banks, which regularly issue public shares for capital, they argue.

Many credit unions were stunned to learn Thursday that the tax credit – which amounted to about $47-million in 2012 – was being eliminated, without consultation with the industry, said Gary Rogers, vice-president of financial policy for Credit Union Central of Canada, an association that represents the sector.

"We are certainly surprised and disappointed. It's a very minor incentive that helps to recognize that credit unions are the small businesses of the financial sector," Mr. Rogers said in an interview.

The move will hurt smaller and mid-sized credit unions the most, including those that serve communities where there are no banks, he said. Mr. Rogers said the decision will tilt the playing field against credit unions at a time when the federal government said in the budget it also wants to increase competition by making it easier for new financial institutions to enter the banking sector. "We find great irony," in Ottawa's stated desire for more competition, Mr. Rogers said.

The tax benefit varies among credit unions, depending on their size and profitability. After a certain point – when a credit union accumulates taxable income that reaches more than 5 per cent of the value of its deposits and shares – the institution is no longer eligible. The measure was designed to help credit unions grow in a Canadian financial sector that is dominated by the major banks, since credit unions are sometimes more willing to lend locally than large financial institutions.

"Credit unions serve a different market, run higher costs partially as a result, and do not have access to capital other than retained earnings and preferred share instruments issued to members," said Peter Routledge, an analyst at National Bank Financial.

However, he added credit unions benefit from other government policies, including having access to mortgage insurance from Canada Housing and Mortgage Corp., something the banks also do, which takes substantial lending risk off the institutions.

"Credit unions benefit mightily from CMHC mortgage insurance so one could look at that as a federal government 'subsidy' that they now have to pay a little more for via the tax code," Mr. Routledge said.

But credit unions worry they will now be at a disadvantage to the banks, putting the future of some at risk. "By reversing this important and long-standing deduction for credit unions, the government will significantly diminish consumer choice for Canadians," said Bill Maurin, acting chief executive officer of Toronto-based Meridian Credit Union.

"Canada is well-served by its big banks. However, it's vital that Canadians have alternatives to the traditional banks, especially in small communities where local residents may not have access to any banking presence," Mr. Maurin said.

There are 25 communities in Ontario where the local credit union is the only financial institution in town. Meridian is the largest credit union in Ontario with just under 250,000 members and 61 branches. It is an example of the swift growth some credit unions have seen in recent years as they added more mortgages to their books and expanded their membership base. Meridian has $9.6-billion in assets, up from $3-billion seven years ago.

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