University of Toronto Law School Faculty Blog

Earl Lipson, et al. v. Her Majesty the Queen, et al.

The Supreme Court of Canada will hear an appeal tomorrow in a case called Lipson v. Canada.  The appeal may prove to be a significant test of the efficacy of the so-called "general anti-avoidance rule" (the "GAAR") in combatting what is perceived to be abusive tax avoidance.

The Lipsons engaged in a series of transactions over two days in 1994 in which they made use of various rules, including the spousal rollover rule (section 73), the spousal attribution rule (section 74.1), and the back-to-back loans rule (subsection 20(3)), to transform what would otherwise have been non-deductible mortgage interest under paragraph 20(1)(c) into, they argue, deductible interest under paragraph 20(1)(c). 

The Lipsons have lost previously at the Tax Court of Canada and at the Federal Court of Appeal.  It is not at all obvious, however, that the Lipsons will lose at the Supreme Court of Canada.

Collectivizing Rights; Privatizing Taxation: The Unarticulated Function of Copyright Collectives

The recent proposal from the Songwriters Association of Canada to fully legalize peer-to-peer file sharing of music by adding a $5 monthly charge to the cost of Internet access (and similar proposals floating south of the border) has brought renewed attention in the role of levies and tariffs collected by copyright collectives in Canada.  I am now beginning a research project that looks at the broader implications of the expansion of collective administration of copyrights and the use of levies and tariffs.  Since the topic is current, I thought I'd use the blog not only for sharing some of my initial thoughts, but hopefully, to solicit some ideas that will help me to shape them.  Therefore, I'm posting below the description of the project and the questions  it seeks to answer.  Comments on or off the blog will be highly appreciated.  Here it is:

Income Trusts and the Diversified Investor

This commentary was first published in the Financial Post on November 9, 2006.

With the surprise announcement last week by the Conservative government that distributions by income trusts would no longer be exempt from corporate-level taxation, investors in income trusts have suffered material losses to those investments.

Interestingly, investors with diversified portfolios of Canadian equities would have hardly noticed a difference in their wealth and are probably wondering what all the fuss is about.

While the TSX composite index suffered a substantial loss on the day immediately following the government's announcement, it has already made up most, if not all, of those losses. Since the announcement, then, the TSX Income Trust Index has underperformed the broader TSX Composite Index by approximately 10%. Even taking into account the current yield disparity in the two indexes (approximately 9% for the Income Trust Index and 2% for the TSX Composite Index), the TSX Composite Index still comes out ahead of the Income Trust Index by approximately 3%.

While investors in income trusts have been handsomely rewarded over the past few years, so have investors in the TSX Composite Index, who have been rewarded with double-digit returns over the last five years, without even taking into account dividends. The subsequent divergence in performance in the two sectors has revealed what should have been obvious from the beginning: that investors in the trust sector were taking on greater risk than investors in the broader securities market.

Part of the risk that investors were taking on by investing in the income trust sector was regulatory risk: the risk that Canada would cease preferential taxation of income trusts. Part of the risk was ordinary business risk: while older income trusts represented stable companies with stable and predictable cash flows, over the last eighteen months many income trusts were formed out of otherwise marginal businesses in order to take advantage of retail investors' focus on yield. This obsession with yield has now come home to hurt many retail Canadian investors who invested in income trusts on the assumption that they represented a "safe" source of income, especially in a low interest-rate environment in which it was difficult to earn more than 3% or 4% on fixed-income securities.

Far from being low-risk, income trusts were a riskier than the overall market for at least three reasons. The first was lack of diversification, since income-trusts represented only approximately 10% of the TSX Composite Index on a weighted basis. The second was regulatory risk. Regardless of official representations to the contrary, as more and more Canadian corporations adopted the income trust structure for tax reasons, the pressure to clamp down in order to preserve the integrity of the corporate tax system would have only increased. The third was ordinary business risk. As more and more issuers converted to the income trust structure for tax reasons, the relative quality of the issuers declined, increasing the risk in the sector.

More about income trusts

Two commonly invoked reasons for the new tax on income trust distributions are: (1) to ensure fairness (indeed, the government introduced the new tax as the centrepiece of a "Tax Fairness Plan"); and (2) to prevent impairment of the "competitiveness and productivity" of the Canadian economy that would result from greater recourse to the income trust structure by Canadian companies.

In this online opinion article, I take issue with these justifications for the new tax.

Income Trusts Changes

The Minister of Finance announced last week changes to the taxation of income trusts that will take effect in 2011 for existing income trusts.  The following op-ed appeared in the National Post this past weekend addressing the changes.

Cutting the GST

The Globe and Mail has a story by Steven Chase this morning on the federal government's plan to reduce the rate of the GST from 7% to 6% in the budget.  In the story, Chase claims that the staff of the Department of Finance is not supportive of the plan, primarily on the basis that the GST is, in several respects, a "better tax" than the income tax.  Let's examine the two main arguments countering the "let's cut the GST" idea.