The federal Department of Finance launched consultations today on income trusts.

Finance has released a consultation paper that seeks discussion and third-party input on a number of key questions concerning the popularity of so-called flow-through entities (such as business trusts) related to economic efficiency, the estimated impact of FTEs on federal tax revenues, and an international comparison.

The paper estimates that federal tax revenues in 2004 were $300 million lower than they would have been if FTEs were structured as corporations. Of this, business income trusts accounted for $120 million, energy trusts accounted for $55 million, REITs accounted for $80 million, and limited partnerships accounted for $45 million. The total value of conversions and IPOs in 2004 was $6.6 billion.

It adds that future growth of the FTE market will reduce future tax revenues. The paper estimates that in general, a 10% increase in the FTE market capitalization would reduce federal tax revenues by about $35 million per year.

And, increased holdings of FTEs by tax-exempt investors could have a significant impact on federal tax revenues in the future, it argues. “For example, a 10 percentage point increase in the proportion of FTEs held by tax-exempt investors would decrease federal tax revenues by $105 million per year,” it says.

The paper suggests policy approaches that derive from the discussion of issues in this paper could include: limiting the deduction of interest expenses by operating entities, taxing FTEs in a manner similar to corporations, or better integrating the personal and corporate income tax system to make the tax system more neutral between all forms of business organizations.

Today’s launch of consultations follows through on the announcement in Budget 2005 that the government would have open and transparent consultations with stakeholders on tax issues related to FTEs. Submissions are due by December 31.

During the consultation process, Finance will continue to monitor developments in the FTE market. Any future initiatives will be taken following these consultations and in full consideration of the costs and benefits related to FTEs.

Public input will also be sought at symposiums to be organized and hosted by the Canadian Tax Foundation. The symposiums are intended to help foster a better understanding and public discussion of the tax and economic policy issues relating to FTEs. It will provide further information on these symposiums as soon as detailed arrangements have been finalized.

Copies of the consultation paper can be found on the Department of Finance website at www.fin.gc.ca/activty/consult_e.html.