By Goodwin Ginger

We just hate it when the Pencils make us down our pristine hard cover International Publishers edition of Das Kapital Volume One to sharpen a pencil of our own. It seems we sparked a bit of controversy with our BCE article in which we claimed that the conversion would cost the state $800 million a year in lost tax revenue or 8 billion over ten years. We were told that our estimate was way to high and that the tax implications would be significantly less. In our mind substantially less means at least 50 percent. But if that seems too steep, we would not know because our critics would not give us their estimate, we will set the threshold at 66 percent. Being fair minded we have decided to construct a more formal model using the Department of Finance’s simplified assumptions. So lets begin.

Scenario A: BCE stays as a publicly traded company.

In the 2005 annual report, BCE reports paying $893,000,000 in corporate income tax (CIT). It further reports a dividend payout of +\- $1,473,000,000 including common and preferred shares. Using the Department of Finance’s simplified model we can estimate how much tax was payed on the dividend. The basic model assumes that 39% of dividends flow to non-sheltered Canadian residents (taxable), 22% flows to non-Canadian residents, and the remaining 39% to non-taxable entities. Hence only 61% of dividends are taxed in any given fiscal year. Of that, the taxable resident portion is taxed at an effective rate of 22 percent and the non-resident amount is taxed at 15 percent. We can thus compute the total CIT and personal income tax payed on the dividend which equals $1,067,992,400.


BCE Dividend Payout $1,473,000,000
Category of Shareholder % of Dividend Tax rate Tax Paid
Resident Taxable 39 % = 574,470,000 @ 22% $126,383,400
Non-resident Taxable 22 % = 324,060,000 @ 15% $ 48,609,000
Non-Taxable 39 % = 574,470,000 @ 0 % $ 0
Total tax on Dividend payout     $ 174,992,400
Add BCE CIT     $ 893,000,000
Total CIT + IT on Dividend payout (2005)     $1,067,992,400


Scenario B: BCE converts into an income trust.

The basic structure of income trust works as follows: Stage 1. Company A acts as the trustee of Trust X into which company A transfers all cash after all operating expenses are paid out to Trust X. The tax advantage is that no CIT is levied on this transfer. As such the $893,000,000 million paid out in CIT by BCE is forgone by the government. Stage 2: the $893,000,000 that would have been taxed is added to the $1,473,000,000 which was previously paid out as dividends which sums to the princely total of $2,366,000,000. This sum is then distributed according to the same model as that used in Scenario A above with adjusted tax rates.


BCE Trust Cash distribution $2,366,000,000.
Category of Shareholder % Cash Distribution Tax rate Tax Paid
Resident Taxable 39 % = 922,740,000 @ 38% $350,641,200
Non-resident Taxable 22 % = 520,520,000 @ 15% $ 78,078,000
Non-Taxable 39 % = 922,740,000 @ 0 % $ 0
Total tax on Cash Distribution     $428,719,200
Add BCE CIT   @35% $ 0
Total Tax     $428,719,200



Results and Conclusion

So now we come to the claim that we have substantially underestimated the revenue loss to the state on the BCE conversion. To do this take the total from Scenario A $1,067,992,400 and subtract the total from Scenario B of $ 428,719,200 which equals $639,273,200 in forgone tax revenue. Our initial estimate of 800 million annually was, it is true slightly high, but not substantially high. According to our model it was $160,726,800 over. However once you price in revenue growth at BCE and compound interest over ten years our call of 8 billion in forgone revenue over the next decade was a low ball figure.

This should hardly be a surprise giventhat the Department of Finance’s model suggests that the conversion to trusts reduces the effective tax rate on corporate profits from 42.85% to 18.12%. And this speaks to the general thrust of our argument. The increase in revenue flowing to investors has been achieved via regulatory arbitrage; not one new product was brought to market, nor was productivity increased, nor was one job created to “create” this “value” for shareholders. And this gives the lie to all those supply side arguments that taxing capital is inefficient. What is inefficient is providing tax giveaways to shareholders of companies that produce nothing save a drag on the revenue of the state and a termination stub to unionized employees. We suppose we should thank our teachers for math. We will let the Pencils do the simple math to determine whether we or they met the substantial 66% cut-off.

Note: In both scenarios there was no consideration of future tax payments on retirement income. Hence, the deferred tax implications are another matter. What we are concerned about is forgone annual tax revenue.