Federal Finance Minister Jim Flaherty has announced a new tax on income trust distributions in a bid to stem the growing number of companies that are converting to trusts.

In a hastily called news conference Tuesday afternoon, Flaherty said $70 billion of new trust conversions have been announced so far this year — something he said is hurting the economy.

Finance Minister Jim Flaherty announces a new 'tax fairness plan.'
(CBC)

He called trust conversion "a growing trend to corporate tax avoidance."

Flaherty told CBC News the government took into consideration the effect the announcement might have on the markets, but defended it as a measured response.

"Nothing changes for four years," he said. "They'll continue their distributions to their unitholders over the course of these four years."

He defended the surprise nature of the announcement.

"Well, the last government did nothing but muse about it and that was the problem," said Flaherty. "There's still an RCMP investigation of the Department of Finance in Ottawa about leaks arising from that."

Flaherty's announcement comes three weeks after BCE proposed the biggest trust conversion in Canadian history. It proposed to convert its Bell Canada subsidiary to a trust — a move that would save it $800 million in tax by 2008.

By some estimates, the federal and provincial governments stand to lose as much as $1 billion annually in tax revenue to trusts. There are now more than 250 income trusts in Canada.

Trust conversions are increasing in popularity because trusts do not pay corporate tax. Instead, they pay out most of their income in distributions to unitholders, who then pay tax on those distributions.

Flaherty said that situation could not be allowed to continue.

"This trend has caused me growing concern," he said. "It's not right and it's not fair." 

Trusts that begin trading as of Wednesday or later would face the new measures in 2007. Existing trusts would have a four-year transition period and would not face the new rules until 2011.

That means the Bell Canada trust conversion would not qualify for the four-year grace period because it has not begun trading as a trust.

One class of trusts — real estate investment trusts — will not be affected by the new rules.

Flaherty also said Ottawa will cut the corporate income tax rate by half a percentage point as of Jan. 1, 2011, to further "level the playing field" between income trusts and corporations.

The small change in the tax rate is unlikely to mollify many in the financial sector.

"The morning is going to be a fascinating place on Bay Street," said Finn Poschmann of the C.D. Howe Institute.

"Absolutely the market is going to open with a cloud over it," he added.

The President of the Canadian Association of Income Funds was quick to denounce the change Tuesday. 
 
"Finance Minister Jim Flaherty's announcement of a punitive tax against this important sector of the Canadian economy was done precipitously and without consultation with the industry," said George Kesteven in a statement. "The government's action will directly affect the savings of millions of Canadians who have benefited from investing in income trusts."
 
Income splitting for seniors

In another major announcement, Flaherty said that senior citizen couples would be able to split their retirement income as of the 2007 taxation year. Until now, income splitting was limited to Canada Pension Plan payments and spousal RRSPs.

He also increased the age credit amount by $1,000 to $5,066, effective this taxation year. That will benefit low- and moderate-income seniors.

"Approximately two-and-a-half million retired Canadians will benefit from this move, it's really huge for them," said Independent MP Garth Turner, a longtime advocate of income splitting. 

Many seniors have come to rely on income from income trusts. Flaherty said these new measures aimed at seniors would allow them to "retain more of their income in their retirement years."