The federal finance department’s obsession with “tax leakage” is currently focusing on income trusts. As much as $300 million-$500 million in such losses, which Ottawa’s mandarins appear to define as anything they don’t confiscate from those who earn it, have been bandied about.

Defenders of income trusts have rallied around the point that the sums are small by federal revenue standards, or that a better solution would be to end double-taxation of corporate dividends (ably advanced by the C.D. Howe Institute’s Jack Mintz).

Both are good arguments. But all sides, especially Ottawa, may be missing a larger point: what if there aren’t any tax losses to begin with? I can’t speak for so-called “business trusts,” but I know a little about energy royalty trusts. And I think they probably generate far more in tax revenue than Ottawa is “losing.”

Years ago, I viewed energy royalty trusts as mostly a dumping ground for dead-end managers and broken-down producing assets with no future. But the sector has evolved, matured and improved. Today, 35 energy trusts provide about one-fifth of Canada’s oil and natural gas production — almost one million barrels of oil equivalent daily. They’ve demonstrated an eminently suited business model to revitalize and extend the productive lifespan of aging oil and natural gas fields.

Therein lies my point: under a traditional corporate business model, many of these assets would have no future. For exploration companies, whose market performance depends on growth, such fields’ high operating costs and lack of new exploration prospects make them a waste of capital and a diversion of scarce human talent. Over time, they just wouldn’t be worth operating. They’d be wound down, shut down and abandoned, leaving hundreds of millions of barrels of oil and natural gas equivalent in the ground — along with billions of dollars in lost value. Now that would cause “tax leakage.”

The energy trusts still want these assets. They’re drilling, developing, re-engineering, optimizing and otherwise eking every last barrel out of the old fields. One energy trust
CEO I know jokingly calls himself the “slum landlord of the Western Canada sedimentary basin.” He doesn’t run dirty, ill-managed plants; he’s just making the point that he’s taking assets nobody else wants and transforming them into something useful.
More like an orphanage than a ghetto tenement. His story illustrates the benefits of energy trusts: getting the most out of an aging supply basin, producing volumes that would otherwise generate no revenue, in an era of global supply scarcity.

As for the taxman, the energy trusts’ production generates major provincial royalties, portions of which find their way to Ottawa as equalization payments. The operated field facilities generate local property taxes. Head offices pay city taxes. Purchases to sustain operations trigger federal GST and provincial sales taxes in British Columbia and Saskatchewan. The trusts’ thousands of employees pay hundreds of millions in personal income taxes yearly. And the energy trusts’ cash distributions, estimated at $4 billion this year, are subject to income taxes, even if at a reduced rate or deferred in RRSPs. Sounds more like a tax gusher than leakage.

What ratio of the energy trusts’ current production might fall into this category of “produce at a reduced tax rate or shut it down and get nothing?” Half? A quarter? All of it? I don’t know. I know of no hard numbers available.

On the other hand, it seems I’ve thought about this issue more imaginatively than the federal Finance Department, a situation that is pretty scary in itself. To put my hypothesis to the test, I’ve asked the good folks at the Calgary branch of the Fraser Institute whether they’re interested in carrying out the necessary economic research. Stay tuned. IE

More of George Koch’s writing can be found at www.drjandmrk.com.