Category: Economics

As readers of any of my sites know, I was a very big supporter of the Harper government’s decision in late 2007 to reduce the federal corporate income tax to 15% in 2012; it is currently 18% in 2010; and will be 16.5% in 2011. It was 21% from 2008 and 22.12% in 2007.

First, you had Tim Hortons moving its corporate headquarters back to Canada, where they will realize a substantial cost savings in taxes vs. their US operation.

Today, you have Biovail and Valeant merging together (note that long-time investors would know Valeant formerly as ICN Pharmaceuticals), but the key paragraph is the following:

Following completion of the merger, the new Valeant will be headquartered in Mississauga, Ontario and will remain a Canadian domiciled corporation, listed on both the Toronto and New York Stock Exchanges. In addition, the combined company will retain Biovail’s existing principal operating subsidiary in Barbados, which will continue to own, manage, control and develop intellectual property for the combined company. The location of the combined company’s U.S. headquarters will be determined after the close of the transaction.

This is purely for tax reasons. In Valeant’s California headquarters, they are subject to corporate income taxes of approximately 40% – 35% federal and about 8% state (which is deductible from federal taxes).

In Ontario, the current tax rate is 18% federal and 14% provincial; the provincial component will be reduced to 12% on July 1, 2010, for a combined rate of 31% in 2010. In mid-2011 and mid-2012, Ontario’s provincial rate goes down half a percent, and in mid-2013 it goes down to 10%. So the company will face the following effective corporate tax rates:

Calendar year 2010: 31%
Calendar year 2011: 28.25%
Calendar year 2012: 26.25%
Calendar year 2013: 25.5%
Calendar year 2014 and beyond: 25.0%

Corporations moving to British Columbia currently face a 10.5% provincial corporate tax rate, which will be reduced to 10% in 2011.

For Valeant, they reported $217 million in pre-tax income in the past 12 months. A 15% tax cut on this amount amounts to a yearly savings of about $33 million or nearly 40 cents a share. Also, any synergy benefits in the merger would also realize a 75% after-tax savings, as opposed to 60% if they had remained in California.

It is this huge 15% tax advantage that will cause more businesses to escape the USA and get into Canada. The US is going to be forced to cut corporate tax rates, otherwise they will continue to see investment leak out of the country like a thin helium balloon. As long as Canada doesn’t reverse this decision (which the opposition Liberal party has attacked the Conservatives on this very issue of corporate tax cuts) we will continue to be the beneficiaries of what is a very sound corporate taxation policy.

Article on the Financial Times – “How to best avoid performance addiction” which you might have to type into Google and click through there in order to get the full article. It describes how performance is the only barometer that most (retail) investors allocate capital, so when fund managers get money, they usually are already in quite “hot” sectors due to the prior years’ outperformance. A quotation is the following:

Most asset managers exhibit “enabling behaviours” that reinforce investors’ performance addiction by selling investment products on the basis of past – particularly short-term – performance. Although we all repeat the mantra that “past performance does not guarantee future success”, we still pay too much attention to performance.

…

Imagine a world in which every adviser and asset manager had to discuss three categories of investments with their clients: out-of-favour strategies worthy of consideration; high-performing strategies that continue to have legs; and “hot” performers that have had their run, from which investors should scale back their investments. It certainly would lead to rather different discussions than what typically occurs today.

Unfortunately I disagree with the conclusion. In the investment world, risk-adjusted future performance is everything. Risk-adjusted past performance is the only measurement tool. Note I mentioned the phrase “risk-adjusted” – a fund could have achieved a 1-billion-percent increase of capital by winning a $5 bet on the Lotto MAX (into $50 million) which would be very good fund performance, but the risk taken to get that performance was ridiculously stupid.

Most retail investors know nothing about performing this risk calculation when glossing through various promotional literature of mutual funds.

From an individual perspective, you should absolutely crave inefficient capital allocation (e.g. what we are likely seeing in the Vancouver Real Estate market). It causes less capital to chase other assets (which presumably will exhibit relative undervaluation) which you can snap up for cheaper prices. From a macroeconomic perspective, however, it is very unhealthy for economies to have significant inefficiencies, so when the focus of the speculative boom busts, you usually have to content with economic fallout (e.g. late 19th century/early 20th century railroad companies, mid 20th century automakers, the internet stock bubble, 2008 US real estate market etc.).

The US held a 2-year treasury bond auction today and some $42 billion was awarded at a yield to maturity of 0.769%.

In Canada, the 2-year government note is trading at 1.69%.

I can’t think of a single rational reason why a retail investor (that has a lot less than $42 billion in the bank account) would want to purchase these types of securities when there are relatively risk-free alternatives (such as “near guarantee” GICs and corporate bonds of issuers that would only default in the event of an economic apocalypse).