Canada's Flaherty Backtracks on Plan to End Corporate Tax Break

Canadian Finance Minister Jim Flaherty, pressured by companies such as Alcan Inc., backtracked on plans to scrap a corporate tax break valued at as much as C$2 billion ($1.81 billion) a year.

Flaherty told the Globe and Mail newspaper in an interview yesterday he'll narrow the scope of a pledge made in his 2007 budget to end companies' ability to deduct interest on debt that they incur to finance operations abroad.

Only companies investing through ``tax havens'' or limited- liability business structures will lose the deduction, Flaherty said, according to a transcript of the interview provided separately by the finance department. ``Most'' foreign transactions, including Thomson Corp.'s efforts to acquire Reuters Group Plc, won't be affected, he said.

``Clearly, they've addressed some important improvements,'' said Mike Murphy, executive vice president for policy at the Canadian Chamber of Commerce. The group wrote to Flaherty last month saying the tax change would cost businesses about C$2 billion annually.

Businesses said losing the right to deduct interest expenses would make it more costly to expand overseas, at a time when corporate Canada is facing a barrage of takeovers by foreign competitors. The initial proposal, part of what Flaherty says is a strategy to make corporations pay their ``fair'' share of taxes, also sparked the second clash in six months between his minority Conservative Party government and key supporters.

Overshadowed

In October, the government announced plans to tax the nation's income trusts, causing the popular, high-yield investments' value to plummet.

``This Conservative government has to make sure it doesn't convey an image that it's not pro-business,'' said Nikita Nanos, a pollster with SES Research in Ottawa. ``It undermines part of the core franchise,'' he said. ``It's going to make people question, `What's going on?'''

Flaherty, 57, also told the Globe and Mail he will extend a planned two-year grace period to five years and appoint a panel that will look at international tax issues for Canadian businesses for future budgets. Details of the plan will be released Monday in a speech to the Toronto Board of Trade.

Boost Its Fortunes

The controversy overshadowed a budget designed to boost the Conservative Party's fortunes -- ahead of a possible election later this year -- through tax breaks for families and more funding for the French-speaking province of Quebec. The party's support hasn't moved much since Flaherty released his fiscal plan on March 19, with recent polls showing Prime Minister Stephen Harper's government still wouldn't win a majority of parliamentary seats.

Opposition parties' attacks on the measure got new life this week when Alcoa Inc. said it will make a $26.9 billion takeover bid for Montreal-based Alcan, Canada's 10th-largest public company and biggest metals producer. The offer came less than two weeks after Alcan Chief Executive Officer Dick Evans told the Globe and Mail newspaper that Flaherty's tax proposal would make the company easier for foreign rivals to acquire.

The main opposition Liberal Party introduced a motion on May 10 calling on the government to repeal the tax measure.

The last significant budget reversal by a Canadian finance minister came in 2004, when Ralph Goodale repealed a decision to limit investments by pension funds in investment trusts.

To contact the reporter on this story: Theophilos Argitis in Ottawa at
.

Japan's Notes Halt Two-Week Rally on Concern Rates to Increase

Japan's five-year notes fell this week
on speculation the central bank will increase interest rates again
this year to prevent excessive investment and asset bubbles.

Notes halted a two-week rally after Bank of Japan Governor
Toshihiko Fukui yesterday said borrowing costs are ``very low''
given the economy's strength. Next week, BOJ board members will
vote on rates at a two-day policy meeting and the government will
announce figures for first-quarter economic growth.

``Fukui's comments this week made it clear that the bank
hasn't weakened its determination to increase rates,'' said
Akitsugu Bandou, a senior strategist at Okasan Securities Co. in
Tokyo, one of the 25 primary dealers that are required to bid at
government auctions. ``Selling pressure is hitting the short-dated
debt hardest and people can't get bullish about bonds.''

Yields on five-year notes, which move inversely to prices,
rose 4 basis points this week, according to Japan Bond Trading Co.,
the nation's largest interdealer debt broker.

The yield on the 1.2 percent note due in March 2012 today
declined 2 basis points to 1.225 percent. It yesterday touched
1.25 percent, the highest since April 23. Ten-year bond yields
increased 2 basis points this week to 1.645 percent. A basis point
is 0.01 percentage point.

Central Banks

``If we neglect to implement needed rate adjustments, that
may accentuate risks to the economy that may not be so prominent
otherwise,'' Fukui said at meeting of business executives in Tokyo
yesterday. The BOJ raised its target for overnight lending rates
by a quarter percentage point to 0.5 percent in February.

The Bank of Japan bank may lift rates again between July and
September, Okasan's Bandou said.

Five-year notes yesterday fell for a fifth day, the longest
decline since December, on speculation a Federal Reserve decision
this week to keep borrowing costs at a six-year high will make it
easier for the Bank of Japan to raise rates.

The spread between 10-year government bonds in Japan and the
U.S. was 296 basis points, near the average for the past year. The
gap in yields is likely to stay near 300 basis points next week as
Japan's bonds track U.S. Treasuries, said Akio Kato, an investor
in Tokyo at Kokusai Asset Management Co., which runs the world's
second-largest bond mutual fund.

Japanese benchmark bond yields had a correlation of 0.88 with
U.S. 10-year note yields in the past year, according to Bloomberg
data. A value of 1 means the two moved in lock step.

Spread Narrows

Five-year notes fell at a faster pace than did longer debt as
traders priced in the probability that rates will rise this year,
said Akio Kato, an investor in Tokyo at Kokusai Asset Management
Co., which runs the world's second-largest bond mutual fund.

The spread between five- and 10-year debt narrowed to 41.8
basis points earlier today, the tightest gap since Dec. 27,
flattening the so-called yield curve.

An index of Merrill Lynch & Co. showed bonds maturing in 10
years or longer returned 0.33 percent in the past month, while
shorter tenors returned 0.04 percent.

Ten-year yields near 1.7 percent may attract buyers, said Jun
Fukashiro, a bond fund manager in Tokyo at Toyota Asset Management
Co., which holds the equivalent of $10 billion in assets. The
yield hasn't risen above 1.7 percent since April 18.

A sale of 10-year debt on May 8 drew the highest demand since
February 2005 and a Ministry of Finance report yesterday showed
overseas investors purchased more Japanese bonds than they sold
for a third week.

Five-Year Auction

Traders may try to push up five-year yields before an auction
of the securities next week, according to Akihiko Inoue, a market
analyst in Tokyo at Mizuho Investors Securities Co.

The Ministry of Finance will sell 2 trillion yen ($16.6
billion) of the notes on May 15. Yields in pre-auction trading
yesterday suggested the ministry may set a 1.3 percent coupon, the
highest since January.

``Investors may demand higher yields before buying as the
economic figures in the coming weeks may show signs of a
recovery,'' said Inoue, whose company is one of the 25 primary
dealers that are required to bid at government auctions.

To contact the reporter on this story:
Issei Morita in Tokyo at .