UPDATE 2-Canada gov't may tie income trust rules to budget

(Adds comments from Liberal finance critic)

OTTAWA, Feb 28 (Reuters) - Canada's upcoming budget is likely to include legislation to tax income trusts, Finance Minister Jim Flaherty said on Wednesday, forcing opponents of the tax to either support it or defeat the entire budget and trigger an election.

"Right now I'm inclined to put it in the budget bill just because I will have a budget implementation bill to introduce concomitantly with the budget, so that would probably be my first legislative opportunity," Flaherty told reporters.

Flaherty announced on Oct. 31 that existing income trusts, vehicles that have been used to avoid paying most corporate taxes, would be taxed in line with other corporations as of 2011. New trusts would pay corporate taxes immediately.

Including the measure in the March 19 budget instead of introducing a separate bill, as he had previously suggested, angered the Liberal Party, the chief opposition party, which called it an "undemocratic and calculating move."

"In a democracy, members of Parliament should have the right to vote on this legislation as a stand-alone piece of legislation," McCallum told reporters.

"Certainly we would be loathe to support a budget, however good it was, that contained this income trust policy," he said. "But I can't speak on our party's position as a whole before seeing that budget."

McCallum spoke after a parliamentary finance committee presented its report to Parliament, which backs a Liberal proposal to reduce the trust tax to 10 percent and make it refundable to Canadians, but not foreign investors.

McCallum said the idea would become part of the Liberal platform in the next election, which could be kicked off within weeks if the opposition defeats the budget.

The Bloc Quebecois, while supporting the trust tax, has pressed for compensation for investors who lost money after the tax announcement, and McCallum suggested they would support the Liberal position.

The left-leaning New Democratic Party, however, supports the new tax.

The trust sector lost an estimated C$25 billion ($21.4 billion) in market value following October's announcement.

On Dec. 21, Flaherty released draft legislation that would implement the new rules, and invited comment until the end of January. It is these rules that will most likely be included in the budget bill.

A spokesman said it would also include other measures announced on Oct 31 -- a reduction in the corporate income tax as of 2011, a provision to allow income splitting and therefore lower taxation for pensioners, and an increased credit for seniors.

($1=$1.17 Canadian)