The CD Howe Institute has released an “e-alert” that suggests there is still tax-based incentives for companies to convert into income trusts.

Entititled “Unfinished Business: Achieving Neutral Taxation of Corporations and Income Trusts”, the document is available from the CD Howe web site.

According to the work by Jack M. Mintz, President and CEO of the C.D. Howe Institute and Deloitte & Touche LLP Professor of Taxation at the Joseph L. Rotman School of Management, “When the federal finance minister recently announced an increase in the dividend tax credit, he largely failed in his aim to create a level playing field between corporations and income trusts.”

Mintz does some thorough math and then argues that businesses can increase their value by more than a third by converting corporate assets into income trusts.

He goes on to suggest that a majority of investors “still prefer corporations to convert to income trusts because conversion produces tax efficiency, and a valuation premium.”

Research by the iTrust Institute would indicate that visitors to the TrustInvestor web site certainly maintain a preference for income trusts.  But there is nothing to indicate that the preference or valuation premium is derived from any clear sense of tax efficiency.

Rather, investors seem to value the frequent return of cash in the form of distributions. According to research by BMO Nesbitt Burns, that factor may be one significant reason that returns relative to risk on income trust equities are significantly better than similar measures of valuation for equities in general.

Furthermore, the cash distribution has value as an indicator of company health. The frequency of distribution amplifies the informative value of the distribution.  Investors familiar with “The Intelligent Investor” by investment guru Benjamin Graham, would understand the added value of distributions.

It is not surprising, therefore, that investors value trusts more highly than other equities, regardless of their awareness of tax efficiencies.  In effect, Mintz might simply argue that the tax rules generally allow companies avoid tax when they are structured as trusts and commit to paying net cash returns to investors. After all, tax rules are formulated to deal with large issues in a broad way, and so invoke gross generalizations. And Mr. Mintz is working in the same general realm.

There are a number of income trusts that converted their equity into trust units and found that they triggered tax payments in the process. And some that had never paid tax as a company, started to pay taxes after conversion into a trust structure. It’s an area for further research by the iTrust Institute.

The CD Howe Institute is focused on creating a “tax neutral” environment in Canada. With his new research report, Mr. Mintz recommends several policies for the minister of finance to implement to create a “truly level playing field for corporations and trusts”.

The Institute was formed by members of TrustInvestor.com to encourage awareness & new understanding of income trusts, other flow-through equities, their markets and potential for development. We foster thoughtful dialogue and an inclusive, honest & sustained exchange of useful insight & information. As important, we will monitor the income trust market along with its policy and regulatory environment and make informative representations on behalf of our members.