PricewaterhouseCoopers LLP released its report on intial public offering (IPO) activity in the Canadian stock market along with the prediction that IPO activity will shrink substantially in 2007. This is a big deal for the Toronto Stock Exchange, the seventh largest stock exchange in the world.  It promotes itself as the market of choice for new issues and was, in 2005 at the height of income trust new issues, proud to be the third strongest market for new equity issues. But Pricewaterhouse reports that the Conservative government tax on trust distributions and onerous taxes on new trust issues has put a stop to that strong position and potential for the TSX.

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The Coalition of Canadian Energy Trusts has created a comprehensive study of the role of the trusts in the oil and gas sector as well as the Canadian economy. The CCET Report includes a number of downloadable elements (pdf). Their findings suggest that there is significant public harm including addition of environmental risk if the Conservative tax policies are allowed to cripple an otherwise healthy economic sector. The Coalition has called for due process and for policy makers to make decisions on facts and information. The iTrust Institute recognizes this report as an informative contribution to Canadian’s understanding of income trusts and related policy issues:

BACKGROUND Canadian Energy Trusts: An Integral Component of the Canadian Oil and Gas Industry

CCET REPORT (incl. executive summary)

Appendix A1 - Statement by the Minister of Finance - Oct. 31

Appendix A2 - Coalition Backgrounder

Appendix B - Taxation of Income Trusts: Is it Worth the Cost and the Turmoil? by Yves L. Fortin - Nov. 2006

Appendix C - The Inconvenient Truth about Trusts, by Gordon Tait (BMO Capital Markets)

Appendix D - A Perspective on Trusts and Taxes, by Gordon Tait (BMO Capital Markets)

Appendix E - Market Cap Weekly, BMO Capital Markets - Nov. 9

Appendix F - CO2 Enhanced Recovery: Where to from here? (ARC Energy Trust) - Nov. 21

Appendix G1 - Income trusts are efficient at investing and growing, PriceWaterhouseCoopers LLP - Dec. 7

Appendix G2 - Income Trust Report, PriceWaterhouseCoopers LLP - Dec. 11

Appendix H - Taxation Process for Trust Income

Appendix I - Comparison of Income Trusts and Public Corporations - Taxability

The release of the Report was made with a news conference that can be heard online.

The CCET should be applauded by investors and policy administrators for both the report and their invitation for public scrutiny.  The Institute is further reviewing the CCET release in the context of prior reports and analysis. 

The Department of Finance announced rules for income trusts that allow existing entities to double in size by 2011 without giving up tax-free status. In addition, trusts will be able to convert back into a corporate structure without triggerin capital gains taxes or other tax consequences. There are limits, however, that will ensure taxes are most burdensome for the most profitable businesses.

The government continues with its rules, but now seems to be making efforts to reduce “impediments to conversion,” by trusts back into ordinary securities. Additional rules are described as being “designed to make it easier for these significant changes to happen in Canada and at the same time we get to the level playing field four years from now.”

The announcement of guidelines came on Friday following a federal-provincial meeting of finance ministers. Doubling in size now defines the upper limit of “normal growth” according to the government as it has previously announced new taxes and an interest in “restraining” income trusts.

Specifically, the notion of growth is related to market capitalization. New taxes will not be applied immediately, but will be applied to tax distributions as now planned, starting in 2011, if “growth” is less than either $50 million per year in market capitalization or no more than 40% in 2007 and 20% each year after that. Such growth in market value is considered cumulative so that growth later may be allowed if there is no growth now. However, the $50 million annual limit for small trusts will not be allowed to carry over from year to year.

Equity growth will not be considered growth if it involves replacing debt with equity as long as that debt either replaces debt outstanding as of Oct. 31 2006, or is issued subsequent to that date. On the other hand, if new debt is issued and then later converted into equity, the new equity value will be considered as part of the normal-growth limitations.

Any mergers or reorganizations of existing trusts will not be considered growth “to the extent that there is no net addition to equity.” This is a policy that would seemingly allow for mergers and acquisition activity in coming years, a trend that has become significant in the oil and gas sector.

To complicate matters and add a burden for policy administration, however, the Minister of Finance suggested that all pending trust deals will be allowed and measured against the rules.

But trusts will also have the right to ask for permission to grow more than the limits if managers see their company as having a special case. Managers will be seeking to explain transactions or situations to ensure their company is viewed as a special situation for purposes of meeting government guidelines.

The Department of Finance has just turned the trust market into an opportunity for “special interests” alone. All others will, in the normal course of business, be allowed to growth only within limits. This is despite the government statement that there is concern about lack of growth or productivity in the trust realm.

The net impact: Guidelines may be deemed unworkable by profitable and growing companies upon whom the burden of new tax is most likely before 2011 unless they spend additional money on debt refinancing or reorganization.

Advocis, the Canadian association for financial advisors and Certified Financial Planners has published an article Breach of Trust in FORUM Magazine for December 2006.

Written by Leslie Hayman as President of iTrust Institute, the article went to publication the week the first week of November, the week in which the Government of Canada announced new taxes on income trusts.

The article provides a fundamental perspective on the income trust market and the state in its development at the time the new tax was put in place, also exploring considerations of security and investment risks and returns for financial professionals working to advise clients in regard to trust investments.

Two new studies, one from BMO Nesbitt Burns and another from PriceWaterhouseCoopers have shown the inherent flaws and misinformation on which the Department of Finance has based its decision to tax trust distributions and to “say no” to the “Income Trust Economy”.

First BMO Nesbitt Burns issued a study: Trusts Provide Tax Gain for Government, written by Gordon Tait, an income trust analyst.  He said, “We looked at 126 businesses that converted from equities to trusts between 2001 and 2005 to prove that Ottawa reaped more, not less, tax revenue after firms converted to income trusts...We found that on average the government stood to collect 2.2 times more in taxes by taxing the distributions of the trust than had been paid by the corporations prior to their conversion.”

And then a few days later, we see a fresh report out from PriceWaterhouse.  Their findings were reported to suggest that, “A review of Canada’s more than 250 income trusts indicates that trusts have been making an important contribution to the economy, investing their capital and growing their businesses at impressive rates.”

Significant specific new conclusions included the idea that, among the 250 diverse trusts studied, there was the net income reinvestment rate with more than 200% in 2005 and almost 400% in 2004.

The author concluded that, “The data clearly refutes the notion that the income trust structure is best suited to mature, low-growth companies in stable industries.”