Trusts blindsided by Ottawa

(September 20, 2005) If you haven’t jumped on the income trust bandwagon yet, it might be too late. Monday’s announcement by Ottawa that it is suspending advanced tax rulings on income trusts has sent an instant chill through the industry.

Effective immediately, the Canadian Revenue Agency will not offer advanced opinions on trust structures regardless of when those requests were made. It essentially leaves companies planning to convert with two difficult choices: either blindly stay the course and convert to a trust or abandon their plans altogether.

“We are puzzled by the government’s action,” said Canadian Association of Income Funds president George Kesteven in a release. The decision comes just 11 days after the government released a discussion paper on income trusts.

In an interview, Kesteven added he couldn’t understand why the government waited to make this announcement. If the government had timed this announcement with the consultation paper “It would have at least put some context around the consultation process,” he said. “I think at this point the government is trying to stem the tide of conversions, that is the only message we can read from this,” he added.

It’s quite possible. Trusts have become increasingly popular as they face a lower tax burden, reducing the take for the federal treasury. While companies converting to trusts have been generally smaller in nature, larger companies have show interest in the tax efficient structure in recent months, including Royal Bank, which said a few weeks ago that it may convert part of its business to an income trust.

According to an official with the Ministry of Finance, there is no fixed date as to when the government will resume issuing advanced tax rulings, which suggests the process will remain in limbo, even after the consultation process concludes at the end of the year. As stated in the original release, the government feels it would be inappropriate to issue advance tax rulings on these matters while these consultations are underway and “until the Government announces what action it may take.”

“Since September 8, there has been a lot of speculation as to what actions the government would take in relation to Flow though Entities,” the official added. “We have been closely monitoring — and continue to closely monitor — developments in the FTE market, and it was determined that it would be inappropriate for the government to issue advance tax rulings on these matters during the consultations process.”

The impact of the federal government’s decision will matter most to those companies that are considering creating a unique structure. If it is a standard vanilla type of conversion — as many of the oil royalty trusts are — Kesteven said he would expect some companies will proceed without a tax ruling since the CRA has already established a precedent for those companies to follow.

“It is really the discretion of the management and board of those companies who have to weigh the risk of not getting the advanced tax ruling against delaying of the conversion process,” he added. “Do we go today because it is the right environment to do so or do we wait to get the advanced tax ruling?”

Companies that opt to proceed without a tax ruling risk a dispute with the CRA down the road and could be forced to fight the issue out in an appeal.

The announcement had a predictable effect on the market, especially for companies that have either announced or expressed interest in converting to a trust, including Cinram, CI Fund Management, TSX Group and CanWest Global Communications. The shares of each of these companies were markedly lower, with the TSX and CI suffering the steepest drop. Both were down about 10% by midday.

“By suspending access to rulings in the absence of a policy position on income trusts, the government is creating confusion and disrupting the ability of companies to structure their affairs in the most efficient manner possible,” said CI president Bill Holland. “We are disturbed by the sudden and hurried nature of yesterday’s announcement. There was no discussion with CI before imposing this arbitrary decision that has such a material impact on CI’s shareholders.”

A flood of concerned investors, and a significant drop in the company’s share price, prompted CanWest Global to issue a release stating that CanWest MediaWorks, its wholly-owned subsidiary which is being converted into an income trust, is not affected by the announcement. CanWest’s share price dropped dramatically at the opening bell before rebounding slightly. Shares in the company were down about 5% by noon. The release added the proposed transaction “is not predicated on receiving an advance income tax ruling, nor has one been requested.”

Similarly, a spokesperson for Cinram said the company will proceed with its conversion, if it is in the best interest of shareholders. The government’s decision means Cinram won’t hear back on its application for an advanced tax ruling on the impact a conversion would have on its shareholders. But the company said that was not consequential since it does no relate to the viability of the type of structure the company may adopt.

The company’s calming words didn’t placate the market, as Cinram’s share price was down nearly 8% halfway through the trading session.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(09/20/05)