New Form for Trust?From the Globe and Mail:
as Bay St. eyes Plan B
SINCLAIR STEWART AND ANDREW WILLIS
00:00 EST Wednesday, November 08, 2006
For the past week, lawyers, bankers and industry associations have been lobbying Ottawa for more clarity on -- and in some cases, relief from -- its unexpected crackdown on income trusts. But for a sense of where the sector could be heading, some trust watchers have begun to turn their focus westward, to Vancouver Island.
TimberWest Forest Corp., a logging juggernaut and the Island's biggest landlord, has done something remarkable for an income trust -- it has actually gained ground in the stock markets, albeit by a mere 1 per cent, since the Finance Minister issued his surprise Halloween announcement.
One reason it has managed to buck the trend of falling unit prices is that it isn't technically a trust. True, it acts like one, and is motivated by similar concerns: It pays unitholders a regular cash distribution and minimizes its corporate tax payments. Yet it does this through a hybrid structure -- one that trusts could look to adopt or modify.
A hybrid structure could get around the new rules, but has the potential to spark a long-running battle between Bay Street and Ottawa that could spill over into other areas of the stock market.
"TimberWest right now is not captured in the proposed legislation," said Hervé Carreau, an analyst at CIBC World Markets Inc. "It's a corporation, not a trust, but it has the same advantages -- it pays very little taxes."
The trick is in the structure. Trusts pay out most of their cash flow to unitholders in the form of monthly or quarterly distributions, like a dividend, so there is little to be taxed at the corporate level -- something Ottawa is planning to stop by taxing distributions.
TimberWest units, by contrast, include a piece of equity and a piece of debt "stapled" together. They trade as one security, but the company pays an interest payment on the debt to its unitholders each quarter. The interest payment is tax-deductible, minimizing the company's tax hit.
For trusts that are loath to return to a conventional corporate structure, this is an appealing alternative -- one that bankers and lawyers are working overtime on right now.
"I do think somebody will try it," said an income trust lawyer at one Toronto firm, who predicted Ottawa will grandfather TimberWest, but attempt to block other companies from following suit. Officials at TimberWest did not return calls.
However, providing an exemption to one company could cause an uproar among trusts, particularly in the oil patch, where energy trust executives have formed a coalition to lobby for an exemption.
The government has warned it will not tolerate companies attempting to do an end run around the intent of the new rules, but that will not likely stop the optimists on Bay Street from pushing the envelope with different structures -- a cash cow in terms of fees and potential advisory assignments.
These bankers acknowledge the government could thwart TimberWest copycats by simply denying preferential tax treatment on these "stapled" units. Their answer? Something called income participating securities, or IPSs, which have been used to help U.S. companies convert into quasi-income trusts and list their units in Canada.
"We will continue with our current structure. Nothing changed for us last week," said Gael Doar, head of communications at Centerplate Inc., a Toronto Stock Exchange-listed IPS based in South Carolina.
Centerplate is a catering company -- it serves up hot dogs and pretzels at many U.S. baseball and football stadiums -- and Ms. Doar said the company's lawyers are convinced that it is not affected by changes to Canadian tax law.
There are about a dozen companies like Centerplate, similar to TimberWest, but with one key difference: Theoretically, investors can separate the equity and debt portions of their unit and trade them individually, although practically this never happens (think paper clips, rather than staples). In this way, an IPS is comparable to a regular company whose equity and debt trade in the public markets. This makes it more difficult for Ottawa to scrap the structure without creating a ripple effect, say experts.
"To deny the deduction of that interest is arguably a broader basis of denial than preventing an [income trust] entity from operating on a tax-free basis," said James Morand, a tax lawyer with McCarthy Tétrault in Toronto.
Mr. Morand said IPS structures would be attractive to many firms, although he expects Bay Street will be cautious about pitching the idea until it gets more clarity from Ottawa. "I think at this stage people are still gathering information and trying to determine the intended scope of the Oct. 31 proposal."
Chris Rankin, a trust analyst at Canaccord Capital Corp., suggested in a research note it might make sense for income trusts to collapse their trust structure, and then distribute debt and equity directly to unitholders, much as TimberWest and these IPS structures have done. While he acknowledged the government's warning on avoidance, he suggested Ottawa might have a difficult time limiting investors to owning just debt or just equity.