A new Canadian tax plan may put the brakes on the growth of income trusts, and the proposal has already caused a re-sizing of energy trusts' market capitalizations by 15% or more.
Jim Flaherty, Canada's minister of finance, says, the measures "are necessary to restore balance and fairness to Canada's tax system, to ensure our economy continues to grow and prosper and to bring Canada in line with other jurisdictions...Our actions are clear, decisive and in the best interest of all Canadians."
Flaherty says many companies in Canada have announced their intentions to convert to income trusts as a "corporate tax avoidance" tactic. There were almost C$70 billion in new trust announcements this year alone, he adds.
According to Citigroup analyst Richard Roy, as of June, 237 income trusts were listed on the Toronto Stock Exchange. During the last two years, about 34 companies have converted to the trust structure.
Flaherty says, "...If left unchecked, these corporate decisions would result in billions of dollars in less revenue for the federal government to invest in the priorities of Canadians, including more personal income tax relief. These decisions would also mean less revenue for the provinces and territories."
The measures in the proposed Tax Fairness Plan include a tax on distributions from publicly traded income trusts and limited partnerships; a 0.5% reduction in the general corporate income tax rate as of January 1, 2011; and an increase in the age credit amount by C$1,000. The plan may provide more than C$1 billion of new tax revenues annually to the Canadian government, Flaherty says.
If adopted, the new tax law will apply to current trusts beginning in 2011. It would apply immediately to any trusts formed after the law is adopted.
The plan to cancel tax breaks on trust unit-holders' distributions will become law, says George Gosbee, chairman, president and chief executive of Calgary-based investment-banking firm Tristone Capital Inc., since Conservative party members are favoring the revision in tax code.
"The government has been losing too much tax revenues," Gosbee says, as more and more businesses have been converting to the trust model.
The news hurts energy trusts' valuations today, but it will be good for the Canadian E&P industry, which has been overwhelmed by the buying power of the trusts, he adds. U.S. producers have fled the country, while unable to compete with the trusts for expansionary assets.
"You will see a lot more non-Canadian companies returning to Canada...It makes sense that you should buy in Canada now."
The law change is designed to run off pension-fund and non-Canadian investors in the Canadian trusts, he adds, so those with a larger number of these types of investors will see the greatest pressure on market valuation.
"The Canadian government is leveling the playing field for all Canadian businesses."
Trusts' unit prices have been pummeled, meanwhile. The S&P/TSX Capped Income Trust Index lost 12.6% in value the day of the news; the S&P/TSX Capped Energy Trust Index lost 13.3% in value.
For example, Provident Energy Trust closed at US$11.95 on October 31 and was trading at US$10.52 the next day, when Flaherty made the announcement, or 12% lower. Enerplus Resources Fund was US$54.30 on October 31; it fell to US$45.94 after the news, a 15% decline.
At press time, Provident units were US$9.75, down from some US$13 at their 2006 peak on August 31; Enerplus units were US$40.80, down from some US$59 at their 2006 peak on August 31.
Overall, units of each have lost roughly a third of their value in 10 weeks.
Bernie Picchi, an analyst with independent, New York-based Wall Street Access, notes that all Canadian energy stocks-even those with no known plans to convert to the trust format-fell sharply upon the announcement.
"It might be a buying opportunity, but the price drop among Canadian resource stocks is not irrational," Picchi says. "The income trusts had bid up oil and gas properties to dizzying heights, because they could recapitalize the sellers' cash flows at much higher valuations than the properties' worth to the sellers."
He adds, "Flaherty slammed shut that window."
Gordon J. Kerr, president and chief executive of Enerplus, says, "The measures appear intended to effectively tax trusts the same as corporations. These proposals are expected to have the most impact on tax-deferred investors-pension funds and RRSPs-and non-resident investors."
The Small Explorers and Producers Association of Canada (SEPAC) reports it is very disappointed that the federal government has announced steps which "will seriously harm the income trust sector in Canada."
"SEPAC recognizes there was pressure on the federal government to respond to concerns expressed about the growing size of the trust sector in the economy, but the government has overreacted. A modest tax on income trusts would have served the same purpose without killing the industry...Royalty trusts play a key role in the development of Canada's oil and gas reserves and their demise would be a very serious blow to the petroleum industry."
SEPAC represents 480 member companies of which 80% are oil and gas producers and the rest are suppliers of products and services to the upstream petroleum industry. SEPAC's members drill approximately 15% of the new conventional oil and gas wells each year in Western Canada.
Citigroup's Roy says the decision will cause an extended period of turmoil for the income trust sector while investors scramble to decide which trusts will still be worth owning in 2011. He expects the trusts in his coverage to survive, but near-term performance "will be challenging and will be greatly affected by headlines related to this issue."
Picchi says, "If there are investment lessons in Canada's switch on income trusts, they are these: anything too good to last will not last, and government interests-protecting tax revenues in this case-trump private interests-receiving tax-free streams of cash flow-nearly every time."
Enterra Energy Trust, Calgary, is reconsidering a bought-deal financing in light of the proposed tax-law changes. The C$355-million financing was to close November 9 and has been postponed.
Picchi reports that an association of 40 Canadian energy trusts plans to lobby Ottawa to reverse, or at least modify, the new law proposal.
"We can just imagine the arguments the trusts will use to try to convince Finance Minister Flaherty to reverse his decision-i.e., it will slow drilling and cost jobs. There's at least a distant chance that the government will 'grandfather' existing trusts, but it's very unlikely the government will allow any new conversions of corporations to income trusts."
Jim Flaherty, Canada's minister of finance, says, the measures "are necessary to restore balance and fairness to Canada's tax system, to ensure our economy continues to grow and prosper and to bring Canada in line with other jurisdictions...Our actions are clear, decisive and in the best interest of all Canadians."
Flaherty says many companies in Canada have announced their intentions to convert to income trusts as a "corporate tax avoidance" tactic. There were almost C$70 billion in new trust announcements this year alone, he adds.
According to Citigroup analyst Richard Roy, as of June, 237 income trusts were listed on the Toronto Stock Exchange. During the last two years, about 34 companies have converted to the trust structure.
Flaherty says, "...If left unchecked, these corporate decisions would result in billions of dollars in less revenue for the federal government to invest in the priorities of Canadians, including more personal income tax relief. These decisions would also mean less revenue for the provinces and territories."
The measures in the proposed Tax Fairness Plan include a tax on distributions from publicly traded income trusts and limited partnerships; a 0.5% reduction in the general corporate income tax rate as of January 1, 2011; and an increase in the age credit amount by C$1,000. The plan may provide more than C$1 billion of new tax revenues annually to the Canadian government, Flaherty says.
If adopted, the new tax law will apply to current trusts beginning in 2011. It would apply immediately to any trusts formed after the law is adopted.
The plan to cancel tax breaks on trust unit-holders' distributions will become law, says George Gosbee, chairman, president and chief executive of Calgary-based investment-banking firm Tristone Capital Inc., since Conservative party members are favoring the revision in tax code.
"The government has been losing too much tax revenues," Gosbee says, as more and more businesses have been converting to the trust model.
The news hurts energy trusts' valuations today, but it will be good for the Canadian E&P industry, which has been overwhelmed by the buying power of the trusts, he adds. U.S. producers have fled the country, while unable to compete with the trusts for expansionary assets.
"You will see a lot more non-Canadian companies returning to Canada...It makes sense that you should buy in Canada now."
The law change is designed to run off pension-fund and non-Canadian investors in the Canadian trusts, he adds, so those with a larger number of these types of investors will see the greatest pressure on market valuation.
"The Canadian government is leveling the playing field for all Canadian businesses."
Trusts' unit prices have been pummeled, meanwhile. The S&P/TSX Capped Income Trust Index lost 12.6% in value the day of the news; the S&P/TSX Capped Energy Trust Index lost 13.3% in value.
For example, Provident Energy Trust closed at US$11.95 on October 31 and was trading at US$10.52 the next day, when Flaherty made the announcement, or 12% lower. Enerplus Resources Fund was US$54.30 on October 31; it fell to US$45.94 after the news, a 15% decline.
At press time, Provident units were US$9.75, down from some US$13 at their 2006 peak on August 31; Enerplus units were US$40.80, down from some US$59 at their 2006 peak on August 31.
Overall, units of each have lost roughly a third of their value in 10 weeks.
Bernie Picchi, an analyst with independent, New York-based Wall Street Access, notes that all Canadian energy stocks-even those with no known plans to convert to the trust format-fell sharply upon the announcement.
"It might be a buying opportunity, but the price drop among Canadian resource stocks is not irrational," Picchi says. "The income trusts had bid up oil and gas properties to dizzying heights, because they could recapitalize the sellers' cash flows at much higher valuations than the properties' worth to the sellers."
He adds, "Flaherty slammed shut that window."
Gordon J. Kerr, president and chief executive of Enerplus, says, "The measures appear intended to effectively tax trusts the same as corporations. These proposals are expected to have the most impact on tax-deferred investors-pension funds and RRSPs-and non-resident investors."
The Small Explorers and Producers Association of Canada (SEPAC) reports it is very disappointed that the federal government has announced steps which "will seriously harm the income trust sector in Canada."
"SEPAC recognizes there was pressure on the federal government to respond to concerns expressed about the growing size of the trust sector in the economy, but the government has overreacted. A modest tax on income trusts would have served the same purpose without killing the industry...Royalty trusts play a key role in the development of Canada's oil and gas reserves and their demise would be a very serious blow to the petroleum industry."
SEPAC represents 480 member companies of which 80% are oil and gas producers and the rest are suppliers of products and services to the upstream petroleum industry. SEPAC's members drill approximately 15% of the new conventional oil and gas wells each year in Western Canada.
Citigroup's Roy says the decision will cause an extended period of turmoil for the income trust sector while investors scramble to decide which trusts will still be worth owning in 2011. He expects the trusts in his coverage to survive, but near-term performance "will be challenging and will be greatly affected by headlines related to this issue."
Picchi says, "If there are investment lessons in Canada's switch on income trusts, they are these: anything too good to last will not last, and government interests-protecting tax revenues in this case-trump private interests-receiving tax-free streams of cash flow-nearly every time."
Enterra Energy Trust, Calgary, is reconsidering a bought-deal financing in light of the proposed tax-law changes. The C$355-million financing was to close November 9 and has been postponed.
Picchi reports that an association of 40 Canadian energy trusts plans to lobby Ottawa to reverse, or at least modify, the new law proposal.
"We can just imagine the arguments the trusts will use to try to convince Finance Minister Flaherty to reverse his decision-i.e., it will slow drilling and cost jobs. There's at least a distant chance that the government will 'grandfather' existing trusts, but it's very unlikely the government will allow any new conversions of corporations to income trusts."
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