Private Equity Alert
Reversal of Canadian Income Trust Tax Treatment Translates into Buying Opportunities for Private Equity Fundsby Governor James Blanchard, Jay M. Tannon, and Era Anagnosti On November 7, the Canadian Parliament approved a new proposal by Finance Minister Jim Flaherty to tax income trusts by imposing an entity-level tax on the dividends paid out to unitholders of such trusts. This move is a result of the Canadian government’s perception that the growth of income trusts could have long-term negative effects on the Canadian economy. For income trusts that begin trading after October 31, 2006, the new tax shall take effect January 1, 2007; for income trusts trading prior to November 1, 2006, the new tax shall take effect January 1, 2011. Tax Change Will Reverse Trend of Converting Companies into Income Trusts; Will Not Affect REITsThe growth of Canadian income trusts during the past five years, driven by business and energy trusts, was unprecedented. The Toronto Stock Exchange (TSE) estimates that, from 2002 through September 2006, 54 TSE companies converted into income trusts. Thirty-six of these conversions occurred during the past two years. By September 2006, there were 255 income trusts listed on the TSE with a quoted market value of C$201 billion. Business and energy trusts represent more than 75 percent of all income trusts traded on the TSE. The change in taxation will reverse the trend of Canadian private and public company conversion into income trusts. However, real estate investment trusts (or REITs) will not be affected by the tax change. The contemplated legislation excludes REITs from the statutory definition of “Specified Investment Flow-Through” entity or “income trust.” New Position May Create Acquisition TargetsThe government’s new position tries to level the “taxation playing field” between traditional public corporations and income trusts. Business income trusts may be most negatively impacted as the tax change adversely affects their cash flow. With the value of the income trust dissipating, business income trusts may cash out rather than pursue traditional public company status. This sell-out would translate into significant “take-private” opportunities. Private equity firms have long favored companies with stable cash flow and have displayed an increasing appetite for take-private opportunities. Canadian income trusts, which are built on businesses with sustainable cash flow and proven track records, may be made to order as private equity acquisition targets.
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