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Providing coverage of Alaska and northern Canada's oil and gas industry
September 2006

Vol. 11, No. 39 Week of September 24, 2006

Bust the trusts, or stay the course?

Faced with largest trust conversion, Canadian government opts for hands-off stance; pressure builds for tougher disclosure rules

Gary Park

For Petroleum News

Canadian government coffers are bulging from a petroleum windfall that saw the tax take from industry profits soar to a record C$7.5 billion in 2005, C$3 billion ahead of the previous year.

Statistics Canada reported that the commodity-price-driven bonanza also pumped up oil and gas capital spending by 16 percent to C$36.7 billion.

“These are boom times in Canada’s oil patch, particularly in Alberta, where the soil abounds in black gold,” the federal agency raved.

It said the biggest breakthrough has been the financial and technical ability of the industry to mine the oil sands of northern Alberta, which allowed the province to account for about 66 percent of Canada’s total oil and gas output, followed by Saskatchewan at 18 percent and Newfoundland at 13 percent with a combined 3 percent coming from British Columbia, Ontario, Manitoba and the Northwest Territories.

For all of this gusher, however, there is a constant murmuring in federal circles over the net revenue losses from income trusts, where the oil and gas industry is the largest sectoral participant, and the need to redress that imbalance.

The Canadian trust world now has 247 listings with a market value of C$195 billion, compared with a mere handful of niche players valued at C$10 billion only six years ago, and has turned into a magnet for many U.S. investors.

Telus would be largest single trust

The whirlwind growth of trusts hit a new peak on Sept. 12 when Telus, Canada’s second largest phone company, decided to join the fold.

The conversion, assuming it gains the necessary approvals, will create the largest single trust, with a market worth of about C$20 billion.

The move has a simple rationale: Telus wants to lower its tax burden, hike its stock price (in the immediate aftermath of the announcement its shares rose 14 percent) and boost its annual payout by as much as 3.5 times its current dividend.

By making the move it raises a compelling question: Who is next?

Wayne Adlam, executive vice president of Blackmont Capital, said Telus has “effectively legitimized trusts” and forced all blue-chip companies to consider following suit.

Income trusts are exempt from taxes and distribute most of their cash flow among investors, who then pick up the tax burden.

However, only about one-third of the lost corporate tax is recovered, leaving the federal and provincial governments short-changed.

Jack Mintz, a tax expert at the University of Toronto Rotman School of Management, has pegged the current net revenue loss at up to C$600 million (others say the figure is much higher), raising the question in his mind about whether there are too many trusts in Canada.

He said the trend raises two questions: The loss of revenue and whether the trusts are a legitimate way to run Canadian corporations.

The former Liberal government, after reporting that it lost C$300 million in 2004, first threatened to review the trust tax structure, then, facing an election, backed off and decided to simply make investing in conventional corporations more attractive by lowering dividend taxes.

Finance minister concerned, monitors market

The new Conservative government, under Prime Minister Stephen Harper, endorsed that solution and pledged not to impose any new taxes on the trusts.

Finance Minister Jim Flaherty delivered a message Sept. 18 that trust investors have no immediate reason to fear a tax grab, while leaving all of his options on the table.

“We continue to monitor developments in the income trust market and I remain concerned … so we’ll continue watching,” he said in a conference call.

He refused to be drawn into commenting on whether he would rule out changes to trusts, but said cutting the rate of taxation on corporate dividends creates a “level playing field between investments in corporations as compared with income trusts.”

These are some signs that the sizzling rate of growth in the trust sector may be cooling off.

The cumulative five-year gain for the Standard & Poor’s/Toronto Stock Exchange income trust index is 82 percent, while the index for conventional companies rose 60 percent. But for 2006 trusts have increased 6 percent against 7.5 percent for the S&P/TSX composite index.

Meanwhile, the Canadian Securities Administrators, made up of provincial and territorial securities regulators, insists that action should be taken to force trusts to “improve the nature and extent of their disclosure,” against the backdrop of a Standard & Poor’s study that suggests trust disclosure and accounting practices — which have been variously described as complex and baffling — are deteriorating.

With so much on the table, there is a feeling in the investment community that if not this time then eventually the Canadian government will be forced to conduct a comprehensive review and overhaul of the trust structure.






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