Income trusts still a hot potato

Goodale fends off accusations of leaks; accountant says trusts rife with ‘abuses’; others tell investors to brace for challenges

Gary Park

Petroleum News Canadian Contributing Writer

It’s the issue that just won’t go away in Canada.

Whatever hopes Finance Minister Ralph Goodale might have harbored when he tried to shut down the controversy Nov. 23 by cutting tax rates on corporate dividends rather than hiking them on income trusts have been swept away in the midst of an ill-tempered federal election campaign.

The political heat is on Goodale as pressure mounts to have the Royal Canadian Mounted Police and/or securities regulators investigate whether stock traders learned of the trust decision hours before its decision.

In addition:

• A study by a firm of forensic accountants says the trust sector is still overvalued by 28 percent.

• Major investors warn trusts should not assume that their tax-efficient status is free from government interference.

Timing of announcement at question

In the lead up to the trust ruling there was heavy trading of dividend-paying stocks, which was sufficient for Christopher Thomas, a former broker, analyst and money manager, to identify as “deviant behavior.”

To the surprise of many, some trusts were able to react to Goodale’s announcement 35 minutes after it was made.

Asked if he suspected any leaks from his office or other sources, Goodale declared that was “a complete falsehood.”

He accused his political opponents of “character assassination” and insisted any heavy-trading of dividend-paying stocks prior to the trust ruling was based on “pure speculation” by investors.

Mounties reviewing request for a probe

But Gerry Phillips, the Ontario cabinet minister responsible for overseeing the Ontario Securities Commission, Canada’s largest regulator, refused to get involved, saying that would be tantamount to political interference in the regulatory field.

While that dispute rages, a report from Accountability Research Corp., an affiliate of Rosen and Associates forensic accountants, said the C$20 billion loss in the market value of trusts during the two-month federal review of the sector did not get to grips with accounting and sales “abuses” by trusts.

Although the firm did not include energy and real estate trusts in its examination, it said less than two-thirds of the cash distributions by 50 of the biggest trusts were based on actual income. The rest was the return of investors’ own capital.

It said the tax advantage of the trust structure has been overstated as the motivation for corporations to join the trust ranks and much of that overvaluation “stems from abuses in the financial reporting, valuation and marketing of business trusts.”

Accountability Research said “much of the manipulation relates to the understatement of future capital spending required to maintain the capital assets of the business. Even more of the overvaluation results from the flawed methodologies being pushed by the investment banks.”

The report, entitled “The Worst is Yet to Come,” suggested that the “prospects for serious declines in business trusts are already evident,” with the unit prices for 22 trusts down by 30 percent or more from their offering prices.

For those wondering whether the Canadian government has dropped the notion of imposing a tax on trusts, Ira Gluskin, president of Gluskin Sheff & Associates, a major trust investor, said: “Are we safe? The answer is no. There are civil servants who stay up at nights worrying about income trusts.”

If there is a continuing wave of conversions, the tax treatment of trusts will quickly “move front and center again,” he said.

Robert Bertram, head of investment at the Ontario Teachers Pension Plan, said the government has “not fixed the tax system” or leveled the playing field between corporations and trusts with Goodale’s announcement.