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Income trusts can double in size Government guidelines allow trusts to double in size over next four years; earlier speculation put limit at 15 percent Gary Park For Petroleum News
For seven weeks the Canadian government of Prime Minister Stephen Harper has been under fire on a matter of trust — income trusts to be precise.
Since its Halloween bombshell announcement that trusts would lose their tax-exempt status in 2011, the administration has been assailed from all sides for breaking an election campaign promise not to meddle with the trust structure.
It has been accused of not doing its homework before wiping out C$30 billion worth of income trust value, ignoring the importance of energy-related trusts in squeezing the last drops out of marginal oil and gas fields, and stalling on the release of guidelines to govern the operation of trusts until 2011.
Tired of waiting for government clarification, some trusts decided to push ahead with expansion and merger plans to test the government on what was permissible.
New rules issued Under mounting pressure, Finance Minister Jim Flaherty finally issued the new rules Dec. 15 and may have reduced some of the angst in the process.
Less onerous than what many analysts had expected, the guidelines will allow trusts to double in size over the next four years without jeopardizing their tax-free status, although the conditions are strict.
In the oil and gas industry there is now a feeling that the concessions may set off a new round of trust mergers and acquisitions.
Merrill Lynch analyst Joel Sutherland said in a note that although energy trusts received no special treatment, royalty and resource trusts tied to a specific commodity benefit disproportionately from trusts that have “no comparables,” making them candidates to grow.
Chris Rankin, an analyst with Canaccord Capital, told the Globe and Mail that the “friendly” nature of the guidelines will trigger a “pile of equity issues (and) a tidal wave of mergers.”
Others are claiming there is a backlog of deals which have been shelved since Oct. 31.
Flaherty was quick to describe the rules as “generous.”
“They’re designed to make it easier for the significant changes (to the trust regime) to happen in Canada,” he said.
40% growth allowed in 2007 Trusts will be allowed to grow by 40 percent to the end of 2007 and 20 percent in each of 2008, 2009 and 2010.
Any trust falling short of the annual maximum can carry that deficit over to future years to a total of 100 percent expansion.
There had been a widespread view among analysts that the government might set a 15 percent limit on expansion during the transition period.
Outstanding debt can be replaced with equity without having to include that in the so-called “safe harbor” of 100 percent growth, although replacing new debt with equity will count as growth.
Larger trusts will be able to sell units worth as much as 100 percent of their current market value over the next four years and small trusts with market capitalizations of less than C$125 million will be free to grow their equity up to C$50 million a year in each of the four years.
Flaherty also left the door slightly open to special cases, saying trusts that wanted to expand by more than the fixed limits could make an argument to his department.
He said the percentage caps were based on consultations with many publicly traded trusts and partnerships as well as government observations on the range of growth arising from the normal course of business.
Flaherty said he had heard of 20 cases of trusts that were in the process of expanding or with pre-existing plans to expand and the bulk of them fell within the new guidelines.
Dielwart: one deal has collapsed, another faltered John Dielwart, chief executive officer of ARC Energy Trust and the most outspoken energy critic of the government’s actions, welcomed the clarification, but insisted that the failure to acknowledge the special role of oil and gas trusts “creates challenges.”
He said one deal — a C$496 million merger of Shiningbank Energy Income Fund and Rider Resources — has collapsed, while another deal faltered when Crescent Point Energy Trust said it would pay 18 percent less than its original offer to buy Mission Oil & Gas.
For the government to treat all business sectors the same was a clear demonstration that it did not understand the nature of the oil and gas industry, he said.
Dielwart said he is not giving up on his determination to convince the government to overturn rulings that relate to energy trusts.
Jeffrey Singer, an attorney at the firm of Stikeman Elliott, said the growth limits could pose a problem for trusts that have “meaningful growth opportunities.”
But he endorsed the government decision to allow trusts to transform into traditional corporations without forcing investors to pay tax on the conversion.
Failing to make that commitment would have “added further injury to insult,” he said.
Undetermined backlash However, here is still an undetermined backlash the government may face from those who insist the Harper administration panicked over the loss of revenues from the wave of trust conversions, may have over-estimated the size of those losses and bungled its handling of the operating rules.
Some are unable to fathom why the government bypassed a major source of lost revenue — the 15 percent withholding tax paid by U.S. owners of Canadian trusts, although Flaherty brushed that off by suggesting the 15 percent tax should be even lower.
George Kesteven, president of the Canadian Association of Income Funds, whose members represent two-thirds of the trust market value of C$200 billion, was not ready to give up the fight.
He said the measures won’t prevent the thinning out of trust ranks in 2011, with many trusts being sold to private equity firms because they will be unable to raise capital.
Kesteven said his association will resume applying pressure on the government early in 2007 and, without disclosing the strategy, he would not rule out legal action.
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