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Trust rules get second look Minister bends to pressure from pension plans, who accuse Canada of undermining investment in private equity and venture capital Gary Park Petroleum News Calgary Correspondent
Under pressure from pension plans, Canada’s Finance Minister Ralph Goodale has backtracked on his plans to cap the amount pension funds can invest in the country’s booming income trust sector.
Goodale said May 18 he will suspend the changes contained in his March federal budget until he consults with pension funds, the investment industry and provincial governments.
“The concerns raised by pension funds and other interested parties deserve a closer look,” Goodale said in a news release, without indicating whether he will consider scrapping the budget measure altogether.
He said earlier that he had been “listening very carefully” to critics of the proposal, which was something he could not do prior to the budget for fear of tipping off market participants.
“This is the sort of provision that quite frankly did not lend itself to advance consultation,” he said. “I’m in the process of doing that.” Budget sets limit The budget set a limit to take effect on Jan. 1, 2005, capping pension fund investments in income trusts at 1 percent of fund assets and limiting pension funds to a 5 percent holding in any one business trust.
The limits were intended to stem erosion of corporate income taxes. Income trusts don’t pay tax on cash flows, which they pass directly to unit holders, to be taxed in their hands.
The restrictions were seen as one way for the government to put the brakes on the future expansion of the trust sector which now has a market capitalization approaching C$100 billion. Pension plan attacks proposal The proposal came under attack from the Ontario government, the Ontario Teachers’ Pension Plan with C$77 billion in assets and OMERS, which manages net assets of C$33 billion for Ontario municipal employees.
They accused Goodale of choking off major investments in private equity and venture capital, especially by large pension funds that are hungry to invest in new asset classes such as the booming trust sector.
The teachers’ pension plan earned almost C$800 million from income trusts in 2003.
“We have a funding crisis in pension plans in Canada and many pension managers are endeavoring to close that gap to be able to meet the pension promise,” said Jim Leech, senior vice president of the teachers’ plan.
“If we use the income tax to in fact put up artificial limitations you are guaranteeing suboptimal performance,” he said in a statement.
Ontario Finance Minister Greg Sorbara said in a letter to Goodale that concerns raised by the pension and investment sectors should be “fully explored” and discussed with provincial finance ministers before any legislation is introduced.
Goodale said he has also heard from proponents of the investment limits, who fear a major drain on federal revenues as pension funds become larger investors in trusts, which pay little or no taxes.
The tax leakage has been estimated by the C.D. Howe Institute at C$500 million to C$700 million a year. Foreign ownership limited While that tug-of-war continues, energy income trusts are grappling with their own challenge posed by the budget, which will impose a 49 percent limit on foreign ownership of trusts that want to qualify for investment by tax-sheltered retirement plans, or increase the withholding tax for foreign investors in Canadian trusts.
Randall Findlay, president of Provident Energy Trust — one of five trusts believed to have more than 50 percent foreign ownership — said his trust is scrambling to decide what to do about its 70-75 percent U.S. resident ownership before the new rules take effect over the next three years.
He told a conference call earlier this month that “it’s probably the number one or number two item” that is discussed at board meetings.
Findlay said Provident has explored its concerns with a wide array of legal firms, but no one has yet produced “the perfect solution by any means.”
One option already being pursued by Pengrowth Energy Trust involves the creation of class A and class B units, so that non-resident ownership requirements of the Income Tax Act are complied with and their access to mutual fund money is protected. Trusts scooping up assets Regardless of any uncertainty hanging over them, energy trusts are more focused on utilizing their cash flow to scoop up junior E&P companies, non-core assets and other trusts to maintain their production volumes.
There are now 27 producer trusts, four more than last year when the sector generated cash flow of C$3.6 billion and invested C$5.36 billion in the industry, the bulk on acquisitions. Of the cash flow, C$2.56 billion went directly to unit holders.
The 23 trusts in business last year pumped out an average 291,372 barrels per day of oil and natural gas liquids, 6,355 bpd outside Canada, and 1.33 billion cubic feet per day of natural gas, with a mere 14 million cubic feet per day from foreign sources.
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