Income trusts refuse to give up their fight with Ottawa over the new tax they'll face in 2011, despite the fact the federal government last week doled out more generous-than-expected concessions to the sector.
“The patient's still dead in four years. All the government has done is given us a few painkillers in the interim,” said George Kesteven, president of the Canadian Association of Income Funds (CAIF).
After market close last Friday, the Harper government offered a few breaks to the embattled trust sector, saying it would allow existing trusts to double in size over the next four years and convert back to public companies with no tax hit.
Mr. Kesteven said these measures don't change the fact that the 2011 tax will thin the ranks of the sector.
“Generous? Generous is in the eye of the beholder.... You're still going to see value destruction in the sector,” he said.
“You're still going to see businesses being sold out to private equity firms and taken out because they can't raise capital,” he said.
Mr. Kesteven, whose group represents 65 per cent of the $200-billion trust market by capitalization, said his organization plans a campaign to galvanize public opinion and put pressure on Ottawa to relent on the surprise tax.
“I think pressure is an understatement,” Mr. Kesteven said.
He declined to divulge CAIF's lobby strategy, which is expected to be deployed in early 2007, but wouldn't reject the possibility of legal action.
“We would rule out nothing at this point.”
Polls suggest that the trust tax, despite representing a broken election promise, is not a burning issue for the broad electorate.
CAIF wants to change this, Mr. Kesteven said, adding this should happen “once the public becomes aware of the contribution of the sector to the Canadian economy and the long-term damage that could accrue from what the government is doing.”
The Oct. 31 trust tax measure applies to new trusts in the 2007 tax year and existing trusts in 2011.
Trusts have been lobbying Ottawa without luck to exempt existing trusts from the tax, or to at least lengthen the tax-free grace period to 10 years from four.
The energy trust sector appeared most placated by last Friday's guidelines.
While executives there are still unhappy about the decision to tax trusts, some said the ability to grow by 100 per cent over the next four years should help them to deliver on their business plans.
It helps that the Finance Department will allow two firms to merge without penalty, as long as the action does not result in an increase of their combined equity.
The business trust sector appears less amenable. Unlike the oil patch, where the similarity of the businesses allows for plenty of merger opportunities, business trusts comprise a highly varied group, and the appearance of acquisition prospects here is much less predictable.
Last Friday's rules provided trusts with some certainty, but short of what they'll need before growing.
“I think that income trusts can now make decisions with a greater degree of comfort,” said Michael Friedman, a lawyer with McMillan Binch Mendelsohn LLP in Toronto. “There's still not 100-per-cent certainty, although we're far closer than we were a week ago.”
Mr. Friedman said it remains difficult for trusts to commit to significant expansion plans until they see the actual text of the legislation implementing the trust tax. (This has yet to be tabled.)
One issue, he said, concerns the lack of a subjective element in the guidelines released Friday. The specific limits on issuing new equity may work just fine for some growth-minded trusts, but be incompatible with the strategy of others.
“The inquiries we're getting right now [are] what are the rules of the game going forward?” he said.
Even with this uncertainty, bankers say the guidelines should help deal with the pent-up demand for financings that have been sitting in the pipeline.
Only a handful of trusts have forged ahead with financings, while the majority have sat on the sidelines, afraid to complete a deal that Ottawa might later deem “undue expansion.”
Banks have also been pitching debt-heavy deals to trusts as a way to get around the restrictions on equity issuance, leading some to believe the trust sector will begin to assume much higher amounts of leverage.
