Nearly six years after Ottawa introduced tax rules that effectively ended the rise of income trusts, a new breed of entrepreneurs is returning to the model, stuffing foreign assets into trusts that generate fat dividends and avoid Canadian corporate taxes.
The trend started in late 2010, when Eagle Energy Trust went public as the first new energy trust to appear following the 2006 rule change. A second, Parallel Energy Trust, followed last year. Now a third, called Argent Energy Trust, has filed a prospectus and is looking to raise $325-million to go public in coming months.
But it's not just the energy sector. New trusts are being formed to snap up real estate, wind farms and natural gas distribution networks in the U.S., Europe and Asia.
Murray Lee, who leads PricewaterhouseCoopers' cross-border tax practice in Calgary, says he knows of an energy trust and three other non-energy trusts that "have a realistic shot at filing their prospectuses by some time in the third quarter."
The driving motivation for many of these ventures is falling prices for many assets as a result of the recent economic turmoil – think houses in the southern U.S., or infrastructure in Spain.
"Really, I see this whole thing as a beautiful example of international capital markets integration," said Bob McCue, who leads Bennett Jones LLP's tax dispute resolution practice. He has, with Mr. Lee, been among the leaders in establishing the new trust model.
They hope the tax advantages of the trust structure plus the allure of big dividends will create a revival of a market segment tossed on the rocks in 2006, when new tax rules were introduced. Those rules, however, only applied to trust income generated in Canada. Invest in U.S. or overseas assets, and the old rules still apply – as they do to real estate income trusts. In both cases, trusts that distribute their earnings can avoid being taxed in Canada.
That's why REITs, especially those grabbing U.S. properties, have also seen strong interest. And those building the new trusts say they are unlikely to attract Canadian government interest because they aren't depriving this country of revenue.
"The basic concept here is that Canada is better off having income that can be taxed in Canada in the hands of shareholders or unitholders," said Stephen Pincus, chair of the REITs and Income Securities Practice at Goodmans. "And if you have a U.S. portfolio of assets, they would not otherwise produce Canadian tax revenue."
Canadian investments in U.S. assets aren't new. The past decade has seen the emergence of TSX-traded companies that deal in U.S. school buses (Student Transportation Inc.), electricity (Atlantic Power Corp.) and hospitals (Medical Facilities Corp.). Canadian markets, which are accustomed to IPOs as small as $100-million, can be a far more favourable place to raise money than the U.S., where IPOs often don't get off the ground unless they are $1-billion or larger.
But the idea is clearly gaining steam. Mr. Pincus has a client who is in the process of registering a prospectus for a new REIT with U.S. and Canadian assets. Argent is taking a second stab at going public – its first attempt failed, as did that of another would-be energy trust, North American Oil Trust, when markets stumbled last summer,
The experience of the newest crop of trusts has been mixed. Eagle has outperformed other energy companies, and both it and Parallel have successfully raised money in recent weeks. But Parallel units are down below $6.50 from their IPO at $10. Dundee International REIT, another new player that went public last August, is down at a time when other Canadian REITS, like Boardwalk and H&R, are substantially up.
Troubles with new entrants have raised skepticism about the model. Indeed, there are several reasons why the new trusts are different than their predecessors. For one, they introduce currency risk to investors, since they trade in foreign assets. They also may not be tax-free, since they can be subject to tax in the jurisdiction where they operate.
Energy players, such as Argent, face the added obstacle of attempting to raise money to investors currently fleeing oil and gas names. As one investor put it: "Can you imagine trying to sell an energy deal in this market?"
But Brian Prokop, Argent's chief executive officer, expressed confidence the company will find a big audience among investors who are six years older than they were when the previous trusts went bust – and who may have an even more acute appetite for yield.
"If they were popular back then, they should be more popular now," he said.