Looming deadline promotes uptick in income trust conversions

Looming deadline promotes uptick in income trust conversions

As Canadian income trusts prepare to change their corporate structures before Jan. 1, 2011 when they lose their preferential tax treatment, there is likely a lot of work ahead for lawyers involved in the conversion process, according to a recent report.

Income trusts have to convert to corporations due to changes in their Canadian federal tax treatment at the end of this year, which make the trust structure unattractive for investors and unit holders in the vast majority of cases.

So far in 2010, approximately 40 income trusts have announced their conversion plans or completed a transaction, and more are likely to follow before year-end, according to a report by Torys LLP.

From the in-house counsel standpoint, it’s important to have proper communication with internal and external stakeholders to ensure there are no surprises in the conversion process, says Torys partner Glen Johnson.

“They need to ensure that the market doesn’t have any surprises. There needs to be a full disclosure and understanding behind the reasons to convert or not,” Johnson tells InHouse. “It’s also important to understand the distribution policy that is going to be selected going forward.”

That involves advanced planning on financial agreements, debt agreements, and employment contracts that might be affected by the decision to convert.

“With many companies, when they actually do hit the time to convert, they are finding it much easier when they have already done a full internal analysis on what has to change, what doesn’t have to change, and how do they propose to go about it in terms of the operational agreements and employment contracts that facilitate the process,” says Johnson.

The nice thing for income trusts that still have to go through the conversion process is the path has already been opened. And the conversion process has gone through shareholder meetings and courts without any major complications for many companies that have already converted, adds Johnson.

He predicts 80 per cent of Canadian trusts will have gone through the conversion process by the end of year. That means there will likely be an uptick in the number of conversions in the fall and winter. And since the process involves at least one shareholder meeting and two court appearances to be complete, it takes some time to set up.

The conversion countdown for income trusts stemmed from a political decision by the federal government in 2007. Large Canadian companies liked the income trust structure due to tax benefits and had converted to it in droves, before the government cut them off.

Once the federal government removed these benefits, meaning companies would be taxed much the same way as corporations by the end of this year, most trusts faced the decision that they would have to convert into corporations.

“We made our decision based not on political calculations,” Finance Minister Jim Flaherty said at the time. “But on principles of tax fairness, balancing the needs of individual investors with the interests of taxpayers and their families.”

The recession only made it more difficult for trusts to convert due to financing constraints, which put pressure on distribution levels at a number of trusts, according to the report.

For a minority of trusts that might decide to keep their structure past the end-of-the-year deadline and pay the higher taxes, their managers might still rely on available tax credits or other structural attributes to defer a decision on conversion since the tax-free conversion will be allowed until the end of 2012, says Johnson.

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