Just as the seeds of Canada's income trust boom were being planted, two countries that had seen similar types of investments flourish in their own markets were taking steps to have them outlawed.
The year was 1985 and the governments of Australia and the United States were caught in a political quandary over a new type of investing trend. Though it would be years before the same kind of movement would spring up in Canada, each situation was strikingly similar to the income trust explosion that now has Ottawa worried.
It began in Australia where small pockets of companies began turning themselves into income trusts through the early eighties in a bid to lower their corporate taxes. Clive Hildebrand, a veteran of Australia's mining sector, remembers those days well. What started as a few corporate conversions blossomed into a few dozen in the blink of an eye.
"Some smarties in the merchant banking community basically got together and said 'How can we pay less tax?' " said Mr. Hildebrand, former chief executive officer of Queensland Coal, one of Australia's biggest business income trusts. "It was a very smart move."
The rise of income trusts in Canada has Ottawa concerned it could be losing at least $300-million a year in corporate tax dollars as the sector grows. With the federal government now pondering what to do with income trusts, the steps taken by the United States and Australia are being put under a microscope. In the eyes of some observers, they could serve as a proxy for how the Finance Department will proceed.
In Australia, the trust structure was once the sole domain of real estate and resource firms. But by the mid-eighties, a wider range of firms was climbing aboard the bandwagon and being rewarded by investors. When Mr. Hildebrand converted Queensland to a trust in 1984, its stock price tripled in one afternoon.
Across the globe, a familiar scene was unfolding in the United States, where a similar type of structure, the publicly traded partnership (PTP), was sprouting up in a multitude of industries. Having watched pipelines and property trusts benefit from a tax-free PTP structure, a parade of new U.S. businesses were rushing to convert. The names ranged from amusement park operators and macadamia nut growers to the Boston Celtics basketball team. In just six years, the numbers grew from zero to more than 100.
The benefits were obvious. Business trusts and PTPs paid no income tax and instead turned the bulk of their profits over to investors. Though unitholders were still subject to tax on their gains, the cash distributions were seductive.
But the heyday wouldn't last. In 1985, the Australian government became the first to clamp down. A white paper released by Australia's finance department that year raised alarms about the loss of tax revenue.
Since individual investors were taxed at lower rates than corporations, the rise in trusts meant less money for government. The corporate tax base was being eroded, the Australian government warned. And if the business trust trend was allowed to continue unabated, it could eventually engulf the market.
The clampdown happened quickly. Within a matter of months, companies that weren't involved in the real estate or resource trust businesses were given three years to find an exit strategy. By 1988, the Australian business trusts would have to choose between maintaining their current structure at higher tax rates, converting to a public company or turning private. Most opted to become publicly traded companies. Those that decided to continue as trusts soon learned they had little use for the structure once the tax advantages were gone.
"We were a printing manufacturing business," said Peter Onley, former CEO of Computer Resources Trust, which struggled after the moratorium and succumbed to a takeover a few years later. "Not a good structure for a business that needed capital, in hindsight."
Market damage was unavoidable. Unit prices fell and firms were stunned when the government intervened. Among those caught off guard was Computer Resources, which converted just two days before the 1985 freeze was put in place.
While the Australian government never put a figure on the amount business trusts were worth in terms of lost corporate taxes, the U.S. Congress estimated the trend was costing Washington $245-million (U.S) a year. But rather than issue a blunt three-year deadline as Australia had, the United States decided on a less abrupt approach.
In 1987, PTPs that didn't fall into the category of slow-growth investments (roughly a third of them) were given 10 years before they would be taxed as corporations. The decade-long process helped ease the sting for PTP investors.
Most PTPs opted to restructure as publicly traded corporations, but Cedar Fair LP, an operator of amusement parks, was one of three of those operations that decided to retain the partnership structure. Years of lobbying in the late 1990s persuaded Washington to let the remaining PTPs be taxed at a special corporate tax rate of 3.5 per cent, a sort of grandfathering clause for the remaining trio. But the concession came at a steep price: Cedar Fair and the others can't grow outside of their core businesses.
"We can't just take our PTP structure and suddenly start buying malls or auto dealerships," said Brian Witherow, vice-president of Cedar Fair. "We have to stay within the world of what we do."
No stranger to roller coasters, the amusement park giant has seen its world stabilize in subsequent years. However, government intervention has all but killed the market as U.S. investors remain cool to the sector, instead choosing high-yield bonds or debentures. The once blossoming PTP market has been pared back to 49 partnerships. And the sector is still fighting to lure back investors.
Unlike Canada, which has seen the trust sector swell to more than 220 listings on the Toronto Stock Exchange, Australia implemented its freeze before the numbers could explode. And the U.S. intervention limited the damage to a small patch of niche investors, rather than the broad base of mom and pop unitholders and pension funds that drive the Canadian trust sector.
That the Canadian government is now studying the Australian and U.S. examples closely is perhaps not a surprise. When Canada's first income trusts were created, pioneers of the sector looked to U.S. partnerships as a model. And at least one official inside Finance Minister Ralph Goodale's department has worked in the Australian finance ministry and is well versed in how that country corralled the growth of trusts.
What is surprising to some, however, is the fact that Canada's sudden concern over the growth of income trusts in 2005 has come so long after the clampdowns elsewhere. Upon hearing of Ottawa's predicament, Mr. Hildebrand couldn't mask his amazement that Canada is only now treading down a path well worn by the United States and Australia. "I always thought you guys were ahead of us."
Tightening the trust loop
Australia
The year: 1985
The decision: Business trusts such as Queensland Coal are given three years to choose an option: become publicly traded, turn private or remain as a trust and be taxed.
The impact: The market slumps. Some investors hang on to collect distributions. Eventually most of the business trusts convert to publicly traded companies.
United States
The year: 1987
The decision: Congress clamps down on publicly traded partnerships like the Boston Celtics. They are given 10 years to pick an exit strategy.
The impact: One-third of the PTPs are forced to restructure and most convert to publicly traded companies. Since many investors already vacated the sector in the late 80s, it dies a quiet death.
Canada
The year: 2005
The decision: Ottawa issues a white paper suggesting trusts like O&Y REIT are costing the corporate tax base $300-million a year and hampering innovation.
The impact: Unitholders, who see the move as a signal that change is coming, shave roughly $9-billion from the trust market. All eyes are on Ottawa's trust review, expected to wrap up by the end of the year.
© The Globe and Mail
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