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Shattered Trusts

TORONTO, Ont. - The Canadian government's new Tax Fairness Plan, which looks to create a level playing field between income trusts and corporations, was unleashed on Halloween, causing ghoulish effect...

TORONTO, Ont. – The Canadian government’s new Tax Fairness Plan, which looks to create a level playing field between income trusts and corporations, was unleashed on Halloween, causing ghoulish effects on the Toronto Stock Exchange (TSX). The TSX plummeted almost 300 points Nov. 1 as investors dumped income trusts and stocks in blue-chip companies looking to convert to trusts.

Income trusts have shares or trust units which are traded on securities exchanges just like stocks. Under the current system, income trusts exist as flow-through entities, meaning their income is redirected to unitholders, and as such, they avoid double taxation from combining corporate income tax with shareholders’ dividend tax. The government’s plan, announced by Finance Minister, Jim Flaherty, intends to restore balance and fairness to the federal tax system, by installing a Distribution Tax on distributions from publicly traded income trusts by 2011.

Massive telecom companies BCE and Telus had both announced plans to convert to trusts in the last two months, prompting the government to move forward with the plan. Combined, the two companies were expected to cost the government $800 million in annual income tax if they became income trusts.

Several major players in the transportation sector were affected by this decision, including TransForce Income Fund, Contrans Income Fund and Mullen Group Income Fund. Though the value of each group’s trust units took a dip after Flaherty’s initial announcement, the market bounce-back was almost immediate, as valuations began creeping their way back to previous levels by Nov. 3.

“I think they’ve already started to recover,” said Larry Dries, chief operating officer with TSI Group. “In the first few days there was some bloodletting, but starting on (Nov. 3) and even (Nov. 6) they started recovering and I would expect that to continue.”

Dries said the bounce-back was expected, as announcements of this kind usually spark overreaction in the marketplace followed by a fairly large correction – as well as some decent opportunities for buyers.

But even though many income trusts are on the rise again, they must now take time to consider what strategic options they have, says David Newman, financial analyst with National Bank Financial.

“I think right now that’s a big unknown as to how each corporation’s going to respond to this news,” Newman says.

Paying out dividends is a possibility, though Newman says there will be a “hair cut” for income trusts regardless once they have to start paying corporate taxes. Privatization is another possibility, but that move is more suited with smaller organizations, Dries says.

“It’s conceivable somebody like ATS Andlauer may decide to privatize, but for the large ones like TransForce and Contrans, I’m not sure privatization is in the works for them,” he says.

Brian Mascarenhas, vice-president and chief financial officer of ATS Andlauer Transportation Services, says that though he doesn’t see the company changing its strategy within the four-year tax shield, the organization is looking into income participating securities (IPS) as a way to possibly tip-toe around the new law.

According to an article in the Nov. 8 edition of The Globe and Mail, with IPS’s, “(t)heoretically, investors can separate the equity and debt portions of their unit and trade them individually, although practically this never happens…In this way, an IPS is comparable to a regular company whose equity and debt trade in the public markets. This makes it more difficult for Ottawa to scrap the structure without creating a ripple effect, say experts.”

Though the IPS route may seem like a quick fix for income trusts looking for a break, analysts are cautioning organizations to tread carefully until the government clarifies how the Tax Fairness Plan will affect IPS’s.

Income trusts in the transportation sector have seen the benefit of mass consolidation in recent months, but will the government’s new plan mean the end of new acquisitions?

Most experts Truck News spoke with say no. In fact, some say that though the nature of consolidation may change, the actual amount of consolidation may increase because of cheap valuations in the industry.

“I think at the end of the day, (more consolidation) is probably a decent thing to the extent that it’s economically efficient and can divide scale and better service,” Newman says.

“Sure, it reduces the competitiveness, but it depends on what field you’re in. If there are enough players out there, they have a competitive field to agree to some consolidation to bring scale and efficiencies.”

Dries says it will be interesting to see whether income trusts rethink their acquisition and growth strategies.

“I would tend to think they will start rolling their (acquisitions) back. They may even go from being buyers to being sellers,” he says. “The sector is clearly consolidating. I think it’ll change the nature by which it consolidates.”

Dries says there are plenty of non-income trusts that are clearly on acquisition trails, especially companies in the freight forwarding sectors.

Transportation companies have proved themselves to be global players as well, Dries says, including FedEx’s recent acquisition of Watkins Motor Lines.

“In the Canadian industry there are a lot of small carriers which I think are going to be consolidated out of sheer necessity,” he says. “It will change the character of the consolidation, but I think the consolidation will continue.”

At least two current income trusts have continued consolidating since the Oct. 31 announcement.

On Nov. 6, Contrans announced the acquisition of Tripar Transportation, while the Mullen Group closed its acquisition of the Brady Group.

But despite the continued expansion of these companies, most analysts believe the movement of corporations to become income trusts has been stopped dead in its tracks.

“There will be no new trusts in my view. Why bother? Why not just be a corporation? The benefits are gone,” Newman says.

Canadian Transportation and Logistics Income Trusts

* Atlas Cold Storage Trust

* ATS Andlauer Income Fund

* Canada Cartage Diversified Income Fund

* Colabor Income Fund

* Contrans Income Fund

* Halterm Income Fund

* Jazz Air Income Fund

* Livingston International Income Fund

* Mullen Group Income Fund

* Oceanex Income Fund

* Student Transportation of America

* TransForce Income Fund

* Trimac Income Fund

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