On September 19, 2005, Minister of Finance Ralph Goodale announced that he has requested the Minister of National Revenue to postpone, with immediate effect, providing advance tax rulings respecting flow-through entities (FTEs), such as income trusts. The request follows the release on September 8, 2005 of the federal government’s consultation paper on the Canadian federal income tax treatment of FTEs.1
Market reaction to this recent announcement has been swift and significant. Much of this reaction seems to be the result of the uncertainty created by Minister Goodale’s announcement. Investors and other market participants are struggling to understand the government’s broader intentions for the continued use of income trusts and other FTEs.
We do not find the announcement surprising. In fact, we expected to see such an announcement in conjunction with the release of the consultation paper. It has long been known that the federal tax authorities have been concerned about the potential impact of conversions of large public companies into income trusts, and recent activity in this area has no doubt caught their attention. Given their underlying concerns, it would be surprising to see the government continue to issue advance tax rulings while engaged in a consultation process to determine what, if any, stance they should take regarding FTEs, from both taxation and overall economic policy perspectives. It is important to understand that, except for issuer-specific reasons, it is not necessary to obtain an advance tax ruling to successfully convert a public company into an income fund (although some issuers seek advance rulings for an extra level of tax-planning comfort).
Advance tax rulings must, however, be obtained for the restructuring of an income fund from a trust-over-corporation to a trust-over-trust structure. A number of offerings have been structured with the public income trust owning shares and debt of a corporation. Although this provides sufficient tax shelter at the outset, it does not do so as the underlying business grows. To deal with this situation more effectively, the public income trust should preferably own its interest in the operating business through an intermediate trust that, in turn, owns an interest in a limited partnership that carries on the business. Converting from a trust-over-corporation to a trust-over-trust-over-limited partnership requires an advance tax ruling. Again, in the context of the announced consultation process, it is not surprising that the issuance of advance tax rulings has been put on hold.
We do not interpret Minister Goodale’s announcement as a general indication that the government wishes to shut down income fund IPOs or follow-on offerings by existing income funds to expand their businesses. We also expect a full analysis of the effect of income funds on the Canadian economy to show a number of significant benefits that will have to be factored into the government’s deliberations. This latest announcement reinforces our earlier suggestion that interested parties take the time to file a submission in response to the government’s consultation paper.
1. Please see Torys’ memo "Department of Finance Consultation Paper on Tax and Other Issues Related to Income Trusts and Limited Partnerships" at www.torys.com//publications/client_memos.aspx.
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