Canada's income trusts: New deal flow, new rule bookChanges to taxation create opportunities for private equity |
Proposed new tax rules for income trusts in Canada mean a changing deal landscape for private equity investors. Until legislative changes were announced late last year, income trusts had served as a liquidity vehicle for privately owned companies, making them a competitor to private equity investors. Income trusts also served as an exit vehicle for private equity funds. But with income trusts likely to lose their tax advantage over corporations in 2011, new deal opportunities have been created in the M&A market in Canada — as well as a host of considerations to keep in mind when evaluating those opportunities.
Unique due diligence considerations
The Canadian trust marketplace is limited; only about 150 business trusts exist. They are in a wide range of industries including manufacturing, media, food service and technology; capitalization ranges from millions to billions. How can private equity investors assess opportunities? In addition to evaluating the operations and nature of the assets for investment and growth potential, they must also understand the legacy impact of the income trust structure.
Income trusts fall outside the corporate rule book, and there is limited takeover market experience. Therefore, it is critical that private equity investors understand the rights and privileges of the unitholders — as well as the structure of the trust. Key considerations include:
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What are the exact tax attributes of the income trust? In the past, these considerations were not as relevant. Because of proposed tax changes, income trusts need to firm up their tax pools and develop a strategy to optimize their tax position.
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What are the exact terms of the "trust indenture"? Corporate legislation is not applicable to trusts, and the trust indentures outline the rights of the unitholders and other relevant items to a takeover.
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Unwinding the trust structure in the course of a takeover: Because of the complexity of unwinding a trust structure, understanding the tax implications is a must. In contrast to the corporate market, for example, there have been a number of transactions where the business has been acquired directly from the trust, rather than by an outright purchase of trust units from individual unitholders. This allows the purchaser to avoid the consequences of unwinding the trust, as well as assuming its historical tax obligations.
Deloitte has advised on a number of these complex transactions, helping investors to fully understand the unfamiliar structure and unitholder implications of their income trust targets. The Canadian market is attractive to domestic and foreign investors alike — who see tremendous value in using their capital to unleash the potential that may be constrained by new tax legislation. Although the future of income trusts as a vehicle in Canada is uncertain, one thing is for sure. Now is the time for private equity investors to take advantage of this great value opportunity.