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Canada's Trusts Look To Corporate Status After Tax Decision

by Mike Godfrey,, Washington

22 January 2007

True Energy Trust, a mid-sized exploration and production trust based in Calgary, Canada, has announced that it will be converting into a corporation following Finance Minister Jim Flaherty's controversial decision to impose a new tax on the income trust sector.

In a statement, True said that it has been investigating a number of restructuring alternatives subsequent to the Federal Government’s October 31, 2006 announcement on tax policy regarding income trusts and came to the conclusion that its conversion into a "growth oriented, dividend paying intermediate exploration and production company" would be the best path for the company.

"Based on this review of the alternatives, conversion back to a corporation before 2011 has been determined by management and the board of directors as the best opportunity to enhance unit and asset value over time," the company stated.

Holders of True trust units will receive an equal number of shares of a newly formed corporation that will hold the assets previously held directly or indirectly by the Trust. The exchangeable shares will also be exchanged for common shares based on the conversion ratio thereof. This will result in approximately 70 million shares being issued and outstanding. True’s outstanding convertible debentures will be assumed by the new corporation.

True said that it will also consider any new clarification of the tax legislation in regard to its plans.

The reorganization will be subject to all required regulatory approvals and securityholder approval by at least 66.6% of the votes cast by unitholders of the Trust and holders of the exchangeable shares.

The Canadian government has decided to tax income trusts in an attempt to tackle what it considers a "growing trend toward corporate tax avoidance" caused by the vehicle's more favourable tax treatment compared with the more conventional company structure.

Finance Minister Jim Flaherty has said that his 'Tax Fairness Plan for Canadians' aims to "restore balance and fairness to the federal tax system" by creating a level playing field between income trusts and corporations.

The changes have been prompted by a string of income trust conversions by top Canadian companies, such as Telus Corporation, Canada’s second-largest telecommunications company. The government wants to shut off this "growing trend toward corporate tax avoidance" claiming that the short-term tax breaks created are causing "an economic distortion that is threatening Canada’s long-term economic growth and shifting any future tax burden onto hardworking individuals and families".

There was more than C$70 billion (US$61.83 billion) worth of income trust announcements last year and the sector is said to total C$200 billion - a situation Flaherty said was "not right and not fair".

"It is the responsibility of the Government of Canada to set our nation’s tax policy, not corporate tax planners," he remarked.

Under the tax plan, a 'Distribution Tax' will be applied beginning 2007 to distributions from publicly traded income trusts and limited partnerships set up after the October 31 announcement. Trusts formed prior to this date will benefit from a four-year transition period.

The new tax, which was devised largely without consultation and announced without warning, has caused consternation in Canada's business and investment sector. Several corporations with well-advanced plans towards converting to trust status have been forced to rethink their strategies in the wake of the announcement.

One such company is Telus, Canada's second largest telecoms company, which unveiled plans last September to convert into an income trust primarily to continue benefiting from a long-standing tax break.

Expressing "bemusement" over the government's decision, Telus chief financial officer Robert McFarlane told Canada's Globe and Mail newspaper that Flaherty's decision decision has been "prejudicial" to the company.

"If you're going to treat trusts in a certain manner, all trusts should be treated similarly," he added, noting that investors in Telus would be put at a disadvantage compared with those in companies formed prior to the announcement.

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