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The Taxing Issue of Energy Trusts

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The Taxing Issue of Energy Trusts THE TAXING ISSUE OF ENERGY TRUSTS by Lesley Sun-Ju Kim A thesis submitted in conformity with the requirements for the degree of Master of Laws Graduate Department of the Faculty of Law University of Toronto © Copyright by Lesley Sun-Ju Kim 2008 Library and Bibliotheque et 1*1 Archives Canada Archives Canada Published Heritage Direction du Branch Patrimoine de I'edition 395 Wellington Street 395, rue Wellington Ottawa ON K1A0N4 Ottawa ON K1A0N4 Canada Canada Your file Votre reference ISBN: 978-0-494-45071-0 Our file Notre reference ISBN: 978-0-494-45071-0 NOTICE: AVIS: The author has granted a non­ L'auteur a accorde une licence non exclusive exclusive license allowing Library permettant a la Bibliotheque et Archives and Archives Canada to reproduce, Canada de reproduire, publier, archiver, publish, archive, preserve, conserve, sauvegarder, conserver, transmettre au public communicate to the public by par telecommunication ou par Plntemet, prefer, telecommunication or on the Internet, distribuer et vendre des theses partout dans loan, distribute and sell theses le monde, a des fins commerciales ou autres, worldwide, for commercial or non­ sur support microforme, papier, electronique commercial purposes, in microform, et/ou autres formats. paper, electronic and/or any other formats. The author retains copyright L'auteur conserve la propriete du droit d'auteur ownership and moral rights in et des droits moraux qui protege cette these. this thesis. Neither the thesis Ni la these ni des extraits substantiels de nor substantial extracts from it celle-ci ne doivent etre imprimes ou autrement may be printed or otherwise reproduits sans son autorisation. reproduced without the author's permission. In compliance with the Canadian Conformement a la loi canadienne Privacy Act some supporting sur la protection de la vie privee, forms may have been removed quelques formulaires secondaires from this thesis. ont ete enleves de cette these. While these forms may be included Bien que ces formulaires in the document page count, aient inclus dans la pagination, their removal does not represent il n'y aura aucun contenu manquant. any loss of content from the thesis. Canada ABSTRACT THE TAXING ISSUE OF ENERGY TRUSTS Master of Laws 2008 Convocation Lesley Sun-Ju Kim Faculty of Law, Graduate Department University of Toronto The federal government announced the Tax Fairness Plan (the "Plan") on October 31, 2006. Under the Plan, income trusts are taxed in much the same manner as corporations, thereby losing the flow-through tax advantages previously associated with this structure. In this thesis I argue that energy trusts should be able to retain these tax advantages associated with the income trust form. In Part II, I describe these tax advantages, with a focus on foreign investors and tax exempt entities. In Part III, I explain the operation of the Plan and describe the way in which it interferes with these tax advantages. In Part IV, I explain tax expenditures and canvass the arguments for and against retaining these tax advantages for energy trusts. In Part V, I conclude that it is good public policy to exempt energy trusts from the Plan and retain the tax advantages of the income trust structure. ii THE TAXING ISSUE OF ENERGY TRUSTS TABLE OF CONTENTS I. Introduction 1 II. The Tax Advantages of Income Trusts 8 A. Foreign Investors 18 B. Tax Exempt Entities 32 III. The "Fairness Plan" 35 IV. Are Tax Advantages for Energy Trusts Good Public Policy? 41 A. The Case in Support of Energy Trust Tax Advantages 44 B. The Case Against Energy Trust Tax Advantages 56 C. Weighing the Arguments for a Carve-Out for Energy Trusts 65 V. Conclusion 76 VI. Appendices a VII. Bibliography e iii LIST OF APPENDICES I. Income Trust Buyouts After Income Trust Tax Announcement a II. Income Trust Equity Financings d iv 1 I. INTRODUCTION On October 31, 2006 the Minister of Finance, Jim Flaherty (the "Minister") introduced the new "Tax Fairness Plan" (the "Plan") for Canadians. As a result, the tax benefits previously enjoyed by the income trust sector are expected to come to a close at the end of 2011.1 Income trusts essentially flow income through to their unitholders free of entity-level tax. However, under the Plan, the tax treatment of certain publicly traded flow through entities, also known as income trusts, will be more like that of Canadian public corporations, and their investors will be taxed more like shareholders. In announcing the Plan, the Minister stated that corporations converting to the trust structure "don't pay their share of taxes" and if trusts were to continue to proliferate, "the tax burden will shift onto the shoulders of hardworking individuals and families."3 In this thesis, I argue that the federal government unwisely included energy trusts in its Plan to tax income trusts like conventional publicly-traded corporations. In the 10 years leading up to the October 31, 2006 announcement, publicly listed income trusts, and the trust sector more generally, have gained popularity as investment vehicles. From 2000 to 2006 in particular, there had been sharp growth in the income trust sector. In 2005, prior to the Plan's announcement, the 227 income trusts trading on the Toronto Stock Exchange (the "TSX") represented 10 per cent or $176 billion of the quoted market value of all securities listed on the TSX (the quoted market value has been as high as $200 billion).4 By number of issuers, income trusts comprised 15 per cent of 1 Department of Finance Canada, New Release/Communique\ "Statement by the Honourable Jim Flaherty, Minister of Finance" (31 October 2006) online: <http://www.fin.gc.ca/news06/06-061 le.htrnl> [Department of Finance, Flaherty]. 2 KPMG, "Current Developments: Income Trusts and Real Estate Investment Trusts" (November 2006) online: KPMG <http://www.kpmg.ca/en/services/audit/documents/itreitNov2006.pdf> at 2 [KPMG]. 3 Department if Finance, Flaherty, supra note 1. 4 Toronto Stock Exchange, "Income Trusts on Toronto Stock Exchange (TSX)" (2005) at 3[TSX]. 2 all listed issuers;5 just before the Plan was announced the number of income trusts trading on the TSX reached 256.6 This asset class is comprised of energy trusts, business trusts, REITs and power and pipeline.7 In September 2005, income trusts represented 39 per cent of equity capital raised on the TSX, 31 per cent of initial public offering ("IPO") dollars, and 22 per cent of new listings.8 Energy trusts had contributed 46 per cent or $80 billion of the quoted market value in 2005, but of the 227 trusts that had been trading on the TSX, only 38 were energy trusts (17 per cent of all TSX traded trusts).9 Thus energy trusts proportionately raise more capital than other forms of income trusts. Compare these numbers to business trusts: in 2005, they contributed 31 per cent of the quoted market value but there were 144 business trusts which comprised 63 per cent of the 227 income trusts trading on the TSX.10 More recently, from the time of the Plan's announcement to March 31, 2008, 47 income trusts have shut down leaving approximately 212 income trusts listed on the TSX.11 Income trusts are headquartered throughout Canada, but by quoted market value, before the Plan was announced, 63 per cent were based in Alberta. The rest were headquartered as follows: 21 per cent in Ontario, 9 per cent in Quebec, 6 per cent in other 5 Ibid. ° Deloitte, "Income Trust Buyouts: Lots of Activity, Little Tax Revenue" (December 2007) online: <http://www.deloitte.eom/dtt/article/0,1002,sid=3634&cid= 177044,00.html? WT.mc_id=caen_theme_IT> [Deloitte, Income Trust Buyouts]. TSX, supra note 4 at 3. * TSX, supra note 4 at 3. 9 TSX, supra note 4 at 3. 10 TSX, supra note 4 at 3. 11 TSX Group. "Listings: Canadian Income Trusts" (5 June 2008) online: <http://www.tsx.coni/en/listmgs/sector^rofiles/income_trusts/index.html> [TSX, Canadian Income Trusts]. provinces and 1 per cent are in the US.12 Because Alberta has the largest oil and gas reserves in the country, these statistics help to demonstrate how important the income trust structure has been to the oil and gas industry. Prior to the Plan, royalty trusts produced about 11 per cent of the oil and 23 per cent of the natural gas in Canada and had a combined market capitalization of $34 billion.13 As a result of this rapid growth in the income trust sector,14 the Plan, with its new income trust tax was announced. The Minister stated that the introduction of the income trust tax was in response to the growing trend towards corporate tax avoidance.15 The 2006 announcements by Telus Corp. and BCE Inc.16 of their intention to convert into income trusts appear to have been the catalyst for the Minister to announce this new tax.17 "[I]t goes almost without saying that to be effective a tax base must be politically acceptable." However, while a majority government can always force amendments to legislation,19 the Conservative Party currently forms the smallest minority government in Canadian history. Therefore, the final fate of the income trust tax remains somewhat precarious, though as time goes on, the likelihood that the tax will be repealed by a 12 TSX, supra note 4 at 3. " J. Alex Tarquinio, "Not and oil baron? You can still get oil royalties" The New York Times (17 October 2004), online: New York Times < http://www.nytimes.com/2004/10/17/business/yourmoney/17ener.html>. 14 Department of Finance Canada, Consultation Paper, "Tax and Other Issues Related to Flow-Through Entities (Income Trusts and Limited Partnerships)" (September 2005) [Department of Finance, Consultation Paper] at 3.
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