Written By Bernard Morris, Greg M. Johnson, Kathleen L. Keller-Hobson, John H. Kousinioris

Determining whether to convert to a corporation or pursue another alternative is complex. In assessing the merits and timing of such a decision, management and trustees of an income trust must consider a number of factors, particularly strategic, tax, financial, market and legal considerations. Here are some key questions to ask in making a decision as to the best alternative:

Strategic

• What is the income trust's business strategy? does it want to grow through acquisitions or organically?
   
• Is the income trust encountering liquidity problems, making a sale more attractive?
   
• Does the income trust want the ability to issue equity securities as consideration for an acquisition?
   
• Will conversion permit more tax-efficient acquisitions?
   
• What is the level of foreign investment? Are increasing foreign investors putting at risk the income trust's favourable status as a "mutual fund trust"?
   
• Will conversion make the income trust a more likely take-over target?

Tax

• How much is the value of continuing the tax-free holiday on distributions until the end of 2010?
   
• Will a reduction in distributions reduce the benefit of the tax-free holiday?
   
• Will the income trust's forecast growth exceed the "normal growth" guidelines?
   
• What will be the tax treatment of the income trust and subsidiary entities after 2010? Will conversion result in an acquisition of control of corporate subsidiary entities?
   
• What will be the tax implications of conversion for unitholders (residents, non-residents and tax exempts) and holders of options and retained interests?
   
• What will be the tax implications of conversion for holders of subordinated debt? Has the debt declined in value since issuance, which may give rise to debt forgiveness issues?
   
• Does the income trust have other bases (e.g., tax depreciation, tax pools, tax losses, resource expenses and undeducted financing expenses) on which to reduce taxable income if it converts?
   
• Can the income trust return capital rather than distribute income (e.g., through the use of resource expenses) thereby avoiding the tax on distributions?
   
• Can the income trust implement other tax planning to reduce taxable income (e.g., by leveraging the business or effecting a conversion with a corporation with tax losses)?
   
• To what extent does the income trust have foreign source income (e.g., foreign oil and gas properties)?

Financial

• What is the income trust's expected financial performance? does it expect to continue or vary future distributions?
   
• Will the income trust need to reduce distributions to fund acquisitions, capital expenditures or operating costs?
   
• Will the cost of a conversion have a significant impact on cash flow?
   
• If the income trust converts, to what extent will after-tax income of the new corporation be less than current distributable income?
   
• What will be the new corporation's dividend policy? How will this affect market value?

Markets

• How does the income trust's trading price compare to other income trusts or corporations in similar industries or with similar market capitalization? Will there continue to be investor demand for units?
   
• What factors, if any, determine the unit valuation other than income distribution levels?
   
• How will conversion or announcement of conversion impact the trading price? Will this impact the exchange rate for outstanding convertible bonds of the income trust?
   
• What is the income trust's investor base? Will reduction or suspension of distributions or announcement of conversion result in significant churn in the units? Could this make the income trust a more likely take-over target?
   
• Does the income trust require capital for acquisitions, capital expenditures or operating costs? Will the income trust be able to access capital?
   
• What will be the income trust's cost of capital compared to that of a dividend-paying corporation?
   
• Would the ability to access foreign capital markets improve the availability of capital, reduce the cost of capital or improve liquidity?
   
• Does the income trust have publicly-traded debt? What modifications will be required to accommodate the conversion and at what price (both cost and risk of approval)?
   
• Is the market capitalization of the income trust sufficient to warrant it continuing to bear the cost and obligations of being a listed, reporting issuer? Is there sufficient liquidity in the units?

Legal

• Will conversion trigger "change of control" provisions (e.g., such as in credit facilities, publicly-traded debt and compensation arrangements)?
   
• Are the financial entitlements of holders of retained interests subordinated to unitholders? How will conversion of retained interests affect the financial interests of existing unitholders?
   
• Do holders of retained interests have voting or veto rights which will impact structure and approval?
   
• Are there management contracts with founders or sponsors? How will they be impacted by conversion or acquisition?
   
• What rights of a holder of a retained interest should continue after conversion (e.g., special voting or veto rights, rights to nominate directors and other rights embedded in an existing shareholder agreement between the holder of the retained interest and the income trust in respect of ownership of the operating subsidiary)?
   
• What level of approval is required by unitholders? Will "majority of minority" approval be required? Will debtholder approval be required?
   
• Do market conditions or other circumstances mean unitholders are likely to oppose conversion or exercise dissent rights?
   
• Are there perceived or potential conflicts on the board of trustees, making a special committee of independent directors appropriate?