Income Trust Market Update

June 02, 2009

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Economic Outlook for Income Trusts

Decisions with respect to any particular income trust will depend in part on the economic outlook for the economy as a whole and the relevant sector in particular. While there are always uncertainties about any forecast, it is clear that Canadian economic growth will be negative in the order of minus-three percent in 2009 and weakly positive in the order of one-and-a-half to two percent in 2010. Inflation is likely to remain below the Bank of Canada target in 2009 and 2010 and hence the policy interest rate is likely to remain extremely low at least through this period. Growth in 2011 and 2012 is likely to be stronger but excess capacity is unlikely to be eliminated much before the latter part of 2012. The best planning assumption is for the Canadian economy to be operating at capacity in 2013 and for global demand for commodities to be strong once again.

David A. Dodge, O.C., Senior Advisor at Bennett Jones LLP, Former Governor of the Bank of Canada

At the height of the income trust boom, there were more than 250 publicly-traded income trusts in Canada with a total market capitalization in excess of $200 billion. Today, just under 200 trusts remain, with a total market capitalization of less than $100 billion.

The tax changes announced in October 2006, which will prevent income trusts (other than certain qualifying REITs) from continuing to deduct income distributions for tax purposes, become effective in 2011. Since the introduction of tax legislation in July 2008 to facilitate tax-deferred conversions, approximately 15 income trusts have converted or announced their intention to do so. Though management and trustees of income trusts will, by now, have given preliminary consideration to conversion, many have deferred making a final decision until closer to the end of 2010 in the face of current economic and market conditions.

Deadline for Conversion Decision

Publicly-traded income trusts in existence on October 31, 2006 can still continue to enjoy the tax-free holiday on income distributed to unitholders until the end of 2010 provided that the “normal growth” guidelines are not exceeded. After that time, the effective rate of tax for these trusts will approximate that applicable to corporations and income will, effectively, be distributed to unitholders as dividends.

The tax conversion rules permit these trusts to convert to corporations on a tax-deferred basis at any time up to the end of 2012 and, depending upon the conversion method selected, to transfer the tax attributes of the income trust to the new corporation. Depending upon a trust's particular tax situation, it may defer a conversion decision until the end of 2012 if the impact of the tax change during the preceding two-year period is not expected to be material.

Alternatives Available

There are many considerations to be taken into account in determining whether to convert now, the most important question being whether the non-tax benefits of immediate conversion outweigh the benefit to the income trust of the remaining 18 months of tax holiday. However, depending upon the income trust's business strategy, financial and market outlook and other considerations, there may be other more attractive alternatives to conversion, such as putting the income trust up for sale, merging with another income trust, being taken private by a significant unitholder or a management-led buy-out, converting to a U.S. master limited partnership if there are significant U.S. unitholders or assets, or “staying the course” and restructuring to achieve tax efficiency prior to 2011.

Convert Now

Key reasons for deciding to convert now include: ??

Wait and See

Reasons an income trust may defer a conversion decision until closer to the end of 2010, apart from losing the tax holiday, include:

Stay the Course

And finally, if there are no significant benefits to conversion, an income trust might stay the course and not convert, but structure its affairs to remain as tax efficient as possible. However, in making such decision the trust must consider: ??

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