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Canadian Business Trust

Canadian Business Trust. Betty Ho Stephen Wasmuth Greg Logan Stella Li. Canadian Business Trust. Agenda: Introduction (pre-October 31 st 2006) Event on October 31 st. Business Trusts to be Analyzed. Stephen – Inter Pipeline Fund . Greg – Yellow pages Income Fund.

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Canadian Business Trust

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  1. Canadian Business Trust Betty Ho Stephen Wasmuth Greg Logan Stella Li

  2. Canadian Business Trust Agenda: • Introduction (pre-October 31st 2006) • Event on October 31st

  3. Business Trusts to be Analyzed • Stephen – Inter Pipeline Fund • Greg – Yellow pages Income Fund • Stella – Boston Pizza Royalty Fund

  4. Introduction of Income Trust • A legal entity traded on securities exchange like stocks ending with the .UN symbol • Hold income-producing assets • Debt or Equity instruments • Royalty Interests • Real Properties • Monthly or quarterly distribution (6%-30% annually) in the form of interest, royalty or lease payments • Payout to investors on a tax-efficient basis • Also known as Income Funds, Unit Trusts, Investment Trusts

  5. History of Income Trusts 1985 First business trust conversion(Enermark Income Fund) 1986-1997 Energy trusts and REIT trusts 1998-2000 Trust was neglected 2001 Income trust rediscovered 2002 S&P and TSX commenced 3 Trust Indices 2003-2004 Establishment of limited liability 2005-2006 S&P announces inclusion of trusts in S&P/TSX Composite Index

  6. History of Income Trusts Graph from TSX website

  7. History of Income Trusts Chart taken from globeinvestor

  8. Types of Income Trust Proportion of trusts per type based on Total number of trusts = 247 • Business Trusts • REITs • Resource Trusts • Utility Trusts

  9. Characteristics of an Business Income Trust • Mature business cycle • Require limited capital maintenance • Stable cash flows (cash/trust units) • Companies with basic sets of transactions, year after year

  10. Businesses that are Income Trusts

  11. Typical Investors of Income Trust • Large investor groups (Canadian Pension Plan /Ontario Teachers Pension Plan) • Individual investors • Those who want stable cash flow • Retirees or baby boomers preparing for retirement

  12. How Does it Operate? Unitholders Unitholders provide funds to the trust. The trust uses these funds to invest in income generating assets. The asset pays a return to the trust. Trust Unitholders receive cash distributions and return on capital Corporation Figure taken from www.fin.ge.ca

  13. Reasons to Invest in Income Trusts • Potential higher yield than bonds • The flow-through tax-efficient structure generally gives higher distributions than dividends • It provides income distribution and potential gain in value • When interest rates are low

  14. Reasons to Convert to Income Trust • Reduction in corporate tax • Raise capital while retaining control • Deleveraging • Management discipline • More efficiency in cash flow allocation • Elimination of “adverse investment incentives” • An announce of intention to convert can increase share price

  15. Reasons to convert to Income Trust

  16. Risks for Investors • Lack of Diversification • Surrendering growth opportunity • No guarantees in distributions or return on capital • Sustainable tax benefits is not certain • Limited liability • Volatility

  17. Risks for Converting Companies • Slow down in growth opportunity • Interest rate movements • Compatibility with business industry • Companies may need to retain some capital

  18. Governance of Business Trusts • Declarations of trust (DOTs) • Canadian Securities Administrators (CSA) • Policy 41-201 • Interim and annual MD&A • Ontario’s Securities Act • Internal audit committee

  19. Declaration of Trust • Defined: An agreement between the trustees of the trust • Type of business • Operation of trust • Rights of unitholders • Rules and provisions

  20. National Policy 41 – 201 Income Trusts and Other Indirect Offerings • Purpose: to indicate how existing regulations apply to non-corporate issuers • Provides guidance and recommendations on disclosure, accountability and liability for insider trading • Vendor liability • Stability ratings • Prospectus disclosure

  21. Disclosure and Prospectus Requirements • Required – Public companies/sole holder of majority of units • Source of funding (current and future) • Specific risk • Impact of risk • Approaches to diminish risk • Goodwill calculation • Executive compensation • Restrictive financial covenant • Done on a timely basis

  22. Taxation of Income Trust - Basics Resident Unitholders Non-resident Unitholders Tax-exempt Unitholders Income from trust = $39 Tax (38%) = $14.82 Income from trust = $22 Tax (15%) = $3.30 Income from trust = $39 Tax (0%) = $0 Trust Income from corp. = $100 Tax (45%) = $0 Corporation Business income = $100 Tax (35%) = $0

  23. Taxation of Income Trust Example from www.fin.gc.ca

  24. Taxation of Income Trust • Income Tax Act under Mutual Funds • Funds retained in trusts are taxed heavily • Federal tax = 29% • Provincial tax = 45% average (on federal tax payable) • Ex. if earnings were $100, federal tax=$29; provincial tax is 45% x $29=$13.05 • Funds retained in companies are taxed at corporate rates • Trust can payout higher than their income in the form of dividends

  25. Issues • Loss in tax revenue • Growth in Canada • Others

  26. Canadian Business Trust Issues – Loss in tax revenue • Estimated loss in revenue of $300 million • Government action • Increase tax on trust • Limit amount of trust investment in pension funds • Increase Dividend Tax Credit • Market response • Lost of $23 billion • Recovered • Jack Mintz of University of Toronto vs. CAIF

  27. Canadian Business Trust Issues – Growth in Canada • “Trust misallocate capital, the savings of Canadians and that capital is the primary source of our economic growth” ~Peter Godsoe, former chairman and CEO of Bank of Nova Scotia • Canada’s competitiveness at danger • No retained earning for capital expenditures (plant/equipment/technology)

  28. Canadian Business Trust Issues – others • Disclosures and Accounting methods • 85% of business trust have accounting issues • CSA reports • Trust funding distributions through L/T credit facilities and reserves • Management must match distribution • Yield are matched to competitors • Not according to corporate model • Lack of flexibility in management • Good? • Debt covenants are not required to be disclosed • High yields are comparable to junk bonds • “Canadian junk trust market”

  29. What happened on Oct 31, 2006?!?

  30. “Tax Fairness Plan” • Distribution Tax • Decrease in Corporate Income Tax of 0.5% in 2011 • Increase in Age credit amount by $1000 • Permission for income splitting for pensioners starting 2007

  31. “Tax Fairness Plan” – Distribution Tax “Specific Investment Flow-Through” (SIFT) • When trust is resident of Canada • Trust units are of OR have investments in a stock exchange or other public market • When the trust holds one or more “non-portfolio properties” • Canadian Corporation, Resource properties, Timber Resource properties and Real properties, investments (2 conditions) • Non-portfolio earnings • Business income in Canada • Income or capital gains from “non-portfolio properties” • Not dividends received • No more deduction allowed

  32. “Tax Fairness Plan” – Distribution Tax Table 6: SIFT Tax Rates: Distributed Non-Portfolio Earnings, 2007-2011 **Those amount that is not distributed will be taxed at the ordinary federal and provincial rate. Table from www.fin.bc.ca

  33. “Tax Fairness Plan” Decrease of Corporate Income Tax rate. Table 3: Federal Corporate Income Tax Rates, 2007-2011 Table from www.fin.bc.ca

  34. “Tax Fairness Plan” Increase of Age credit • Only significant for 65 years or older • Increase of phase out rate • Help low to middle class seniors

  35. “Tax Fairness Plan” Pension income splitting • Allow those that qualify for pension income tax credit to transfer this credit to spouse

  36. “Tax Fairness Plan” • New Income Trusts (after Oct 31, 2006) • This applies on 2007 taxation year • Existing Income Trusts • This applies on 2011 taxation year

  37. “Tax Fairness Plan” Table 2: Simplified Comparison of Investor Tax Rates in 2011 Table from www.fin.bc.ca

  38. Impact of “Tax Fairness Plan”

  39. Impact of “Tax Fairness Plan”

  40. “Tax Fairness Plan” In conclusion

  41. Inter Pipeline Fund (IPL.UN) Market Cap $1.7 Billion

  42. IPL.UN – One Year (Daily) P/E≈ 15 P/E = 12.20 P/E Expansion?

  43. IPL.UN – 5 year (weekly) Earnings Growth?

  44. Company Overview • Created 1997 in Calgary Alberta • Owns and Operates four business segments: • Conventional Gathering • Oil Sands Transportation • NGL Extraction • Simon Storage Limited

  45. Conventional Gathering • Transported approx. 201,400 b/d of crude in 2005 • Moves crude oil from producer owned batteries and truck terminals to key market hubs is Alberta and Saskatchewan.

  46. Oil Sands Transportation • Sole transporter of Cold Lake bitumen production. • It has the capacity to transport 435,000 b/d • Can be cost effectively expanded to 705,000 b/d.

  47. NGL Extraction • Processes pipeline quality natural gas to remove natural gas liquids (NGL) comprised of ethane, propane, butanes and pentanes-plus • Uses shrinkage gas, profit comes from spread between selling all NGL’s seperately and the cost Shrinkage Gas.

  48. NGL Extraction con’t • Inter Pipeline's extraction business consists of 100% ownership interests in the Cochrane and Empress II Plants and a 50% ownership interest in the Empress V Plant • NGL’s are generally used directly as an energy product and as a feedstock for the petrochemical and crude oil refining industries.

  49. Simon Storage Limited • Wholly owned subsidiary of Inter Pipeline Fund • Multi site operator of bulk liquid storage, handling and distribution in the United Kingdom, Germany and Ireland • On January 1, 2006 Simon acquired Tanklager-Gesellschaft (TLG) (2nd largest independent petrochemical storage business in germany.

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