I agree with the Canada's decision to effectively eliminate income trusts. The problem with trusts is that too much tax revenue is bled off to others. As a consequence, individual Canadians were left to shoulder the burden. Now that the rules have been changed, corporations and trusts will pay their fair share.
I do not think the prices of the trust units have fully factored the new tax regime. As an example, Canadian Oil Sands Trust (COS-UN) fell C$3.01 to C$27.41 for a 9.89 percent drop. Given that the trust will start paying taxes of 32% in 2011, I think that drop underestimates the net effects.
Some might argue, as CIBC World Markets has, that cash taxes will not be 32%. The following was quoted from a CIBC Equity Research Report issued today.
This best case scenario is supported by looking at the after-tax impact to our NAV estimates under varying current tax rates in 2011 and beyond. Given a view that essentially all of the trusts in our universe will maintain active capital spending levels under the new tax regime (and therefore will reduce the effective corporate tax rate from 31.5% to a lower figure through the generation of tax pools), we estimate that effective tax cash rates will fall in the 15%-25% range by 2011 for the majority of trusts in our universe.
For oil sands companies, most of their capital, about 95 percent, is classified as CCA 41A capital. CCA 41A capital qualifies for immediate write-off subject to certain rules. Essentially, as soon as the project reaches payout, in four to seven years after construction, 41A is depleted and there is very little capital remaining in the capital pools. There will be some CEE and CDE, Canadian Exploration and Canadian Development Expenses, remaining tax pools. But after payout almost all of the capital will have been written off for taxation purposes. Thus, intuitively I would argue that the effective cash tax rate for oil sands companies will be much closer to 32 percent than to 15 percent.
In direct reference to Canadian Oil Sands Trust, I doubt it will exist much beyond 2011. The current management offer absolutely nothing. Until last night, the trust offered tax efficiency and thus a price premium. After 2011, that sole advantage will be gone. Now that the trust will be on a level playing field with similar oil sands companies, I expect some other company looking for reserves will buy Canadian Oil Sands Trust.
In summary, I am not sure that prices have fully factored in the new reality of higher tax rates. And I expect those trusts, which are completely passive vehicles, might become take-over candidates for other companies seeking growth or reserves.
