My Income Trusts
by Jim Stanford, Economist, Canadian Auto Workers
July 9, 2003
The Globe and Mail recently published an investigative series on income trusts (June 23-28) that shone some badly-needed sunlight onto the dealings of the hottest, but most dubious, segment of Canada's financial industry. Income trusts are now worth $55 billion, and that value could soon double. They account for all of the action - and all the commissions - down on Bay Street these days. Indeed, last year, almost 90 percent of all the IPOs launched on the Toronto Stock Exchange were for income trusts.
Yet the moniker "income trust" is a gruesome misnomer, for these instruments neither guarantee income (many investors think they are just like bonds, but they are wrong) nor inspire trust. They exist for one reason, and one reason alone: to exploit an odd loophole in Canada's tax structure which allows trusts to avoid paying the corporate income tax.
Clever wheelers and dealers are now finding all kinds of ways to bundle existing businesses into trusts, allowing investors to reap a higher return - and generating plum commissions for themselves in the process. The community of trusts reads like a Who's Who of the mundane side of Canada's economy: shopping malls, dockyards, fast food outlets, mattress-makers, propane tankers. But there's nothing mundane about the lucrative financial action the trust boom has inspired. The latest hot prospect: an income trust for - get this - the Yellow Pages, which could fetch up to $1 billion when it closes later this month.
All this is outrageous stuff, but it gets worse. More recent innovations include investment trusts which invest solely in other stocks and bonds, thus allowing purely financial speculators to take advantage of the trust tax loophole. Cross-border income trusts are another new breed, through which foreign investors can establish a trust in Canada, which in turn reinvests in businesses or properties back in the host country. This allows foreign investors to exploit the Canadian tax loophole, even on assets that aren't located in Canada. The only requirement is that the foreign investors lure in enough Canadian partners to qualify as a tax-exempt Canadian trust.
Management fees for income trusts are typically both secretive and exorbitant. The latest trend features unitholders paying outrageous up-front sums to Bay Street insiders to "internalize" overpriced management contracts, revealing a lucrative and audacious corruption more fitting of Ceaucescu's Romania than modern Canada.
Most of all, the whole craze gives the lie to Bay Street's long-standing claim to be the "handmaiden" of growth and innovation in our economy. In theory, those well-paid money managers are matching innovative, growing companies with the capital they need to finance their growth. This claim is vastly overstated at the best of times, but completely incredible in the case of income trusts.
Mundane, existing businesses are simply being given a new packaging, exploiting a tax loophole and generating business for a commission-starved brokerage set longing for a bull market in just about anything. And the whole point of the trusts is precisely to pay out as much cash as possible to investors - not to reinvest it in "growth" or "innovation."
Income trusts have facilitated the avoidance of hundreds of millions, perhaps billions, of dollars in corporate taxes. But is there a single redeeming feature of this financial practice from an economic or social perspective? Will my next Yellow Pages directory somehow be more efficient or readable thanks to all this expensive financial intermediation?
Sure, I can sit back and take potshots at this latest manifestation of the frenetic but useless hyperactivity of Bay Street. Or I can jump right in and join the party. I once tried to launch my own IPO - Jim.com (see http://www.caw.ca/news/factsfromthefringe/issue17.asp) - at the height of the dot-com craze. It failed miserably. Let's see if I have any more luck with this latest fad:
Jim's Waterheater Fund. This fund will be modeled on the Consumers' Waterheater Fund. I currently pay ten bucks a month to the gas company for my existing waterheater. Forget that action: I'll start my own income trust, and pay myself tax-free for all those nice hot showers I take.
Jim's Cottage Dock Trust. This one's modeled after the trust that runs the Halifax dockyards. I'll charge big bucks for every cruise ship or cargo carrier that ties up at my lakeside dock, then distribute all the resulting income to my unitholders. No dockings, no distributions. But in any event I will carefully manage the whole process from my favourite reclining chair, right out there on the pier - for a suitable management fee, of course.
Jim's Cholesterol-Reduction Income Trust: The A&W royalty fund pays distributions based on the sale of Papa Burgers and related sundries. But my doctor says I have to stop eating fast food. So for every Papa Burger combo I don't eat, I will pay $4.99 into the fund. Distributions will be tied to my quarterly cholesterol readings.
Jim's Place REIT: Sure, Bay Street already makes good money from my real estate the old-fashioned way: off my mortgage. But why stop there? I'll re-bundle my circa-1870 home in Toronto's hot Roncesvalles district as a "heritage landmark trust." The trust's management (that's me) will collect a suitably secretive portfolio of management fees, based on indicators like the length of the grass in the back yard and the state of the paint job.
I'm offering 100,000 units in each trust for a nice round $10 apiece. Buy into three and I'll give you the fourth for free. The units will be hot-sellers, so buy early and buy often. Because sooner or later some enterprising and determined federal politician - a former finance minister, perhaps? - is going to close this loophole and consign the whole shell game to the historical oblivion it richly deserves. So we might as well get while the getting's good.
A version of this article appeared in the Globe and Mail. Read the prospectus carefully before investing in my income trusts - or any other.
Thursday, April 23, 2009
Posted by Fillibluster at 4:39 PM