Sun Sets on B.C. Income Funds

New tax rules have ?prompted B.C. income funds to reinvent themselves. (Return to B.C.'s Top 100 of 2011.)

A&W Revenue Royalties Income Fund
A&W Revenue Royalties Income Fund is one of the holdouts, and has not converted to a corporation.

New tax rules have 
prompted B.C. income funds to reinvent themselves. (Return to B.C.’s Top 100 of 2011.)

Jan. 1, 2011, was the deadline set by the federal government for income funds to convert into regular companies. This year’s list of the top 100 companies bears testimony to the changes, with veteran funds such as Swiss Water Decaffeinated Coffee Income Fund, Tree Island Wire Income Fund and PRT Forest Regeneration Income Fund reporting as regular corporations. By next year, our list will be devoid of most income funds, save for real estate investment trusts (REITs), which are largely exempt from the changes.

Finance Minister Jim Flaherty announced the changes on Oct. 31, 2006, a year after his predecessor rejected similar action. The federal government was absorbing a significant hit to tax revenues as a growing number of public companies – including, at the time, telecom giants Telus Corp. and Bell Canada – embraced income trusts. Many companies were establishing the trusts to funnel profits through to shareholders. Trust income was taxed at a lower rate than corporate profits and dividends, giving the companies more cash to distribute to unit holders, who were in turn taxed at a lower rate. The trusts became favoured havens for corporate cash, while investors appreciated the higher yield the trusts typically offered. Ottawa, on the other hand, wanted its cash too.

One by one, the trusts began converting, slowly at first and then en masse as the deadline approached. Tree Island Wire Income Fund became Tree Island Industries Ltd., Sterling Shoes Income Fund reverted to Sterling Shoes Inc. and Swiss Water Decaffeinated Coffee Income Fund became Ten Peaks Coffee Co. Inc.

“It would have been a disadvantage to us – quite a considerable disadvantage – if we didn’t convert back, because we would have been taxable at the corporate level and the income-trust level,” says Sherry Tryssenaar, CFO for Ten Peaks. “It would have been one of the worst possible scenarios for our shareholders.”

One observer says the transition Ten Peaks and other B.C. funds have made won’t have much of an impact on the corporate landscape. “It’s status quo. They basically go from being trusts to corporations, and the symbol changes, but other than that the underlying business doesn’t change,” says Richard Liley, Canadian equities analyst at Leith Wheeler Investment Counsel Ltd. in Vancouver.

The disappearance of the funds has been gradual and steady, says Liley, and the funds based in B.C. tended to be smaller players than the large funds Leith Wheeler typically sought. The firm typically acquired positions in companies with market caps of $400 million and greater, such as Calgary’s Pengrowth Energy Trust and Baytex Energy Trust (which have both converted to corporations now).

One of the holdouts is A&W Revenue Royalties Income Fund, which CFO Don Leslie believes continues to serve its purpose as a trust after minor structural changes. Unlike other trusts, the A&W fund launched in 2002 not as a flow-through entity for A&W revenues but as an entity to hold the trademarks and brands of the popular fast-food chain.

While profits from A&W restaurants are subject to the 25 per cent corporate tax rate, revenues from the licensed use of the A&W brand and trademarks are taxed at the 18 per cent rate applied to trust income. “[It] gives us more money to be able to pay out to our unit holders,” Leslie explains. “It’s more effective for us to stay as a trust than to convert that trademark entity to a corporation.”

Leslie and Tryssenaar agree that the demand for trust units remains high, even as the sun sets on the income funds of the past decade. Trust units deliver high yields to investors, and the demand for yields is as great as ever.

“Based on our valuation, which was very strong, it seemed like there were a lot of investors still interested in investing in ours, and that was reinforced when we did a secondary offering in February of this year, where we sold $70 million of additional trust units to investors,” Leslie says.

Swiss Water, for its part, used the abandonment of its trust structure to restructure the company and rebrand itself. Swiss Water remains the name of the decaffeination business, but the Ten Peaks name lends a contemporary, western Canadian moniker to the overall operations. The name is a nod to the peaks above Moraine Lake in the Rocky Mountains. “We took the opportunity to change our name as well because we consider ourselves a specialty coffee company, even though our primary business is in decaffeination,” Tryssenaar explains. 

Response from investors during a recent road trip was positive, she says: “People anticipated that there would be changes, and they were seeing other income trusts convert, so I don’t think it was a surprise.”