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The trouble with income trusts

Edgar, Tim 2004, The trouble with income trusts, Canadian tax journal, vol. 52, no. 3, pp. 819-852.

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Title The trouble with income trusts
Author(s) Edgar, Tim
Journal name Canadian tax journal
Volume number 52
Issue number 3
Start page 819
End page 852
Publisher Canadian Tax Foundation
Place of publication Toronto, Canada
Publication date 2004
ISSN 0008-5111
Keyword(s) trusts
debt-equity
buyouts
debt
equity
Summary This paper sketches broadly the efficiency and equity effects of income trusts that make their use as a substitute for the direct holding of shares of a corporation problematic for tax policy purposes. The paper also considers the potential effectiveness of an equity recharacterization rule applicable to the high-yield junk debt that is the common feature of the basic income trust structure. The author suggests that this type of narrowly focused rule would be more target-efficient than other possible responses to income trusts, such as fundamental reform of the corporate income tax or the restrictions on the holding of trust units proposed in the 2004 budget. However, a principal difficulty in designing an equity recharacterization rule is ensuring that it applies equally to structures that realize the same effect as the basic income trust structure but do not use high-yield junk debt.
The author argues that income trusts are examples of tax-driven financial innovation in the sense that they replicate an existing set of securities and therefore have no nontax rationale. These securities are essentially redundant, and the innovative process of which they are a product does not constitute “genuine” financial innovation. This essential characteristic of income trusts distinguishes them from real estate investment trusts, which arguably do not present a tax policy problem (or at least not the same one). More particularly, income trust transactions are redundant in the sense that they do not complete capital markets by providing investors with a risk and return payoff profile that is otherwise unavailable. In the absence of any efficiency gains or desirable distributional effects associated with income trusts, the available tax benefit is the subject of a defensible government response intended to eliminate it. But without any clear evidence that income trusts are substituted generally for the corporate form, any response can defensibly be limited to a narrowly targeted one that introduces a “taxlaw friction” by shifting the debt-equity boundary that is the focus of the basic income trust structure. Because the precise dividing points along this boundary lack any obvious normative content, the suggested policy focus should be the development of a legislative response that redraws the debt-equity boundary in a manner that minimizes perceived efficiency losses otherwise associated with the use of income trusts.
Language eng
Field of Research 180125 Taxation Law
HERDC Research category C1 Refereed article in a scholarly journal
Persistent URL http://hdl.handle.net/10536/DRO/DU:30002365

Document type: Journal Article
Collection: Law
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