Foreign asset income trusts revive interest in income trust market

April 13, 2012

The public offerings of two foreign asset income trusts (FAITs) have revived interest regarding income trusts in Canada, bringing to light a relatively untapped market. The key factor driving this renewed attention is that FAITs are not subject to traditional Specified Investment Flow-Through (SIFT) rules, as a result of their ownership of assets outside of Canada.

The royalty trust and income trust markets trace their origins to 1986 and 1995, respectively. As interest rates declined during the period and beyond these trusts became popular, since they provided lofty yields well in excess of the prevailing interest rate payable by corporations with similar credit ratings. The reason for the discrepancy was primarily due to the fact that royalty trusts and income trusts were flow-through vehicles that avoided the payment of corporate level tax. The yields payable by these trusts varied, but were typically in the 8 – 10% range.

Unfortunately for investors, the party effectively ended on October 31, 2006 when the Department of Finance announced their intention to introduce rules (the SIFT rules) to tax income from “non-portfolio properties”, including Canadian real, immovable or resource property if the fair market value of the property was greater than 50% of the equity value of the trust, as well as property held by the trust and/or non-arm’s length parties that is used in the course of carrying on business in Canada.

The public offerings of two FAITs, Parallel Energy Trust (Parallel) and Eagle Energy Trust (Eagle), have revived interest in the income trust market, since neither Parallel nor Eagle are subject to the SIFT rules as a result of their ownership of U.S. oil and gas properties. As a result, provided they are able to return their oil and gas income from the U.S. without the incidence of U.S. tax, they act like the royalty and income trusts of yesteryear. Indeed, both trusts provide a hefty yield (13% for Parallel) and one that is relatively stable, since it is based on proved reserves. For example, in the case of Parallel, the proved and probable reserve life index and the proved reserve life index are roughly 27 and 13 years, respectively.

Despite the attractive and relatively secure yields, neither Parallel nor Eagle has a strong following in the market. The reason for this relative anonymity in light of the attractive yield offered could be a result of a confluence of factors. However, regardless of the status of FAITs there should be an untapped market that they can service, if properly marketed, provided they weather the initial storms that many new financial products suffer.

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