Document Type

Article

Publication Date

2007

Abstract

The Department of Finance has introduced two separate sets of legislation that together attempt to limit demand in the income trust market (though with very different revenue consequences). However, neither the proposed legislation nor the existing Income Tax Act contains an equity recharacterization rule. Consequently, the tax results associated with the standard income trust and royalty trust structures can still be realized with direct holding structures, in which the use of a trust as a pooling mechanism is eliminated and investors hold directly a combination of high-yield junk debt and a specified number of shares of the issuer. Until now, these junk bond structures have been used primarily for cross-border investment into the United States, to avoid the us corporate income tax without any significant loss of non-tax attributes. But the elimination of the foreign property holding restrictions for tax-exempt deferred income plans, such as registered pension plans and registered retirement savings plans, means that there is very little in the way of any tax-law constraint on the acquisition of direct junk bond substitutes by this class of investors in a domestic context. This article highlights the use of stapled securities as a particular direct holding structure that could be used to avoid the application of the department’s latest legislative proposal, which applies dividend tax treatment to targeted income trust structures. The authors suggest that the department will most likely have to modify this draft legislation to specifically address stapled security structures. They illustrate how the us experience with stapled shares, and particularly the congressional legislative response, provides a workable template for the necessary modifications. However, this legislative template would only address the use of stapled securities in intermediated structures. Some form of equity recharacterization rule to address the use of stapled securities in disintermediated structures is also needed to ensure the target effectiveness of the draft legislation.


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