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Income trust study raises red flags Nov. 24, 2005. 07:56 AM JAMES DAW

Investors could easily lose another $20 billion, or 28 per cent of the total share value of 165 business income trusts, a new research paper predicts. "The $20 billion potential loss is in addition to the $10 billion decline that has occurred since the Department of Finance initiated its tax review of the trusts in September," according to Accountability Research Corp. The Toronto company headed by forensic accountant L.S. (Al) Rosen has expanded on an analysis it did in May. A new 40-page report went to clients last week and to a select group of journalists yesterday. "We took a hard look at the figures for the 50 largest business trusts," says Rosen, who has been warning about potential problems with income trusts for the past three years. "Once you compare them to the market, the gross inflation or balloon mechanism of these trusts becomes obvious." He says the decline in share values will occur when investors "wake up" to the nature of cash distributions they receive from trusts, or as a growing number of business trusts cut their distributions to unitholders or declare bankruptcy after using up all potential sources of additional capital. Rosen, his son Mark and analyst Diane Urquhart, suggest in their report that, if Ottawa had decided to impose a modest tax on business trusts, it would only have reduced the value of the business trusts by about $5 billion. Finance Minister Ralph Goodale announced yesterday that he would not impose a tax on income trusts, but would instead level the playing field for public corporations by reducing the effective tax rate on dividends. A much larger concern for income trusts than taxes, the analysts argue, is that retail investors lack a thorough understanding of what they have bought, and the sustainability of cash distributions that they receive from business trusts. They did not analyze energy, royalty or real estate income trusts. Their report concludes that: ? Retail investors who own the bulk of income trust units do not recognize that less than two-thirds of the cash distributions they receive come from income or profit, while the rest is a refund of their original capital. ? When investors misinterpret the nature of those cash distributions, they pay more for a trust unit than they would for a share of an equivalent business. But the authors do not believe the price premium is justifiable.

SIPA Inc. – P.O.Box 325, Markham, ON, L3P 3J8 – Tel: 905-471-2911 – e-mail: SIPA@sipa.to - web: www.SIPA.ca

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? Seventy-five per cent of the 50 largest business trusts — including Yellow Pages, Aeroplan, Superior Plus, Energy Savings, BFI Canada, Altagas, TimberWest Forest Group, Keyera Facilities and Mullen Group — distribute more cash than they earn in income. ? On average, those trusts pay cash distributions that are 158 per cent of reported net income. If they only distributed their net income, then their share values would likely drop by 20 per cent. ? The amount that the group of trusts estimate they will spend each year to maintain their capital assets is only 32 per cent of total depreciation expenses reported under standard accounting rules. The risk is that they will "run capital assets into the ground." ? Investment bankers who put together the deals to convert corporations into the equivalent of a single-business mutual fund have been motivated by $1.4 billion in underwriting fees based on inflated sale values. ? If the trusts continued to issue new units to raise money for capital maintenance, current unitholders could lose 20 per cent of their unit values. If the trusts merely ran their capital assets into the ground, unit holders could lose 46 per cent of their unit values over time. ? The trusts with the lowest percentage of earnings to support their distributions are Medical Facilities, Parkland, Royster-Clark, BFI Canada, Canwest Media Works, TimberWest, Consumers' Waterheater, Cineplex Galaxy, Avenir Diversified, Chemtrade Logistics, SFK Pulp, Energy Savings and Brick Group. The analysts recommended a small tax on income trusts and an enhanced tax credit to eliminate the current double-taxation of profits from corporations that pay dividends. But Ottawa is only proposing to act on the second recommendation. The authors say other actions are required, however. They propose new government regulations and securities enforcement actions to deter what they argue are accounting, valuation and marketing abuses. Only one of the eight largest business trusts replied yesterday to a request for comment on the report from Accountability Research Corp. Securities regulations governing disclosure constrain companies from speaking about financial information that is not being distributed generally. Gillian Hewitt, manager of corporate reputation for Aeroplan, said "Aeroplan does not comment on analyst's reports." Rosen said that his firm has received no criticism of the technical analysis contained in the report on income trusts.

Reprinted from the Toronto Star