Mr. Speaker, it is an honour for me to enter into the debate on Bill C-55. My colleagues have been lucid on a number of aspects of the bill which are very significant, and I concur with their positions.
I will limit my remarks to one particular aspect of the bill which has to do with the inclusion of income trusts, one aspect that is covered by the Bankruptcy and Insolvency Act and the Companies' Creditors Arrangement Act. The issue has to do with an element that is relatively new. It has become very significant and is the subject of rather significant controversy in Canada today.
What are income trusts, which I think have been surreptitiously inserted into the act as just a tiny amendment? In the first act, in the BIA, it suggests that a person now be defined as including an income trust. The CCAA, which is the Companies' Creditors Arrangement Act, defines an income trust as a unit holder and the trust itself is traded on a recognized stock market and covered under the provisions of the act.
What are these instruments? They are complex and sophisticated financial entities. By the underlying asset or group of assets, most of the income these assets generate is distributed to unit holders. They are kind of the equivalent of a shareholder yet they are not. They are unit holders and they are very different.
An income trust is formed when an operating entity creates a trust instead of offering its securities directly to the public. The proceeds from the sale of the units are used to purchase the common shares and high yield debt of the operating entity. It is important for us to recognize that they buy the equity and high yield debt of the operating entity. The combination of the trust's equity and debt holdings allows the income to flow through to unit holders, usually tax free.
There are essentially three types of income trusts: business income trusts, energy trusts and REITs.
The business income trust typically acquires all or substantially all of the issued equity and debt of an operating entity. Under a common business income trust structure, the trust earns income primarily from interest payments received on the debt of the operating entity. Business income trusts are used in many sectors such as manufacturing, food distribution and power generation and distribution.
Energy trusts are quite different. They earn royalty income from resource properties through a royalty interest or earn primarily interest income through the holding of equity and debt of the operating entity.
The third class are REITs, real estate income trusts. These generally acquire income producing real property under an income through leasing the property to an operating entity or they earn primarily interest income through the holding of equity debt of an operating entity.
Business income trusts are particularly useful for mature businesses that are not seeking additional capital because it increases their ability to distribute earnings. As the popularity of income trusts increases, more and more businesses are contemplating converting all or part of their operations to income trusts. The most recent was speculation of a Canadian bank to convert part of its business into an income trust. That among other matters brought a knee-jerk reaction from the Minister of Finance. It sent a shiver through Canada's capital markets and caused a deluge of anger from seniors across the country.
There are two different issues here, but nevertheless the one instance has to do with income trusts and their recognition and the other one has to do with the tax structure and how to deal with taxes. I will not deal with the tax structure. That is for another time.
In the context of Bill C-55, we also must note that while banks are not covered by the Bankruptcy and Insolvency Act or the CCAA, the Companies' Creditors Arrangement Act, an income trust, if the bill is passed in its present form, will put a bank's income trust, if it experiences financial difficulty, under the provisions of the BIA and the CCAA. On the one hand we have the bank never covered by the BIA. On the other hand if it forms an income trust, the part that is in the income trust will be covered by the bankruptcy act.
No one knows what the implications of such an event would be at this time. To pass a law without at least some consideration of possible implications would, in my opinion, not only be shortsighted but indeed irresponsible.
Let us now remind ourselves that income trusts, business, energy or REITs, typically acquire all or substantially all of the issued equity and debt of an operating entity. Since the income trusts hold debt, let us examine this debt, in a very preliminary way admittedly because we do not have time to get into all the details.
There are at least two classes of debt. The equity that is treated as debt by the income trust is non-arm's-length, private market debt that pays a coupon determined by the operating company's management. Although this debt is covered by a debt indenture, the debt generally does not carry the covenants or protection of a public market debt. It is subordinated to other claims on the operating company and should be viewed as equity for all purposes except tax purposes.
The debt held by the income trust is distinct from third party arm's-length debt issued by the operating company. Third party creditors that lend to an operating company owned by an income trust are in the same position as creditors to a corporation. Interest payments on bank loans or fixed income debt are paid out of pre-tax income. This debt pays a market rate of interest and has the same covenants as other bank loans and public market issues. Most important, the third party debt issued by the operating company has a superior claim on the assets of the operating company. When calculating the leverage of the operating company, however, only the third party debt is considered because the debt held by the income trust is treated as equity.
It is now evident that the inclusion of income trusts under the provisions of the BIA and CCAA is not a simple matter. It has been the subject of some study for years. It is becoming increasingly important as the popularity of income trusts increases. In fact, recently one of these income trusts declared bankruptcy in Ontario although there is no provision under the existing Bankruptcy and Insolvency Act for it to do so.
As the popularity of income trusts increases, the number of structures increases the probability of business failures in this area. We do not like to talk about this very much because after all we do not like to talk about business failures and it is much better to talk about successful business enterprises.
We need to recognize that if we are going to be dealing with this we have to be very careful to prepare ourselves for this. One might ask how important this is as a sector of the Canadian economy. In 2000 the market capitalization of income trusts was about $18 billion. In 2004 it rose to $118.7 billion. There are some reports, depending on which one is looked at, it is approaching $180 billion. That is a very significant market capitalization.
We have seen that these income trusts are sophisticated financial instruments. They own equity in operating entities, debts of operating entities and may indeed incur debts as income trusts in themselves.
The amendments apply only to income trusts, the units of which are traded on a registered stock market and are subject to the rules and regulations of security commissions. Those are the ones we are dealing with. There may be other income trusts that are not registered but those are not the ones covered by this act.
Whether those rules and regulations would be adequate in the case of a financially troubled income trust to determine asset value remains to be determined, particularly in cases where an income trust might hold less than 50% interest in an operating entity. The income trust might find it difficult to get direct access to that operating entity's financial information because it does not have a controlling interest.
While I am not prepared to oppose the inclusion of income trusts in the BIA and CCAA as being proposed to us now, I need to be assured that investors and creditors will be adequately protected if this bill is passed.