Valuation of Income Trusts: An Exploration of Clienteles and Implicit Taxes

39 Pages Posted: 24 Apr 2006

See all articles by Kenneth J. Klassen

Kenneth J. Klassen

University of Waterloo - School of Accounting and Finance

Devan Mescall

University of Saskatchewan

Date Written: April 2006

Abstract

Canadian income trusts are a publicly-traded flow through structure. Their use in Canada has expanded beyond the traditional real estate sector (REITs). We use this alternative business structure to explore the valuation of investor taxes in a broad equity market setting. Adapting a pricing model, we determine that the value of earnings generated by an income trust should be higher than a corporation only if the marginal shareholder has a low tax rate. Empirical evidence shows that the value of earnings is higher for income trusts than for a set of matched businesses operating as corporations, consistent with the marginal investor in income trusts being a low-tax rate individual. A second set of tests explores the implicit taxes borne by common shares. We find that the relation between pre-tax returns and earnings for common stock is significantly lower than for income trusts, consistent with the implications of implicit taxes. This research contributes to our understanding of clienteles and implicit taxes in the common equity market.

Keywords: Equity valuation, taxation, income trust, REITs

JEL Classification: G12, H25, E62

Suggested Citation

Klassen, Kenneth and Mescall, Devan, Valuation of Income Trusts: An Exploration of Clienteles and Implicit Taxes (April 2006). Available at SSRN: https://ssrn.com/abstract=897542 or http://dx.doi.org/10.2139/ssrn.897542

Kenneth Klassen (Contact Author)

University of Waterloo - School of Accounting and Finance ( email )

Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x38550 (Phone)
519-888-7562 (Fax)

Devan Mescall

University of Saskatchewan ( email )

Edwards School of Business
Saskatoon, Saskatchewan S7N 5A7
Canada

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