Shareholder Taxation and Valuation: The Case of Canadian REITs

Abstract

This study examines the implications for the Canadian real estate investment trust (REIT) sector of two tax policy changes introduced by successive Canadian governments in November 2005 and October 2006. The first, on November 23, 2005, reduced the tax on dividends, thus narrowing the gap in the total tax paid using the corporate versus income trust form. The second, on October 31, 2006, removed the tax advantage of the income trusts, but excluded qualifying REITs. The question addressed is whether and, if so, how these events affected REITs’ growth opportunities and their ability to raise capital and undertake new investments. The first step in the analysis was to test the effect of the tax change announcements on REITs. For this purpose, an equally weighted portfolio of Canadian REITs as of each announcement date was constructed. Daily trust return data were obtained from the Canadian Financial Markets Research Center. Using the market model, abnormal returns were calculated for the period September 4, 2004 to November 21, 2006. Because the Standard & Poor’s/Toronto Stock Exchange (S&P/ TSX) Composite Index included a number of REITs, the S&P/TSX 60 was used to control for shifts in the market. The second step involved conducting cross-sectional tests in an attempt to identify non-tax factors that might have affected abnormal returns around the time of the announcements. Among factors considered were those identified by market observers as explaining the popularity of REITs: REIT size, distribution yield, effective tax rate on undistributed income, and profitability (measured as rate of return on REIT assets). Int Adv Econ Res (2012) 18:120–121 DOI 10.1007/s11294-011-9335-y