K Inc. is a Canadian corporation whose shares are traded on a stock exchange. K operates three divisions within its corporate structure. Two of the divisions are in the technology field and are in the early stages of their growth cycles. They are both profitable with strong research and development capabilities. The third division is older and very mature. Its products are widely accepted and profitable. Its income and cash flow are very stable and predictable. K’s management feels that its share value is not fully exploited because the divisions have diverse characteristics. Consequently raising capital for new development in younger divisions is costly.
To alleviate this problem K is considering selling off the third division as a separate entity. They feel this can be achieved by setting up a separate corporation to house the division. The separate corporation would issue shares to the public and the funds used to acquire the division from K Inc. Management has also been looking at the use of an income trust as an alternative to the corporate format.
K has requested your advice on this matter.
Required:
1. Explain to K how each of the structures work with respect to profits, tax, and distribution to investors. Demonstrate with calculations where possible.
2. Is an income trust appropriate in this situation? Explain.
3. Would your answer to (2) above be different if the third division was a group of real estate rental properties?