Canada - Income Trusts - No Trust

The Canadian government (a Conservative minority) announced this week that existing income trusts, who pay little to no corporate taxes, would begin paying full corporate taxes in 2011. For those on the block to conversion to income trust status to eliminate paying corporate taxes, the income trust tax of 34% would be applicable immediately.

Two recently announced conversions, BCE and Telus, which themselves would have deprived the government of $1.1 billion annually in taxes, placed this in the government's "must take action" in-tray, despite a recent election promise that income trusts would be left alone. The opposition Liberals had pondered the very same move last fall when then in government, leading to a large drop in the income trust market at that time. The trust market had, however, largely bounced back since then.

A quotation from this story more or less synopsizes why the government, despite it's earlier pledge to leave the trust sector alone, felt it had to act:

Had the entire TSX converted to income trusts, it had the potential to be disastrous not just for government revenues but for Canadian productivity, although many companies would have likely gone back to the market for investment capital.

The action on the part of the government led to a 13% average drop in that sector this past week. However, many have speculated doesn't reflect the underlying valuation change due to having a significant tax burden imposed. Some experts suggest that in the weeks and months ahead, this sector, which now constitutes about 10% of the TSX Composite Index value, is slated to see further weakness.

The howling from trust-owning pensioners has been predictable, given that most trusts were bought for their income yield, typically ranging from 6-11%, which is pretty juicy in today's environment. Many of these pensioners claim to have "lost trust" in the Conservative government.

It is interesting to note that this same structure began to gain some prevalence in the US, Australia and Britain, a number of years ago, before legislators recognized the tax-shift burden that would fall to the middle class, and shut down the advantageous tax rates for them. However, they did this before these structures had gained the widespread popularity, as they have in Canada.

In this regard, Canada is simply following suit, but with many asking the question: Why did it take so long here?




JW

The Confused Capitalist