How will income trust changes affect you?

We do not think the news is all bad, especially over three or four years. The distributable cash positions for trusts are still strong.

The Negatives

Some softness will occur in fund flows into this category over the next few weeks, as investors absorb the news, and realize that the existing trusts are still attractive.

A large number of oil and gas trusts have been held by foreign investors. They are the most affected, since they will move from a 15% to a 46% tax bracket. The announcement could motivate them to remove the trusts that have dropped in value from the Canadian market.

Existing trusts will likely lower their distributions, as they prepare to pay the tax at the end of the four year grace period.

While volatility will remain high as a result of the announcement, we believe that income trusts remain an attractive investment. They may still appeal to conservative investors looking for an asset class that provides a portion of its return in the form of income and has a low correlation to other asset classes, such as fixed income and equities, although its tax advantages may have been reduced.

Impact on the Canadian dollar

The Canadian dollar will be affected, as Canadian income trusts are popular with foreign investors. These investors might move their money elsewhere if they are forced to pay tax on their Canadian trust holdings.

However, a falling Canadian dollar can be favourable for portfolios which have a lower Canadian equity weighting.

The Future

The Minister of Finance hinted strongly that the Conservative Government would reduce personal income taxes, although he wouldn’t provide details. We can expect some announcements on this proposal before the next budget.

The grace period of four years will allow income trusts to develop solutions in order to anticipate the government’s next moves in this area.

While in the short term, the move will spark instability in the market and investors may sell their fund units, it could lead to companies making use of the trust structure only when appropriate for their business. As with all market place panics, as soon as the uncertainty is removed, the normal investment cycle will resume. Companies will continue to make profits, earnings will continue to rise, and dividends and distributions will remain.

We believe that a calm and rational approach based on discipline and fundamentals will lead to investment success. And why not take advantage of other investors’ insecurities?

As the renowned investor John Train told us, “For the investors who know what they are doing, volatility creates opportunity”.

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