Yesterday, I received a question regarding income trust and what will happen to them in the next 18 months and I would like to take today as an opportunity to discuss the up coming changes.

 2006 was the year of the income trust boom. At the peak there were over 250 publicly traded income trusts in Canada with a market capital of over 200 billion. Not surprisingly, the Canadian government took notice; in October of 2006 they announced tax changes that would prevent income trusts from continuing to deduct their income distributions for tax purposes in 2011.

 The government stand on income trusts came shortly after Bell Canada Enterprises (BCE) announced that they were planning on converting their subsidiary Bell Canada into an income trust. This move would save BCE over 800 million dollars in taxes by the year 2008. In fact, income trusts were so tax efficient the Canadian government estimated that they were losing over 1 billion dollars a year in taxes.

 To assist in the conversion, the government introduced new legislation in the summer of 2007 which has prompted about 15 companies to begin the conversion process.  Under the new federal legislation, publicly traded income trust in existence before October 31, 2006, can continue income distributions until the end of 2010. Starting on January 1, 2011 these companies will be subjected to their effective tax rate and income will be distributed in the form of dividends. 

The conversion rules permit companies to transfer certain tax attributes of the income trust to the new corporation. A company may defer their conversion until the end of 2012 if the impact on tax change during the preceding two years is not expected to be material.

 There are basically two things that can happen to income trusts, they can remain a trust or convert into a corporation. Some companies will be able to remain a trust if they are not planning on exceeding “normal growth” guidelines. If the income trust wants to grow through acquisitions and/or plans on raising capital through a stock offering, the company would need to convert to a corporation. However, for companies like North West Income Fund; who have not needed to raise any capital through a stock offering in recent years, would not benefit from converting to a corporation. If a company decides to remain an income trust after the deadline and later re-examines a possible conversion in the future, the company would need to consider that transitional tax conversion rules end on Dec 31, 2012. Companies that start the conversion process after Dec 31, 2010 will forfeit the ability to transfer certain tax attributes to the new corporation.

 The other method is to convert to a corporation and be subject to the 2011 corporate tax rate which is suppose to be 18.5% according to the Library of Parliament. The conversion to a corporation will be tax neutral for grandfathered Income Trusts until the end of 2010. For companies whose pay out ratios is below 80%, there will be no need to cut their dividends. An example would be Parkland Income Fund, whose current pay out ratio is 55%. 

 So what does all this mean for an investor? If you are currently investing in income trusts and want to know what will happen to your stocks, you can start by checking out their history. Does the company have a history of acquisitions? Then they might be a candidate for converting to a corporation. Do they have a pay out ratio over 80%? Then they would have to adjust their dividend. If you’re looking for some additional information, please feel free to contact us here retire1st@retirefirst.com.

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