bad day for anyone with money in income trusts.
http://www.bloomberg.com/apps/news?p...M&refer=canada
Canada's Income Trusts, BCE, Plunge on New Taxes
By Theophilos Argitis
Nov. 1 (Bloomberg) -- Shares of Canadian income trusts plunged, wiping out more than C$20 billion ($18 billion) in market value, after the government said it plans to tax the high-yield securities for the first time. BCE Inc., which planned to convert to a trust, had its biggest drop in 23 years.
Finance Minister Jim Flaherty said late yesterday he will also raise dividend tax rates for pension funds and foreign investors that own trusts. The changes would go into effect next year for new trusts, while existing securities will be exempt until 2011.
``We expected the market to be down and dirty on this -- and it is,'' said John Priestman, who runs about $5.3 billion in income trusts for Guardian Group of Funds in Toronto.
Montreal-based BCE, Canada's biggest phone company, fell C$3.49, or 11 percent, to C$28.21, at 10:46 a.m. on the Toronto Stock Exchange. The shares earlier fell as much as 14 percent, the biggest drop since the company was created in 1983. Vancouver-based Telus Corp., another trust conversion candidate, fell C$9, or 14 percent, to C$55.93.
The Canadian dollar had its biggest decline in two months as foreign investors unloaded their trusts. The S&P/TSX Capped Income Trust fell as much as 13 percent, the most since it was launched in 2002. Real Estate Investment Trusts, or REITs, were little changed as they were exempt from the tax changes.
Sector Growth
The measures threaten to shut down the fastest growing segment of the Toronto Stock Exchange, and may halt some of the C$70 billion in new trust conversions announced in recent weeks by firms such as BCE. The number of trusts in Canada has tripled to about 250, and their market value has soared 20-fold in six years to C$200 billion after firms were attracted to the tax breaks.
The decisions in recent weeks by BCE and Telus, Canada's two biggest phone companies, to become trusts may have forced the government's hand. These two firms alone would have increased the market value of trusts by C$50 billion, boosting the government's tax losses from trusts to C$800 million a year. Trusts avoid most corporate taxes by paying out their cash flow to investors in monthly dividends.
The tax measures are ``clearly disappointing,'' said BCE CEO Michael Sabia, on a conference call today. He said BCE is reviewing its conversion plans.
Flaherty ``is essentially shutting the sector down,'' said David Wolf, chief strategist at Merrill Lynch & Co. in Toronto. ``This will resonate cruelly through the Canadian income trust market.'
Surprise Move
The tax measures caught many income trust executives and investors off guard, as they expected the minority government would be unwilling to make such an unpopular change until after the next election.
``Things changed a great deal this year and we're faced with a situation where Canada was moving to an income trust economy,'' Flaherty told reporters in Ottawa last night. ``For months there has been a growing trend toward corporate tax avoidance.''
BCE, Canada's biggest phone company, has gained 15 percent over the past two months as investors anticipated a switch to the structure. The company announced plans to convert its Bell Canada unit to a trust on Oct. 11. Flaherty said the structure isn't ``suitable'' for phone companies.
``The government had to address the problem sooner or later,'' said Denis Durand, a senior partner at Jarislowsky Fraser Ltd. in Montreal, which oversees C$58.5 billion, and is ``marginally'' invested in income trusts. ``There was a concern that too many unsuitable companies and industries would try to convert and that would affect the reinvestment process.''
More Coming
Other companies that have announced plans to take advantage of the income trust structure include Dundee Wealth Management Inc., an asset-management firm, that plans to sell a minority stake in its Goodman & Co. mutual fund arm through an initial public offering of trust units. Dundee said it's reviewing the IPO plans.
``We knew there were more coming,'' Flaherty said, adding he's following moves by governments in Australia and the U.S. to curb growth in these securities. ``It's absolutely necessary to act on this issue in the interest of fairness.''
Income trusts fell because the increased taxes on payouts make them less attractive for investors. Until this year, the returns for the S&P/TSX Capped Income Trust Index, including dividends, have topped the benchmark S&P/TSX index each year since 1999.
The announcement ``is going to deliver some pretty nasty re-evaluations of all the trusts,'' Marcel Coutu, chief executive of Canadian Oil Sands, said in a telephone interview. ``We'll certainly be thinking about how it impacts us and how the trust sector is going to evolve from here.''
Corporate Taxes
The government plans to tax trusts in much the same way it taxes corporations. As a result, trusts will no longer be allowed to deduct for income taxes the payouts they make to shareholders. Income will then be taxed at a rate of 31.5 percent by 2011, the finance department said in a statement yesterday.
The changes will effectively raise the tax rates for investors in tax-sheltered retirement accounts, pension funds, and for U.S. investors. The U.S. shareholders, who pay a 15 percent withholding tax on their trust dividends, will be paying a tax rate of 41.5 percent in 2011, the government said. Tax- exempt Canadian pensions will pay 31.5 percent, according to the finance department. Individual investors would continue to pay about 46 percent on trust payouts.
Tax Rules
The income trust issue has been a political minefield in Canada over the past two years. Trusts lost billions of dollars in market value last year when the previous Liberal government said it might change the tax rules, prompting Flaherty's Conservative Party to pledge in the campaign for elections in January that it would not tax trusts if it won power.
Rather than tax trusts, the previous Liberal Party government cut dividend taxes to reduce companies' incentive to convert to trusts, a move Flaherty said didn't go far enough.
The Conservative Party lacks a majority of seats in Parliament and needs support from opposition parties to pass laws. The New Democratic Party, which had called a moratorium on new income trusts earlier this month, may be ready to support the plan, Judy Wasylycia-Leis, head of financial affairs for the party, said in a telephone interview.
To help soften the blow, Flaherty announced C$6.5 billion in additional tax cuts over six years, mostly for seniors, including a plan to allow income-splitting for pensioners as of next year.
The government also said it will cut the corporate income tax rate by one-half percentage point as of Jan. 1, 2011, and increase the age credit amount by C$1,000 to C$5,066.
