Posted 11/1/2006
By Deirdre McMurdy
First and foremost remember this: don't panic.
The absolutely worst thing for any investor to do is to react to quickly to the news instead of sticking with your (You do have a Big Plan, don't you?
That means that if you owned income trusts last week, you probably still want to own them this week. And next week.
By all means review them in the context of the recent news about changes in their treatment by the federal ('Finance'); Department.
Frankly, if you own anything for tax purposes solely, it may not be such a hot idea anyway. But if you decide that you can live through the turmoil of the next few weeks, there may even be some cherry-picking to be done at a time when value isn't all that easy to find in the market.
Ottawa stuns market with pledge on income trusts
But we're getting ahead of the story here. So let's begin at the beginning.
It was quiet in the Ottawa press gallery around 4:30 on Halloween eve.
Most reporters had ducked out early to take their kids around the block or to meet for drinks, when the announcement came that Finance Minister Jim Flaherty was holding a press conference in half an hour in the theatre of the National Press Building
Given that markets had just closed when the press corps was summoned, the consensus was that Mr. Flaherty was about to say something about the long-simmering issue of income trusts. Nevertheless, the timing and the content of his remarks took everyone – from the oil patch to Bay Street to Parliament Hill by surprise.
Even Finance Department insiders knew nothing of the pending remarks and said that the income trust file was the most closely guarded of the many sensitive issues they deal with.
Trusts have a structure that encourages a large portion of revenues to flow directly to investors in the form of regular distributions, avoiding most corporate taxes. Investors can defer the income taxes they pay by holding the units of trusts in registered retirement plans.
Mr. Flaherty announced a package of measures that will tax distributions by income trusts while also cutting corporate taxes by half a percentage point and changing tax policy for pensioners. He claims these moves will ease the tax burden by C$1 billion a year.
Trusts that begin trading from now on would be subject to his new measures in the 2007 tax year, while existing trusts would have a four-year transition period.
That's all well and good except for the fact that the one thing financial markets will absolutely not tolerate is a surprise.
Over the years, that reality has entirely re-shaped the federal budget process, turning it into an elaborate, drawn-out process of consultation and directions that are clearly flagged well in advance of their ultimate announcement.
Corporations too, have learned to "manage expectations" to the last penny. They provide quarterly "guidance" to investment analysts and shareholders on their financial performance, and are exceedingly careful to forewarn of any anomalies on either the positive or negative side.
That – along with various political considerations – made the sudden directive from the federal government all the more surprising. After all, we're talking about a $200 billion dollar sector of the investment sector, a financial product that millions of Canadians own directly in their portfolios or indirectly through their pension funds.
Given investor demand for these high-yield vehicles at a time when interest rates are historically low, income trusts have also come to represent a huge chunk of the volume of business on the Toronto Stock Exchange (220 are listed), because so many of the energy companies that now dominate the index are income trusts.
Given how high these stakes have become as some of Canada's largest companies (namely BCE and Telus) adopted the income trust format, it's not altogether surprising that there has been – and will continue to be – so much complaining about the Finance Minister's rather unilateral, arbitrary move. Investment bankers, lawyers, securities dealers and brokers, in short, a lot of highly-priced, highly verbal talent just got a major hair cut.
On the government side (and yes, there is one) is an equally urgent and highly-priced agenda.
Forget all the platitudes about productivity and competitiveness in a global economy, bottom line is the income trust dudes were driving trucks through loopholes that allowed them to undermine Ottawa tax revenue flow, diverting hundreds of millions of dollars.
(BCE for example, was especially eager to transform itself into a trust to minimize an $800 million tax bill upcoming in 2008 after a series of existing shelters expires next year.
It's going to take some time for all the dust to settle on this subject in both practical and political terms.
The government has taken a political risk in aggravating several core constituencies in one smooth move: the business/financial community, western Canadian oil interests and investors. In the aftermath of the policy announcement, there's going to be plenty of lobbying to tweak the new rules as they are refined.
