Income trust conversion deadline arrives

As the deadline for income trusts to convert to corporations or face tax penalties comes into effect Saturday, the sector is a shadow of what it was back in 2006.

As the deadline the federal government set for income trusts to convert to corporations or face tax penalties takes effect Saturday, the sector is a shadow of what it was back in 2006.

Since their origins in the 1980s, the curiously titled investment vehicles were wildly popular with investors who loved their juicy distributions. Seniors, in particular, loved them for their ability to provide steady income that often far exceeded what was available from traditional dividend-paying firms.

Finance Minister Jim Flaherty announced in 2006 that income trust distributions would face corporate taxation at the start of 2011. ((Adrian Wyld/Canadian Press))

By the middle of 2006, they had become so ubiquitous that telecom giants Telus Corp. and BCE Inc. were considering converting themselves from the traditional corporate structure into income trusts in order to reduce their tax burden. Then, Gord Nixon, CEO of the Royal Bank of Canada, mused publicly about the possibility of converting all or part of the biggest bank in the country into an income trust.

The federal government had been concerned about "tax leakage" before, but the possibility of two of Canada's largest companies using the structure was enough to force Ottawa's hand into action.

On Oct. 31, 2006, Flaherty said income trusts, with the exception of real estate investment trusts that adhere to strict rules, would be subject to tax on trust distributions — effectively, making them treated the same way corporations are.

The stock-market value of these vehicles, which paid no corporate taxes but rather passed their profits on to unitholders who were then taxed, took more than a 15 per cent haircut in reaction to the news. Some fared much worse.

Under the new rules, all new trusts from that date forward would be subject to the new tax regime, but Flaherty gave existing trusts (of which there were 255 on the TSX at the time, collectively worth more than $200 billion) until the then-far-off date of Jan. 1, 2011 to meet the new requirements.

That deadline will come and go on Saturday, and while the sector is far from non-existent, it's a shadow of its former self.

Last month, Eagle Energy Trust debuted on the TSX — the first Canadian-listed oil and gas trust to launch since Flaherty's Halloween surprise. The company holds only foreign oil-producing assets — a loophole that excludes it from the new tax regime.

Most of the big names have already converted back into corporations. Financial services titan CI Financial converted to a trust in June 2006, before the announcement. The changing of the rules was enough to make CI convert back into corporate form in January 2009.

Yellow Pages Income Fund finalized its conversion on Nov. 1, while oil and gas producer Penn West was set to formally do so on Saturday.

There is now fewer than half the number of trusts on the TSX. The vast majority are REITs, but a few business trusts remain and will presumably operate under the new rules. Some have merely reduced their distributions roughly in line with the taxes they'll have to pay beginning Saturday.