With all the squabbling between Bay Street and Ottawa on taxing income trusts, average Canadians are having a tough time determining what to do with their investments.
Now is not the time to ignore the politics of income trusts, whether you're considering buying or concerned that your existing trust portfolio can't weather an unfavourable tax decision by the federal government. "It's really important that everybody get involved," says Dirk Lever, managing director and head of business trust research at RBC Capital Markets. "Everybody has something at stake on this."
Beyond the individual investors trying to make a buck, the participants in the national debate over the future of income trusts have many millions -- or billions -- of dollars at stake. As such, all sides of the argument are coloured by the ultimate human motivators: greed and power.
The situation began to overheat in September, when investors were put on alert by Canadian Finance Minister Ralph Goodale of the possibility of changes that may reduce the tax advantages of trusts.
As it stands, income trusts generally own debt and equity of an underlying entity and pay little or no tax. Most of their income is distributed directly to unit holders. But the trust distributions are typically higher than dividends from an equivalent corporation that pays taxes.
And that's why a growing number of people want to buy into the trust market.
As bigger companies and even banks ponder the trust structure, the government faces complex issues, such as how much tax revenue is affected and how economic growth is affected if businesses pay out the bulk of their income instead of reinvesting it.
Watching keenly for signs of a change in tax laws that could affect the value of their investments are millions of Canadians, including John Kenny, a 58-year-old retired government employee in the Ottawa suburb of Orleans. He and his wife hold $70,000 in income trust units. They actively manage their investments daily from home.
"I have studied this sector for probably a good five or six years," Mr. Kenny says.
"I'm at it every day, my finger's on the pulse. There isn't a day that goes by that I don't watch the business news channels. We need something like a unit trust to supplement our lives."
Mr. and Mrs. Kenny have another $100,000 in investments outside of income trusts. They, like ther retired investors, want to keep up their high income stream for their own security, and many argue that because their consumer spending rises accordingly, it helps the economy instead of hindering it.
That certainly is the position of Canaccord Capital's diversified trust analyst Chris Rankin, who in October drew the ire of Mr. Goodale after encouraging individuals to write their Members of Parliament to protest changes to trust legislation. At the time, Mr. Rankin blamed the government for a $23-billion drop in the value of trusts since September, and suggested that Ottawa's consultations on trusts were a "sham."
Mr. Goodale responded by saying Canaccord's campaign was politically motivated, pointing out that Canaccord executive Paul Reynolds is the son of Conservative MP John Reynolds, now co-chair of the national Tory election campaign.
"I voted Liberal in the last election," says Mr. Rankin in an interview from his office at Canaccord, one of the nation's largest independent brokers. "It's a natural reaction for Goodale to try to discredit us because he's uncomfortable because he's not doing a good job."
Accusations of partisan politics aside, Mr. Rankin's firm does have a particular axe to grind -- protecting its clients' investment returns. Like pension plans, Canaccord is paid to try to achieve high returns, using securities such as income trusts. A drastic move from Ottawa could harm these returns.
In another corner of the debate are the representatives for the income trusts. Stephen Probyn, chair of the Canadian Association of Income Funds, is dead set against any kind of interference, explaining that income trusts are needed by "millions of Canadians who are trying to provide for their future."
But as the president and chief executive of Clean Power Income Fund, Mr. Probyn has another motive. "Obviously any trust business has to adjust, if they are taxed at the entity level. It would reduce the amount they could distribute, and the unit price would fall accordingly. We've seen the market anticipating that already."
Brokerages, too, have their interests at stake -- the investment banking scene for income trusts has all but ground to a halt amid the uncertainty. Cancelled or postponed trust conversions mean fewer deals to collect fee revenue for.
Mr. Lever, one of Bay Street's top trust analysts, believes that no one will be completely happy with the government's final decision -- including the government.
"Everybody's going to have to give in here in order for the problem to get resolved," he suggests. "Saying they can just do nothing is probably not appreciating the issues the government is facing."
He says the government's solution could include:
Capping the amount of trusts units pension funds can earn, which would limit their popularly.
Putting taxation of payouts of dividends and trust payouts on equal footage, which may lessen the allure of a corporation converting to a trust.
Lowering corporate income tax rates, diminishing the advantage of converting to a trust.
Limiting the amount that can be owned by foreigners or increasing the amount of tax that can be withheld from foreigners when they receive a distribution.
While a decision from the government hangs in the balance -- Mr. Goodale is expected to state his plans in January -- Standard & Poor's isn't going to delay its decision to include trusts in Canada's benchmark equity index, the S&P/TSX composite index, with the rolling process starting next month.
"We should not presume that government policy will be resolved at any particular point. It could go on for several months or several years," says David Blitzer, managing director and chairman of the index committee at Standard & Poor's in New York.
"Income trusts are part of the Canadian equity market. Nothing has changed. The index has got to reflect the market, and we want to move in that direction."
While Canadians wait for the government to make a decision, many investors are digging in their heels.
Among them is Patrick Kim, vice-president of investments at KBSH Capital Management who helps manage the Clarington Income Trust Fund and Clarington Diversified Income Fund.
"It's a vacuum of information that the market is operating in," he says, "and how do we operate our investments in this environment? No. 1 is: Don't panic. The market is relatively illiquid and predominantly retail investors. Remember that these are equities so it's not uncharacteristic that you do get some volatility."
Longer term, he adds, buy-and-hold investors will see less volatility if they choose good quality trusts with stable and growing free cash flows, strong management teams and conservative payout ratios.
That's the same school of thought as Mr. Kenny and his wife. For now, they're enjoying double-digit returns and thinking of buying even more income trusts.
"The worry that is out there has translated into an opportunity for myself and other people to continue cherry picking among the unit trusts we want to put in our portfolio," Mr. Kenny says. "Whatever the government decides to do with it, I don't think it's going to be that dramatic."
Investors who are nervous should take a look at their weighting in trusts, which make up about 10 per cent of the provisional S&P/TSX composite index.
"Make sure you're managing your portfolio and treating income trusts like any other class," advises Gordon Tait, managing director and royalty and business trust analyst at BMO Nesbitt Burns.
"If there's uncertainly, if you're nervous, guess again at how much you want to have exposed in this sector."
Theresa Ebden is a producer with Report on Business Television.
© The Globe and Mail
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