In June 2007, the Government of Canada enacted legislation that will apply a tax at the income trust level on unitholder distributions commencing January 1, 2011. With just over a year remaining until the new legislation takes effect, it’s becoming increasingly important for income trusts to have a clear, direct communication plan in place to inform the investment community of their respective strategies for the new tax regime.
While many income trusts continue to evaluate their options for the post-2010 tax regime, a number of trusts have already taken action, using the pending taxation as a catalyst to convert to a corporate structure early and make any necessary adjustments to distribution levels. The rationale for early conversion and adjusting distribution/dividend levels has often centered on a shift in focus towards a more growth-oriented strategy, and the need to invest more cash into the operating business or to pursue acquisition opportunities. For “early converters” that also cut distributions, effective redeployment of capital in growth opportunities is vital. If it appears that unsustainable, trailing distribution levels were perhaps the defacto “raison d’être” for early conversion and an accompanying distribution cut, the issuer risks a prolonged market discount and a loss of credibility.
Some income trusts have insulated investors from the impact of early conversion by acquiring tax losses that can be applied as credits against corporate taxes. This strategy can enable the converted entity to maintain pre-conversion distribution/dividend levels for a period, and thereby create a longer “runway” for income-oriented investors to make any necessary portfolio adjustments, creating a more orderly market transition to investors that are more growth-oriented.
For income trusts that have not yet disclosed definitive structural or distribution policy plans for 2011, and are currently allowing their unitholders to benefit from a prolonged tax holiday, this issue should be addressed as soon as possible to remove market uncertainty. Concerns in the investment community regarding the sustainability of an income trust’s distributions once they become taxable could result in unit price volatility. To support fair market valuation, income trusts should disclose their contemplated structural and distribution/dividend policy plans, as well as any re-calibration of their future strategy, as soon as they are determined.
Pending taxation for income trusts in 2011 is a transformational event for Canadian capital markets, and as with any significant change comes opportunity. Trusts that effectively communicate their plans, strategic rationale and then successfully execute, can enhance their capital market profiles and build credibility.
Tags: income trust