Adrian Wyld
Friday marks the one-year countdown until most income trusts lose their tax advantages, and analysts say the economic impact of the change will be felt over the coming year.
Although many trusts have been planning to make the switch to a corporate structure since the reforms were announced in October, 2006, by Finance Minister Jim Flaherty, a majority of conversion activity won't happen until toward the end of 2010, said Andrew Kondraski, vice-president at investor relations firm BarnesMcInerney Inc., which recently completed a survey of the transition experiences of income trusts.
Mr. Kondraski added that some trusts have benefited from making the switch early, but the majority will wait until the last minute.
"It comes down to tax benefits... there's no real benefit to going early and that's why you haven't seen a lot going so far. Trusts aren't ready to forgo the tax benefits of their trust status until they have to."
When they do, he said, investors who depend on monthly dividend cheques from high-yield trusts will scramble to find new places to invest their money.
"If their monthly cash distribution goes away, the investors who are attracted to [trusts]in the first place will likely not want to stick around."
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There are about 169 income trusts left in Canada, down from 220 in 2006, said Margaret Lefebvre, executive director of the Canadian Association of Income Funds. About 30 real estate income trusts are not included in the figures because the reforms do not apply to them.
Ms. Lefebvre said she expects a "very large percentage of trusts" to convert by the deadline, but added that some of the largest trusts are holding back because shareholders have so far taken "a dim view of conversion," with post-conversion share prices falling as much as 80 per cent in some cases.
Around 50 trusts have already made the transition, including vegetable grower Village Farms and modular housing provider Black Diamond Income Fund , which announced Thursday their conversions were complete, a year before they were slated to lose tax advantages.
Village Farms senior vice-president and chief financial officer Stephen Ruffini said the decision to convert in 2009 was based on the end of the company's tax year, which will be beneficial to shareholders.
"It made sense to change on our year end, so it doesn't create two tax years, which would have been an incremental cost to our company... so it made sense to do it on Dec. 31."
Mr. Ruffini added that switching to a corporate structure will also make it easier to complete growth plans the Vancouver-based greenhouse operator has for the coming year.
"Being stuck as an income trust would have made those growth plans more challenging to accomplish," he said.
Income trusts are pressured to be immediately accretive, meaning every transaction they conduct must post net gains for the company directly after it is completed.
Those types of investments are difficult for any company to find, whether it's a corporation or income trust, Mr. Ruffini said.
Meanwhile, energy and other business trusts have been consolidating, growing bigger or changing their structures and doing special deals to reduce taxes when they convert.
A number of trusts, including Canadian Energy Services LP and Cathedral Energy Services Income Trust announced plans to become dividend-paying corporations and have entered into arrangements to buy the losses of drug companies to offset the taxes they will now have to pay.
Small development companies are particularly attractive as deal partners because they often have years of losses as they research and develop new products and can't use those losses to offset taxes until they start earning profits, often years down the road.
Ms. Lefebvre said that some companies have benefited from converting to corporate status because they can use other exemptions to offset entity taxes, which income trusts will soon have to pay.
"Although the rate might be roughly the same in theory, if you're a corporation, you have access to various ways to defer tax or shelter tax, none of which are available to an income trust."
However, she added, smaller trusts are simply disappearing because they cannot continue to attract investors when they switch to corporate mode because they are no longer able to pay high-yield dividends.
"Many of those have been taken out of circulation by being bought out by private equity, or being bought out by pension funds," she said, adding that the government wrongly assumed most funds would keep their status and begin paying entity tax.
"The biggest change for the Canadian economy is that small- and medium-sized companies will not have the access to capital that they would before."
"[The income trust]was a creation of the Canadian economy," she said. "It was particularly suited to an economy where small- and medium-sized companies had very difficult access to capital, where the capital market is small."