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The not-so-scary income trust conversion Add to ...

John Brussa's office is filled with Three Stooges memorabilia, a testament to the Calgary lawyer's ability to laugh at unexpected pokes in the eye. That must have come in handy on Oct. 31, 2006.

"It wasn't a happy time," Mr. Brussa said of that infamous day four years ago, when federal Finance Minister Jim Flaherty surprised investors with a major policy change aimed at erasing the tax advantage enjoyed by the hugely popular structure known as income trusts. Although the change would not take full effect until 2011, the announcement instantly wiped out tens of billions of dollars in market value in the trust sector and sent a fearful chill through multitudes of mom-and-pop investors who had been counting on the ample income stream from trusts to secure their retirement years.

For Mr. Brussa - a tax expert at Burnet Duckworth & Palmer who had helped give birth to the income trust phenomenon 20 years earlier, and had built a thriving practice around the sector - the change in the tax treatment looked like a death sentence for the trust industry and a threat to his livelihood.

"[Trusts]were creating jobs, they were providing income to seniors in a very low-interest-rate environment, they were creating a bunch of charitable spinoffs for Canada," he said. "You saw all these good things, and you had a hard time seeing what was on the other side of the ledger."

But now, four years later and with only two months to go before the tax finally goes into effect, he can chuckle.

"At some point, you've got to let go," he said. "I had a chance to sit down with Jim Flaherty a few weeks ago … he's an engaging guy. He passes your 'want-to-go-have-a-beer-with' index."

The long goodbye to income trusts hasn't been as devastating as many investors and professionals had feared. While 60 trusts have already converted into corporations, and another 65 have announced plans to do so, both the remaining trusts and ex-trusts are finding ways to keep the income streams flowing even as the trust structure largely fades into the history books.

"We do still have a very healthy income trust market today, and it looks like we're going to continue to have that healthy income trust market even when we can no longer call them income trusts," said Leslie Lundquist, co-lead manager of the Bissett Income fund, a mutual fund dominated by income trust holdings. "Contrary to worst-case expectations at the end of 2006, the income trusts didn't just disappear … The majority of them are still generating income today for investors."

There are still 113 income trusts on the Toronto Stock Exchange (excluding REITs, which aren't affected by the tax change), but that number is deceiving. According to data compiled by trust adviser Barnes McInerney Inc., all but 29 of Canada's remaining non-REIT trusts have announced their intention to convert back to a traditional corporate structure or to otherwise reorganize their business. And of those 29, only four have definitively stated that they intend to remain income trusts.

Market watchers expect all but a handful of the firms will eventually convert back to a corporate structure. But the initial fears of the market - that these companies' payouts to investors would evaporate upon conversion, all but killing their value as investments - haven't transpired.

The value of trusts and former trusts has generally thrived, as investors have embraced the removal of uncertainty coupled with the still-healthy dividends that many of the investments maintained. The S&P/TSX income trust index is up 20 per cent in the past 12 months, while studies have shown that share prices have generally outperformed market benchmarks both after companies have announced their conversion plans and after conversions are completed.

A Globe and Mail examination of conversion data earlier this year found that on average, payouts to investors were being cut by 33 per cent - a significant reduction, but far less severe than many people had feared. And almost half the trusts that had announced conversions intended to maintain their post-conversion dividends at the same levels as their pre-conversion cash distributions.

"I've been very pleasantly surprised," said financial adviser Sheryl Purdy of Leede Financial Markets in Calgary. "The companies recognize what their unitholders want: Yield."

Still, the end of income trusts will make it harder for investors to find the same kind of yields they had come to take for granted in the trust era, especially in today's low interest rate environment.

"Yields are just lower than they were four years ago," Ms. Lundquist said. Paradoxically, this is happening at a time when many investors, spooked by two equity market crashes in less than 10 years and seeing retirement looming on an ever-closer horizon, are hungrier than ever for investments that yield strong income.

That, say some of the architects of the income trust phenomenon, is where Bay Street is acutely qualified to step in. After all, the trust sector itself arose out of financial industry innovators seeing a low-interest-rate environment and recognizing investor appetite for something that would deliver a better yield. Not only are those same conditions in the marketplace today, but many of those same people are still around looking for novel solutions to fill the market need.

"There's already a well-developed channel for marketing income-producing securities in this country," said Goodmans LLP lawyer Stephen Pincus, another major player in the development of the income trust boom.

Many previously obscure products are now filling the gap in retail portfolios vacated by trusts. High-yield corporate bonds, an asset class for which Canadian retail investors have had little appetite in the past, are growing increasingly popular. New issues of preferred shares and convertible debentures - two dividend-paying hybrid products that share qualities with both corporate bonds and stocks - have been increasing.

Stapled securities - in which an investor gets a piece of both a common share and a trust unit or some other income-generating security - are also arising out of the trust sector conversion, as companies and their financial advisers seek the most tax-efficient ways to continue to deliver income to their investors.

Mr. Pincus's firm has worked on a couple of initial public offerings this year where companies promised a high dividend yield from the get-go as part of their efforts to lure investors.

"I think you'll see more higher-dividend common share IPOs over time, to meet the need of the retail investor," Mr. Pincus said.

There is also growing talk of foreign companies offering high-income, income-trust-like products to Canadian investors - because the tax restrictions being placed on Canadian trusts largely don't apply to non-Canadian businesses.

And Mr. Brussa noted that an increasing number of private income trusts are beginning to emerge in the oil patch, offering many of the benefits of the old income trust sector, but being marketed as private investments rather than publicly traded securities.

"There's always going to be a market for yield products," Mr. Brussa said. "It's sort of like the illegal drug business - it's there because there's a demand for it."




Number of trusts (excluding REITs) as of Oct. 31, 2006.


Number of trusts as of Sept. 30, 2010.


Number of conversions to date.


Number of conversions announced but not yet completed,


Number that will definitely remain trusts.


Approximate number that plan to maintain dividends at same level.


Average reduction in payouts to investors.

Sources: TSX, Barnes McInerney Inc.



High-yield corporate bonds

Preferred shares

Convertible debentures

Stapled securities

High-dividend common shares

Foreign high-income products sold in Canada

Private trusts

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