Finance Minister Jim Flaherty's surprise move to tax income trusts created havoc on Bay Street and Main Street and caused a stir in the Commons on Wednesday but is unlikely to inflict any major damage on the economy.
Income trust investors suffered more than $20-billion in paper losses on their portfolios as some of Canada's best-known companies - from telecom giants BCE and Telus to Yellow Pages, CI Financial, Canadian Oil Sands and Aeroplan - were battered by the rush selling following Mr. Flaherty's surprise announcement that trusts will be taxed.
In Ottawa, the Liberal opposition blistered the Tories, accusing them of lying to Canadians and flip flopping on their promise in the last election not to tax trusts.
Liberal MP John McCallum, former revenue minister, called it a "day of infamy, this Black Wednesday" and "the single biggest blow to Canadians' wealth ever dealt by a finance minister, in a banana republic process."
Investors and several economic commentators also criticized the move, while the group representing trusts accused Ottawa of "directly attacking millions of Canadians who purchased income trusts in good faith based on the Conservative government's promise to leave these important investment vehicles alone."
Despite Wednesday's financial market turmoil, the impact of Mr. Flaherty's moves on the wider economy will be minimal, said Merrill Lynch economist David Wolf.
"I don't think this is a huge deal for the economy either way," Wolf said.
The main effect is to allay fears that trusts, by concentrating on immediate income, might hold back Canada's long-term productivity, he said.
"To the extent that that was a worry, it's now obviously much less of a worry."
On Bay Street, the Toronto stock market's main index tumbled more than 324 points to 12,020.27, a decline of 2.6 per cent, the biggest loss since mid-2004.
The losses were concentrated among trusts, with the S&P/TSX income trust index down 12 per cent - an evaporation of more than $20 billion in market value for investors.
"I tell you, I've got seniors that have income trusts that are down $25,000 or $30,000 today.... They're getting hit in a big way," declared Brendan Caldwell, president of Caldwell Securities Ltd., a Toronto-based brokerage.
Among major names, the Yellow Pages trust faded 17 per cent, the CI Financial fund plunged 18 per cent and the Aeroplan trust lost 10 per cent. There also were big setbacks for Telus and BCE Inc., which wanted to convert into trusts, and Canadian Oil Sands trust, the biggest in Canada.
The news from Ottawa also hit the Canadian dollar, which was down 0.84 cent at 88.20 U.S. cents. Many trust investors have been foreigners who needed to buy Canadian dollars to make their purchases, and who pay only 15 per cent tax on their distributions.
Bank of Canada Governor David Dodge said the government change was fair from a taxing perspective.
"The actions that the government took yesterday regarding the tax treatment of income trusts would appear to eliminate the tax incentive to use one form of corporate organization over another," he said. "Businesses now face a level playing field in choosing the form of corporate organization that allows capital to be allocated to its most efficient use."
However, market players worried about the trust selloff and the psychology of investors.
"Right now there's definitely a sense of panic selling," commented Cecilia Mo, portfolio manager of Fidelity income mutual funds.
Mr. Flaherty's "tax fairness plan" would impose a distribution tax - at corporate income tax rates - on payouts by income trusts. Investors would be taxed as though these distributions were dividends.
This is to take effect in 2007 for newly formed trusts, while existing trusts get a four-year transition period.
Under the existing rules, income trusts avoid corporate income tax because they distribute their cash flow to investors to be taxed in their hands.
Mr. Flaherty said this creates a distortion that threatens Canada's long-term economic growth and shifts billions of dollars in future tax burden on to individuals and families.
Many in the financial community discounted this fear.
"I think they overreacted," said George Athanassakos, a corporate finance professor at the University of Western Ontario.
"I don't think all companies would have converted into income trusts, and I don't think the tax-loss story was the correct story," he said.
Mr. Flaherty's move also attracted broad support.
The Canada Pension Plan Investment Board expressed relief that Ottawa has dealt with a growing problem of tax-motivated corporate changes.
"The resolution of this corporate structure tax arbitrage issue is a welcome result," said CPP board senior vice-president Ian Dale.
"The decision by the government to create a level playing field ... is a suitable outcome."
Ross Healy, president of Strategic Analysis Corp. and a long-time critic of trusts, also endorsed the government's belated move against the "pernicious" structure.
Mr. Healey noted that controversy over income-trust policy - linked to a still ongoing RCMP investigation of possible early leaks of that policy - helped defeat Paul Martin's government while the Conservatives promised no change in the tax treatment of trusts.
"It's ironic that the Conservative government is finally doing what the Liberal government wanted to do."
The National Pensioners and Senior Citizens Federation, an advocacy group which has been assailing what it regards as widespread dubious accounting and governance in trusts, urged all parties to support the minority government's "positive and necessary package of tax reform."
Ontario Liberal Finance Minister Greg Sorbara also was sympathetic to Mr. Flaherty.
"I know the pain of not being able to keep a campaign promise," Mr. Sorbara said. "Sometimes, once you're in government, you just have to do what you think is the right thing."