The Canadian government flip-flopped one more time on the income trust taxation issue, announcing that new trusts would be paying taxes next year while existing trusts would get four more years of tax-free status and then pay. The trigger appeared to be that a number of major corporations were getting ready to convert to trust status and the government wished to forestall this.

The (predictable) result was panic selling of the trusts.

This seems to me to be a really dumb move for a whole bunch of reasons. The basic idea behind the trust model is that a business that is in a position to commit to distributing most of its net income can sign up to do so, and in return avoid paying corporate taxes on said income. The income is then taxed in the hands of the recipient, who pays their personal income tax rate. Now for a taxable recipient with substantial income, I presume the difference will be minor. Canada allows a substantial tax credit on ordinary dividends anyway - to prevent double taxation of corporate income - which I presume would be available (it does not apply presently to the untaxed trust distributions). So those who will be hurt are the lower-income folks who are in such a low tax bracket that they get little benefit from the tax credit, or those who are receiving the distributions into RRSPs, RRIFs, or similar. Also, of course, foreign investors who are already paying a withholding tax and will be further penalized. This seems to me a very regressive step. Which is maybe what was intended, but it will certainly make the strategy seem unfair. It is clear that the government sees a loss of tax revenue that it needs to stop - but that revenue is, in effect, coming from those who can least afford it (other than the foreign investors, of course, who could easily have been targeted by other means if that was the intent). As usual.

However, although the selling seems to be widespread, it seems to me that there will be important differences between the trusts. In particular, many of the energy trusts have much less taxable income than distributable cash flow because of depletion. So before getting all concerned, one should look carefully to figure out how much tax your favorite energy trust will really be paying. I wouldn’t have touched the non-energy trusts anyway because of my overall bearishness.

Of course, the other big question is, will this stick? Who knows, your guess is as good as mine. But certainly the early feedback I have been seeing is that the Conservatives have touched a third rail here. Will they survive it?

I’m neither selling nor buying. There will be lots of time to bottom fish when energy prices have flushed some more.