Friday, November 03, 2006

Canadian Income Trusts-Canadian Government Announces Plan to Tax Income Trusts and the Reason for Decline in Share Prices

After the market closed on Tuesday, the Canadian Finance minister announced the government had plans to tax income trusts in line with corporations. The tax would go into effect in 2007 for new trusts. Existing trusts would have a four year grace period before the tax would hit those companies. The announcement resulted in significant declines in the price of the shares of Canadian Income Trusts.

(click on graphs for larger image)

The reason for the share price decline is directly related to the fact the Canadian trust will have less “cash flow” to pay out as a dividend, repurchase stock or reinvest in the business because of the increase in tax on the company's earnings. The next significant event that could impact these shares is dividend cuts. I would caution an investor that desires to purchase shares in these trusts based solely on the trust's current yields.

If Congress in the U.S. were to eliminate or let expire the 15% tax on qualified dividends, it would be highly unlikely that U.S. dividend paying stocks experience a similar price decline like that of the Canadian Income trusts. The reason being cash flow for the U.S companies would not be impacted by a higher tax on individuals that receive the dividends. Certainly, the U.S company may reduce the dividend growth rate; however, the U.S company would still have access to the cash flow and the company may use the cash to either repurchase shares or reinvest in the business.

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