TD Economics suggests that the trust sector may eventually vanish now that the tax break they enjoyed has been eliminated by the government.

In a research note, TD says that the government measures effectively neutralizes the tax advantage of shifting from a corporate structure to a trust. “Some companies, such as TELUS and BCE, that were in the process of making the conversion may choose not to proceed. And, it is possible that some business trusts could consider returning to a corporate structure,” it says. “In other words, the government’s stated objectives should be fulfilled.”

This assumes that the measures are passed by the legislature, which is always a question when a minority government is in power. “The key risk would be if the government was brought down by a vote of non-confidence on the 2007 budget,” it says. “In our opinion, unless the government falls on the 2007 budget, the announced tax changes will be passed into legislation and this will draw to a close the conversions to the trust structure by large publicly-listed companies.”

“In fact, it is not evident why businesses would necessarily want to retain a trust structure,” it says. “At the moment, trusts face less restrictive disclosure requirements, but this will likely change in the years ahead. Meanwhile, there are a number of restrictions on trusts, such as limits to what can be done with profits. If companies want to simply pass along all of their retained earnings as dividends, it can be accomplished within the corporate structure. So, we are not sure whether the income trust sector will still be present in 10 years time.”

“In terms of more immediate implications, there will be an adjustment in income trust valuations, but markets will do this quite quickly,” TD says. “Canadians holding income trusts outside of tax shelters will be impacted by the valuation adjustment, but their tax burden will not increase. However, the attraction of holding income trusts in RSPs or by pension funds and foreign investors has been significantly diminished.”

“Finally, the cut in the corporate tax rate is meagre, but it is welcome news,” it concludes. “Seniors should be happy with the announced tax changes, particularly the income splitting. By introducing income splitting for senior Canadians, the federal government has opened the door to public pressure for a similar treatment of all Canadians, after all the same tax distortion is felt by seniors living off one pension as a young family that has a stay-at-home parent.”