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Dale Jackson

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Live and Let Die

Dale Jackson


In the 1973 James Bond movie Live and Let Die the bad guy - Mr. Big - tries to get the world hooked on heroin. In the 2006 version, Canadian Finance Minister Jim Flaherty is the villain - but he’s trying to wean investors off of their income trust addiction.

By the end of the year Mr. Flaherty told the income trust industry his decision to close the income trust tax loophole by 2011 was final. “That’s the end of the story” he told a Dec. 19th, 2006 meeting of the Vancouver Board of Trade.

As it stands, income trusts can live in their current form for the next four years but the tax-friendly income bearing investment vehicles, which Canadian investors have grown so fond of since the turn of the century, must die.

Under the current rules income trusts are not taxed on their distributions to unit-holders, which frees up more cash for further distributions. As more and more tax-paying corporations showed interest in converting to the income trust model, Ottawa became more and more concerned over the potential for billions of dollars in lost revenue.

However, trust industry groups such as the Canadian Association of Income Funds are not prepared to live and let die. They’ve formed a lobby group to preserve the trust loophole. Like James Bond they’re taking advantage of a prolonged execution to try to cheat what appears to be certain death.

Middlefield Capital Corp. managing director, Dean Orrico is putting his faith in the huge outcry from politically powerful retirees who rely heavily on investment income. He sees the Conservative minority government as vulnerable to an opposition party that would make income trusts an election issue. “I think this is something that the Liberal Party might want to embrace” he says.

At the same time Middlefield isn’t waiting for the politicians to save the day. Mr. Orrico says his team is “getting selective” with its $2-billion trust portfolio. That means looking for trusts that have the ability to pay out generous cash flows even without the tax break. “Not all trusts will be reacting to the upcoming tax the same way” he says.

Over the next four years Middlefield expects a lot of merger and acquisition activity amongst the existing 256 income trusts trading on the Canadian market. There’s also speculation private equity firms will continue gobbling up trusts. In mid December U.S.-based Harbinger Capital Partners made an $831-million hostile takeover bid for Calpine Power Income Trust.

Oil & gas and business trusts are at the top of the Middlefield list. The company is focusing on 10 to 15 names including Yellow Pages Income Trust, which has increased its distributions since the October 31 announcement and is expecting growth of four per cent to five per cent annually.

Other trusts he feels have the potential for distribution growth beyond 2011 include BFI Canada Income Fund, CI Financial Income Fund, Bell Aliant and Teranet Income Fund. “I think over time you will see trust valuations migrate to those of their corporate peers” he says.

No one really knows how income trust valuations will react as the 2011 deadline draws near so Middlefield is also changing its investment strategy to reduce risk through diversification.

Of the nearly fifty trust holdings in Middlefield’s portfolio about one-third are real estate investment trusts (REITs), which are exempt from the new tax ruling. Another third is invested in oil & gas trusts, and the rest is divided between business, pipeline and power trusts.

Middlefield is also venturing out beyond the world of income trusts for income - repositioning the portfolio to include more high-dividend paying stocks such as banks. “There will always be a demand for income” he says.

Dale Jackson has been a producer at Report on Business Television since its launch in September 1999.

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