Markets Rocked By Flaherty Income Trust Announcement

The markets plunged 300 points when the opening bell rang. It follows Tuesday’s stunning reversal of fortune surrounding  income trusts. Finance Minister Jim Flaherty claims the current rules allow huge corporations to avoid paying taxes and that Ottawa simply can’t afford to take the hit.

By late morning, the markets were off by more than 200 points, as the sell off of companies that were planning to covert to income trusts – like BCE and Telus – took big hits. Others that had already taken the steps were equally hard hit.

Many are now wondering what “Flaherty’s clarity” will mean for investors.

“I’m put out, not to put too fine a point on it,” fumes Brendan Caldwell of brokerage firm Caldwell Securities Ltd. “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.”

But while economists are busy trying to assess what will be, some believe the affected corporate giants will absorb the shock and simply move on.

“Today, and over the next few weeks, I think you’ll probably find that the income trust sector will face some head winds because investors are going to try and figure out how these stocks should actually be valued if taxes are going to be increased or if conversions that were anticipated don’t take place,” advises Craig Alexander of TD Bank Financial Group.

“Having said that, it probably won’t take financial markets very long to figure it out, so there’s going to be some volatility, you know, over the next couple of days, it should shake out fairly quickly.”

The announcement caught Ontario Finance Minister Greg Sorbara by surprise, but he understands the reasoning behind the move.

“It will have a positive impact on corporate taxes, and  … the principles behind what Mr. Flaherty is trying to achieve are very sound and that is a tax system that has the right distribution between corporate taxes and personal taxes.”

The Conservatives broke a major campaign promise by changing the rules in mid-financial stream and while Sorbara has no love for the Tories, he can certainly sympathize with his counterpart’s plight.

“I share his pain,” he acknowledges. “I think it’s just an example of sometimes, you know, once you are in government you just have to do what you think is the right thing. Obviously that was what was behind the health premium.”

The McGuinty government came under heavy criticism and the party was branded the “Fiberals” after breaking a number of election vows – including a pledge not to raise taxes.

Reaction to the income trust changes:

“Today, Canadian seniors and other investors, as a consequence of this government’s broken promise, saw $25 billion of their hard-earned savings go up in smoke in two hours of trading. In comparison, the government’s pathetically small tax relief is $1 billion over a whole year.”‘

Liberal MP John McCallum, former revenue minister, in the Commons.

“The RCMP are not investigating my Department of Finance. They’re investigating your Department of Finance. There were no leaks, there were no e-mails, there were no deals with friends on Bay Street. There was confidentiality.”

Flaherty in the Commons, after being assailed by the Liberals during question period.

“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.”‘

Brendan Caldwell, president of brokerage firm Caldwell Securities Ltd.

“I think (Flaherty) overreacted. 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.”

George Athanassakos, a corporate finance professor at the University of Western Ontario, in London.

“The sell-off right now is definitely driven by a lot of misunderstanding. A lot of people really hadn’t done much homework and they just basically gave up on the entire sector.”

Cecilia Mo, portfolio manager of Fidelity’s income funds.

“On the one hand, the new income trust tax regime will be a blow to many seniors because of the high rate of returns income trusts provide — sometimes with a high risk. However, it is welcomed news that current income trusts will be exempt from the new tax regime until 2011. This will provide investors with four years to adjust to their new circumstances.”

Statement from CARP, Canada’s association for people over 50.

“Income trusts, as high-yield equity investments, have offered Canadians an alternative to complement their portfolio holdings. The big losers, as a result of today’s announced changes, are Canadian investors who already today have seen their investment portfolios erode. We expect to see a drop-off in market value of several billion dollars — an amount that well exceeds the tax loss that the new government is trying to address.”

Ian Russell, president and CEO of the Investment Industry Association.

“I think it’s clear that the government’s intention is to neutralize the tax advantage that income trusts have had over corporate structures. Irrespective of the structure that the company is in, the path to long-term, durable, sustainable value creation is through all the efforts that we have underway to build the business.”

BCE Inc. CEO Michael Sabia.

“I don’t think this is a huge deal for the economy either way.”

Merrill Lynch economist David Wolf.