Gordon Pape Gives Advice To Investors Regarding Taxing Income Trusts

LOCUST VALLEY, NY -- Well-known Canadian author and newsletter publisher Gordon Pape says the proposed plan to tax income trusts will probably become law and investors need to take a new approach to valuing them.

Writing on the http://BuildingWealth.ValueForum.com website, the publisher of The Income Investor, which specializes in trust coverage, said that US investors will be hardest hit by the plan, which was announced by Canadian Finance Minister Jim Flaherty last fall.

Many Americans have invested money in Canadian trusts and lost thousands of dollars when the sector took a big hit after the announcement.

Pape ran a well-attended seminar on Canadian income trusts at the recent World Money Show in Orlando, Florida during which many investors expressed anger and frustration over the Canadian government’s move. During his presentation, he laid out a set of guidelines for evaluating Canadian trusts in the new climate and expanded on his insights on http://BuildingWealth.ValueForum.com which is a Canadian portal into ValueForum.com, one of the most popular and influential investment discussion forums in the United States.

“I left Orlando with the impression many people still believe that the plan will be defeated in the Canadian Parliament,” he said. “That’s wishful thinking. It’s going to happen so we need to look at trusts in a different way.”

He advised using these guidelines for deciding which trusts to keep or buy and which to sell.

Strong core business. If the business model is sound, it will continue to operate and generate profits after Jan. 1, 2011 when the tax kicks in.

Sustainable distributions. Trust distributions are going to be hit with a 31.5% tax after 2010. This will reduce the amount of cash available for distribution to unitholders. Investors who own trusts that are unable to sustain current distribution levels face a double hit -- payout cuts plus the tax bite. Market values will plunge as that scenario unfolds.

Growth potential. Maintaining current distributions is good. Growing them is better. Some trusts may be able to increase their distributable cash by enough to completely offset the tax when it kicks in.

Investors are now attaching much greater significance to distribution increases than in the past, Pape noted. For example, after Liquor Stores Income Fund announced a 7.1% distribution hike last month, the shares jumped 9.7% in the next five trading sessions.

Good liquidity. Pape said that we have already started to see evidence of a flight to quality in the trust sector and that is likely to accelerate the closer we get to 2011. That means there will be less demand for illiquid trusts (except in special circumstances) and bid/ask spreads will widen.

At this stage there is no evidence that acquisitions will result in large premium prices being paid for takeover candidates. For example, Bell Aliant made a $119 million offer for Amtelecom Income Fund (TSX: AMT.UN) at $13 a share. That was a premium of only 15.6% over the previous day’s closing price, which is very modest for a takeover bid.

Gordon Pape is one of Canada’s most respected financial authors and the nation’s leading expert on mutual funds. He is the editor and publisher of the Internet Wealth Builder (IWB), The Income Investor, and Mutual Funds Update. To sign up for Gordon Pape’s newsletters you can visit: http://www.buildingwealth.ca/valueforum/