If you are an owner of income trusts then you may find yourself in a unique position during 2010 because of the new tax rules on the horizon. No, not the HST, I am talking about the new income tax rules that will alter the income trust tax flow-thru that has been such a great benefit for cash flow investments.
The issue: Cash Positions at your favourite income trusts and new tax rules that will strip away individual profits.
Background: During the recession, many companies took a defensive position to their business. The immediate reaction was to cut cost and raise liquid assets on the books. Simply put, companies increased their rainy day fund just in case their business was the next to suffer. As a result many companies stock piled cash and either reduced dividend payouts or did not increase them over the past year.
This was the right thing to do at the time and I was glad to see some of my top holdings rain in their expenses to make sure their businesses stay afloat through rough waters. Many of these investments have fattened up their book values, but there is another obstacle on the horizon—the Tax Man.
Coming to the Tax-Man nearest you, are higher taxes payable for income trust in 2011. To mitigate some of this future tax, some income trusts are beginning to payout more retained earners to reduced tax burdens for future years so that these dividend are paid out before the increased tax.
Don’t believe me? Take a look at a recent press release from Westshore Terminals Income Fund (WTE.UN). On March 12 they announced that a quarterly cash distribution of ($0.42 per unit) will be paid out for Q1. Compare that to a year ago when the pay out was only $0.24 per unit. The distribution announcement then goes on to state that “Westshore has reviewed its cash reserves built up over 2008 and 2009 during uncertain economic times, and has determined that, based on current circumstances, a lesser reserve is adequate.” As a result, cash distributions will be supplemented throughout 2010.
My concern with this process is how will this affect the valuation of income trusts? Generally speaking, income trusts trade based on their cash flow. So when distributions increase the shares generally increase in value as buyers will bid up the price until the annualized distribution percentage moves back to an expected anticipated return.
For example, an income trust currently pays $1 per year and trades at $10 a share (this represents a 10% annual dividend). Now the company increases distributions to $2 annualized (this represents a 20% annual dividend pay out). The shares are bid up in price until the distribution moves back to 10% (this will constitute a share price of $20).
Obviously it’s not as simple as this but the stock market never is.
Will Westshores shares be influenced over the year by these increased distributions or will investors value these investments differently in the future?
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