Two Canadian income trusts well positioned for 2011 tax changes

In 2011, the Canadian government will begin taxing income trusts (with the exception of real estate investment trusts, or REITs). The effect the tax change will have on Canadian investors’ portfolios is something we’ve often discussed in our Canadian Wealth Advisor newsletter.

When the income-tax benefits of Canadian income trusts are eliminated, some may convert to conventional corporations — the same structure as most common stocks. Others may choose to remain as trusts.

Either way, some Canadian income trusts will cut their distributions. That’s because their cash available for distribution to unitholders will fall after they begin to pay corporate taxes and can’t pass it all on tax-free.

The biggest cuts will come from income trusts that now pay out a very high percentage of their cash flows as distributions. That’s often a sign that they’re struggling to remain profitable.

But a handful will rise to the challenge that the tax changes present. In the latest issue of Canadian Wealth Advisor, we update our advice on two that appear to have been looking ahead to 2011 for some time.

Two Canadian income trusts following different 2011 strategies

Bell Aliant Regional Communications Income Fund (Toronto symbol BA.UN) has over 3.1 million telephone customers in rural parts of Ontario and Quebec. BCE currently owns 44.1% of Bell Aliant, a fact that could play a key role in deciding the trust’s future post-2011. More on that in a moment.

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The trust has been facing rising competition for its local and long-distance telephone services lately, and is moving to counter this by expanding its high-speed Internet operations, which generate higher profit margins.

Bell Aliant’s story could unfold in a few different ways as a result of the coming trust tax. It has collected enough tax losses to put off its tax bill until 2012, after which it will likely convert into a conventional corporation. There is also the intriguing possibility that BCE will attempt to buy the trust before the deadline. That would be a very different outcome than the one developing for the second trust we update in Canadian Wealth Advisor.

Great Lakes Hydro Income Fund (Toronto symbol GLH.UN) holds interests in 27 hydroelectric-generating stations in three Canadian provinces and one U.S. state. It also owns a wind farm in Ontario.

The trust’s majority shareholder is Brookfield Asset Management, from which Great Lakes recently agreed to buy a number of additional power-generation assets. The trust’s relationship with Brookfield gives it a number of advantages, including an improved ability to raise capital and access to Brookfield’s management expertise.

Great Lakes has already made the decision to switch to a conventional corporation when the new tax rules take effect. However, unlike many other trusts, Great Lakes’ current low payout ratio should help it achieve its stated goal of maintaining its current distribution and yield, even after it converts.

We’ve updated our buy/hold/sell advice on these two income trusts in the latest issue of Canadian Wealth Advisor. What’s more, when you subscribe today, you can try Canadian Wealth Advisor for one month absolutely free. You have no risk and no obligation. Click here to learn more.