By now, I expect you have heard about the surprise announcement by the Federal government concerning the taxation of income trusts. If you are in the least bit worried as to how this might affect you, let me put your concerns to rest.

Income trusts are a kind of business structure that used to allow income to flow directly to unit-holders without tax. Over the last few years, income trusts have become increasingly mainstream. They now make up 18% of the benchmark Canadian stock index. Some of Canada’s major corporations like BCE and Telus corp. were in the process of converting to the income trust structure when the news hit. Those businesses will now have to re-think their plans.

If the proposed legislation is passed, distributions from income trusts created after Oct. 31 will be taxed at the same rate as corporate dividends. All except real-estate income trusts (REITS) which appear to have escaped the new measures entirely. All other income trusts created prior to Oct. 31 will be subject to the same taxation rules, but only starting in 2011. The government has also added some “sweeteners” to the legislation in order to soften the tax hit to investors, particularly retirees who have come to count on the high levels of after-tax income provided by income trusts.

There is no doubt that we needed to create a more level playing field in the taxation of different business structures. The changes the Liberal government introduced last year were insufficient. Having said that, the announcement Halloween night took everybody by surprise, particularly since the Harper government had pledged not to tax income trusts.

Financial markets always over-react initially to this kind of thing, and yesterday was no exception. Even the bigger, well-respected names in income trusts like Yellow pages and Aeroplan, who will not see their distributions taxed for another 4 years, were extremely hard-hit.

Most Canadian equity funds now hold some income trusts, not to mention companies like BCE and Telus. Nonetheless, the panic selling of yesterday has had little overall impact.  Even the income trust funds which some of you own (CI High Income fund and the Dynamic Dividend Income fund)  have not been significantly affected. Both the managers of these funds had chosen to limit their exposure to income trusts. Both have stated they now intend to use the sell-off as a buying opportunity. If anything, unit-holders of these funds are likely to come out ahead, once the dust settles.

I expect it will take several more days if not weeks for the financial markets to properly adjust. It will take much longer than that before we know if the proposed legislation is a positive move for Canada as a whole.  I will have more comments for you on that and more in my year-end letter.