Carriers face questions after income trust bust

The federal government’s decision to thwart Telus and BCE’s income trust plans could change the way the carriers invest in future network technologies and services, industry analysts said Wednesday.

Finance Minister Jim Flaherty announced a “tax fairness plan” late Tuesday that would make it more difficult for public companies that convert into an income trust to avoid paying corporate taxes. Under the existing rules, an income trust would pay monthly dividends to investors, who would then have to deal with the tax implications, rather than companies taking the tax off profits and paying the government directly. Telus announced its plans to do this in September, and Bell Canada Enterprises (BCE) followed suit last month.

In public statements released Wednesday morning, both Bell and Telus said the government’s announcement took them off-guard, and that they are assessing the situation. “As a result of the announcement by the Federal Minister of Finance, there can be no assurance at this time that Telus will proceed with its proposed income trust conversion,” the statement from Telus said.

Bell, which also released its third quarter results on Wednesday, indicated the company would undergo significant changes whether or not the income trust plans make sense.

“The Minister’s announcement clearly has a significant impact on our proposed conversion and the immediate benefits such a conversion would have delivered to our shareholders,” BCE chief executive Michael Sabia said in a statement. “In any case . . .we will proceed with plans to eliminate BCE’s holding company operations.”

Because shareholders are in complete control of their own tax planning under an income trust, the stock prices of the trusts tend to rise significantly, which is a big reason behind the move, telecom industry analysts said. That would mean, in theory, the cost of capital would have been lower, which they could have poured into new products and network infrastructure investments to remain competitive.

“As an SMB, I’m wondering are they going to pull back on expansion to roll out DSL and cable in rural fringe areas?” said Roberta Fox, principal of Fox Group Consulting, who noted that carriers have primarily been focusing on creating hosted offerings, setting up data centres or improving their billing systems. “That’s where they use the capital they get from the markets. They may decide they have to keep going on the billing projects, but cut back on the rollout of EVDO.”

Others weren’t so sure. Ian Angus, president of Angus Telemanagement Group in Ajax, Ont., said income trusts are best suited for stable industries that have low expenditures and predicable incomes.

“In my opinion it was never appropriate. If you went and read what income trusts were supposed to be, they didn’t fit telecom,” Angus said. “It would have led to stagnation . . . with an income trust, the pressure is very high. It’s supposed to distribute all its profits. It has at least a tendency, although not an inevitable one, to induce companies to reduce their spending.”

Telecommunications providers will need to face competitive realities whether the market is economically favourable to income trusts or not, added Mark Goldberg, a telecom consultant based in Toronto. Even as income trusts they would face hurdles.

“If I’m a carrier, what if I need to invest in some new dial-tone technology that I didn’t anticipate?” Now I have to spend half a billion,” he said. “That means I have to cut my dividend. If I cut that, the stock price drops exactly proportionate to the cut.”

Fox said carriers may decide to renew their calls for looser rules around foreign investment if the fair tax program on income trusts goes through, but Angus was skeptical.

“If the rules were dropped 10 years ago, every phone company in Canada would have been snapped up. And by now they would have been sold again,” he said.

Bell Canada did manage to form an income trust based on the East coast earlier this year that included assets of Aliant and its wireless operation.

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