What Was the Halloween Massacre?

What Was the Halloween Massacre?

Let me explain what the Halloween Massacre was. It refers to a decision back in 2006 by the Canadian government to start taxing all income trusts based in the country. On Halloween, October 31, 2006, Canada's Finance Minister at the time, Jim Flaherty, announced that these trusts would face a tax rate of over 30% on their taxable income, just like regular corporations. This move caused the value for unitholders to plummet almost overnight. You see, income trusts were a big hit with Canadian investors because of their tax perks, which made them attractive until this change hit.

Key Takeaways

Here's what you need to know at a glance. The Halloween Massacre is the name for the Canadian government's decision in October 2006 to tax all income trusts in Canada the same way as corporations. They slapped on a tax rate of more than 30%, which caught many trust holders off guard. This was done to make up for what the government saw as lost tax revenue, and it led to an instant 12% drop in the value of those Canadian income trusts.

Understanding the Halloween Massacre

To understand this, consider how Canadian tax laws worked before. Income trusts could distribute money to unitholders before taxes, making them a go-to choice for many investors in the early 2000s. But that all shifted on October 31, 2006, when Finance Minister Jim Flaherty announced the end of those tax benefits.

The tax law change, which people debated a lot afterward, aimed to fix a supposed shortfall in tax revenue. At that point, there were around 250 trusts on the Toronto Stock Exchange (TSX) with a total market value exceeding $200 billion. Many offered yields up to 10%, so it's understandable why the government's decision stunned investors, causing that immediate 12% value drop.

In the years after, with low interest rates in Canada and the U.S., investors have been chasing yields similar to what income trusts used to offer. As of 2023, income trusts still exist, often as real estate investment trusts (REITs). These hold and manage properties like office buildings, shopping centers, and hotels, and Canada still gives them some special tax treatment. When income passes to unitholders, there's little to no corporate tax, and most distributions get taxed as ordinary income.

Fast Fact

Here's a quick fact for you: Income trusts in the energy sector dropped as much as 17.85% in value in the 10 days right after the government's announcement on October 31, 2006.

Special Considerations

A Canadian income trust was basically an investment fund that held assets producing income and paid out to unitholders or shareholders regularly, usually quarterly or monthly. These trusts had to distribute at least 90% of their net cash flows.

Both investors and the trusts gained from the tax setup. As an investor, you'd get part of the payment as an untaxed return of capital and part as a taxable distribution. The trust itself would pass most cash to unitholders, leaving little for the entity to hold, so taxes were minimal. They paid out earnings before taxes and were typically traded on exchanges.

Important Note for U.S. Investors

If you're a U.S. investor looking at Canadian investments like REITs, remember that payments from these trusts face a 15% Canadian withholding tax. Depending on where you hold the shares, you might be able to claim a foreign tax credit.

Consequences of the Halloween Massacre

The change in how Canada taxed income trusts really upset a lot of investors. These trusts gave higher yields than things like guaranteed investment certificates (GICs), and their value tanked by 12% right after the announcement. One American couple even filed a NAFTA claim for $6.5 million plus costs.

The TSX dropped 294 points on the announcement day as investors yanked money out of trusts. But it bounced back soon, recovering almost all losses, mainly because people shifted to dividend-paying stocks.

Trusts got five years to convert to corporations. Many did that, while others turned into REITs by the 2011 deadline. Those that didn't either went private or got bought out.

Post-Pandemic Effects

The Canadian REIT market took a big hit from the COVID-19 pandemic. In the second quarter of 2020, there was the largest year-over-year quarterly earnings drop ever at minus 13%, as noted by Carolyn Blair from RBC Capital Markets Real Estate Group.

By the end of September 2020, Canadian REITs had a negative 20% return over the previous 12 months, due to issues like tenant bankruptcies, empty stores, reduced retail, and closures in shops and restaurants.

After the pandemic, Canadian REITs looked set for recovery with lower interest rates and better efficiency. But rising rates have slowed investment and demand. The sector's revenue is projected to fall 5.6% to $8.2 billion by 2023.

When Did Canada’s Halloween Massacre Take Place?

It happened on October 31, 2006. That's when the Canadian government surprised everyone by announcing that all income trusts in Canada would be taxed like corporations.

What Was the Impact of the Halloween Massacre?

The announcement led to an immediate 12% decline in the value of Canadian income trusts. The energy sector got hit hardest, losing about 17.85% over the next 10 days.

What Was a Canadian Income Trust?

It was an investment fund holding income-producing assets that distributed payments to unitholders periodically, usually monthly or quarterly. Trusts had to give out at least 90% of net cash flows to shareholders.

The Bottom Line

Income trusts made it through the Halloween Massacre and the tough times of the COVID-19 pandemic. They're not as profitable as before, but the sector is far from dead—it's still active and viable.