It’s now less than a month until Jan. 1, 2011, the doomsday for income trusts laid down by Canada’s Finance Minister Jim Flaherty on Halloween night 2006.

Ironically, the biggest surprise for most investors is going to be how little really changes. In fact, what we’re likely to witness is little more than the investment equivalent of the so-called Y2K crisis of 11 years ago.

Then, if you remember, the world was in a panic about what would happen when computer code that was supposedly locked into the 20th century was forced to consider four-digit years beginning in “2.” Predictions of full-scale system shut downs, the collapse of banking and security systems and generally computers run amok were rife.

As it turned out, Jan. 1, 2000, came and went without so much as a peep. Sure, a lot of companies worked hard to avoid problems beforehand. But when the supposedly momentous day rolled around, nothing happened and the world went on about its business.

Since the trust death sentence was announced, many investors have staked their hopes on the possibility that the 2011 tax would be either softened or postponed. The former was the official position of the chief opposition Liberal Party, the latter of the Bloc Quebecois.

Unfortunately, it’s been clear for some time that the ruling Conservatives aren’t going to budge and that the opposition isn’t going to ride the issue into power. Even the zeal of trust tax opponents has died down, as the government has continued to reduce corporate taxes.

Ironically, governments and lobbyists never held the keys to investors’ returns in the post-trust era. Rather, that’s rested squarely on how well management responds to the challenge posed by losing favorable tax status.

In the first couple years following Flaherty’s announcement, I queried industry executives at every opportunity what they thought the odds were of Ottawa overturning the trust tax. More often than not, I got the surprising answer that not only did they find it unlikely, but that it was not really that important to where they saw their ability to generate investor returns.

To be sure, most would have rather not paid new taxes, and they certainly hoped the government would overturn them. But at most these were a setback, not a real threat to the best companies’ ability to build profitable, growing businesses.

On Nov. 14, 2006–in the midst of Canadian trusts’ still legendary post-Halloween selloff–I posted a Flash Alert titled The 25 Percent Rule. In it, I asked Canadian Edge readers to take a simple litmus test: Would their trusts still be attractive if they cut their dividends by 26.5 percent, the amount of the tax income trusts were slated to face in 2011?

My advice was anyone who could honestly answer “yes” to that question had no business selling. My reasoning was that the trust’s price already factored in the absolute worst-case scenario on taxes and then some. Even were the tax imposed immediately and the distribution cut, the yield would still be generous and the stock worth holding.

Flash forward four years. By any definition we’ve lived through very interesting times. Not only have we seen the end of an historic boom in US real estate. But we’ve also witnessed the worst combination market crash/credit crunch/recession in 80 years. Emerging Asia has replaced the US as the world’s driver of economic growth as well as the largest consumer of basic commodities. The US itself has seen two wrenching political changes, with Democratic landslides in 2006 and 2008 reversing to a Republican rout in 2010.

In fact, about the only thing that hasn’t changed in the past four years is the Canadian government. It remains firmly in the hands of Prime Minister Stephen Harper and his plurality in Parliament, which, in turn, is staunchly against an eleventh-hour reversal of the trust tax.

The advice I gave Nov. 14, 2006, however, has stood the test of time. In fact, as it turned out the extremely negative future trusts were then pricing in has little or nothing to do with the emerging reality of January 2011.

What’s Really Happening

Change is coming and it will be swift. On Jan. 1 each of the 54 income trusts in the table “Still to Convert” will restructure as an ordinary, tax-paying corporation.

They’ll hardly be the first to make the leap, however. In fact, as reported at the time here, the first trust conversions were announced and completed in early 2008. Since then dozens of companies have seamlessly changed their accounting structure without impacting their underlying business, other than paying legal fees.

Converting from a tax-free trust to a taxable corporation does mean absorbing higher taxes. One-hundred percent of the burden, however, is absorbed at the corporate level, not by investors. In fact, converting to a corporation actually reduces the rate at which dividends are taxed for Canadians, and it eliminates the 15 percent withholding for US investors holding these companies in IRAs.

The only real question for investors, consequently, is what the impact of corporate taxes on dividends would be. And here too, the answers have been far more favorable than almost anyone expected in November 2006, including me.

Compare the table “Dividends to Change” with “Still to Convert.” This shows all of the How They Rate trusts–as well as former trust and now converted corporation Yellow Media (TSX: YLO, OTC: YLWF)–that plan to reduce dividends starting in January. Every other company in How They Rate, as well as in “Still to Convert,” will pay the same yield in 2011 that they do now.

As for this list, there’s still a possibility that Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF), FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF), Royal Host REIT (TSX: RYL-U, OTC: ROYHF) and The Keg Royalties Income Fund (TSX: KEG-U, OTC: KRIUF) won’t reduce their payouts next year. I discuss all four in the Dividend Watch List in Tips on Trusts. And I’ve estimated reductions for several other converting trusts based on what I saw was a worst case reading for their dividends next year.

What is shown here, therefore, is a worst-case scenario for dividends in 2011. That’s a total of 26 companies reducing distributions as they convert. The average distribution reduction is roughly equal to the expected impact of higher taxes on distributable income. And the average yield after the reduction is comfortably above 7 percent.

This list is also less than half as long as “Still to Convert.” The reason: Most of the trusts converting to corporations next month will be absorbing the new taxes without changing their dividends.

Their ranks include the following Canadian Edge Portfolio holdings: ARC Energy Trust (TSX: AET-U, OTC: AETUF), Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF), Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF), Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF), Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF), Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF), Just Energy Income Fund (TSX: JE-U, OTC: JUSTF), Keyera Facilities Income Fund (TSX: KEY-U,  OTC: KEYUF), Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) and Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXHF).

As for the companies in “Dividends to Change,” investors can be sure of one thing: All of these post-conversion cuts have been public information for weeks, many months in some cases. Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF), for example, received court approval for its conversion plan on June 24, which it announced on May 4.

Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF) made its initial announcement and set its post-conversion dividend cut on Mar. 2. Already converted Yellow Media also announced early in the year that it would restructure first and then reduce distributions in January.

As investors, we always prefer preserving dividends to cutting them. But by pre-announcing their post-conversion dividend reductions, these companies eliminated all uncertainty about 2011 long ago. The cuts to come therefore have long since been reflected in their unit prices.

Put another way, there is no further downside when these companies convert to corporations, even though they’re cutting distributions. That’s not a market event investors are used to on either side of the border. In fact, you likely have to go back to the phase-out of limited partnerships under 1986 tax reform to get anything similar, as tax-advantaged companies in the US had to adapt their dividends to new taxes.

But we’ve already seen the benefit of removing uncertainty in how these companies have performed since their dividend cut announcements. Davis + Henderson, for example, has returned 31 percent since its conversion/cut announcement. That’s three times the return on the S&P 500 and twice the return on the S&P/TSX Index.

Again, it’s not typical for a dividend-paying stock to rally sharply after announcing a payout cut. But it’s been the rule for income trusts that announce conversions followed by dividend cuts, mainly because setting a clear dividend level eliminates the uncertainty that’s hung over their share prices since Halloween 2006, while laying out a baseline for future robust growth.

Not all of the companies converting Jan. 1 rate buys. Each has proven its ability to weather the worst of all macro environments by outlasting 2008-09. But many have also run up and trade above what I consider to be fair buy prices. Some, like North West Company Fund (TSX: NWF-U, OTC: NWTUF), have simply set their post-conversion dividends too low to really be of interest, despite otherwise being high-quality companies.

If there is remaining risk, it lies with the companies named above that have yet to state a post-conversion dividend rate. The mere fact they haven’t yet may not be significant. Then again, by not stating their intentions they are keeping a black cloud over their share prices, as investors hate uncertainty above all else.

Royal Host, for example, made a sharp spike down this week for no easily discernable reason, other than no one knows what it’s going to do after converting.

So has Chartwell, whose management’s only comment about 2011 dividends was they’d “have much better information within the next three to six months.”

On the other hand, falling share prices mean diminished expectations, which translate into a lower standard to meet when management finally does make up its mind.

And in stark contrast to just a few months ago, the ranks of the yet-to-announce are really not significant, relative to the swelled ranks of those that have, have already converted or else won’t have to convert.

The latter group is listed in my third table, “Not Converting.” Many of these 22 companies are real estate investment trusts (REIT) that met the government’s tougher qualifications to maintain their tax advantages. Others are “income participating securities” or “stapled shares,” which combine a bond with equity into a single high-dividend-paying security and were never technically income trusts.

Northern Property REIT (TSX: NPR-U, OTC: NPRUF) is a REIT with investments that disqualify it under the government’s new rules. As a result, management has elected to reorganize the company as a corporation and to reissue its equity as stapled shares–combining a debt with an equity portion–rather than as REIT units.

Under the plan, which now has shareholder and court approval, the company will create a new tax-paying corporation, NorSerCo Inc. The new entity will hold all the assets of Northern Property that don’t meet the government’s new rules, mostly revenue from the company’s four “ExecuSuite” properties. NorSerCo will make monthly lease payments to Northern Property, which will then qualify as a REIT.

Presumably, the debt portion of the stapled share will pass the NorSerCo income on to the REIT, enabling Northern Property to maintain the same distribution rate. Note that the REIT resumed dividend growth with a 3.4 percent boost, effective with the September payment. A growing portfolio of high quality properties should keep the trend going next year. Northern Property REIT is a buy on dips to USD25.

Brookfield Renewable Power announced Oct. 21 that it won’t be taxable in 2011 as a trust and would therefore defer conversion, with the goal of settling on a permanent structure sometime in early 2011. That may or may not include actually converting. But it will keep the company on target to maintain its current dividend into 2011, no matter how it’s structured.

In fact, we’re likely to see another dividend increase along the lines of the 4 percent bump in March, as Brookfield continues to complete projects and add new assets with acquisitions. Last month, the company inked a deal to buy the 166 megawatt Comber Wind project from parent Brookfield Renewable Power Inc. The plant is close to the company’s Gosfield Wind Farm, which is now up and running, allowing considerable economies of scale.

It’s good to see this kind of asset dropdown is still going on between Brookfield and its parent, a unit of Brookfield Asset Management (TSX: BAM/A, NYSE: BAM). That’s another good reason to stick with this stock, despite a revenue shortfall due to poor hydro conditions in the third quarter. Buy Brookfield Renewable Power Fund on dips to USD20.

Extendicare REIT (TSX: EXE-U, OTC: EXTEF) has actually failed to qualify as a real estate investment trust since 2007. As a result, it’s been paying trust taxes ever since, making conversion to a corporation now an utter waste of time and money. Third-quarter earnings were very solid with a payout ratio of 68 percent. Extendicare REIT is a buy up to USD10.

Aggressive Holding Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) has also elected not to convert to a corporation. The main reason: Extensive operations outside Canada mean it won’t owe taxes as a trust in 2011 or anytime in the foreseeable future, eliminating any incentive to fork over conversion expenses.

The company’s Beaumont, Tex., plant is back running, which should provide a sizeable lift to cash flow in the fourth quarter and into 2011. But even when it was down for repairs, cash flow covered the CAD0.10 per month dividend. And that’s excluding the insurance that should enable the company to recover much of the lost income. The business is still volatile but conservative financial policies are keeping the dividend safe. Buy Chemtrade Logistics Income Fund–a tax-paying SIFT for the foreseeable future–up to USD13.

Unfortunately, Inter Pipeline Fund LP (TSX: IPL-U, OTC: IPPLF) has elected to go the same route and not convert. That’s despite the fact that Canadian limited partnerships are getting socked with the same taxes as trusts.

The owner of energy infrastructure with a big presence in the oil sands region can certainly afford to absorb the levies without cutting dividends, as it plans to. Business is very strong, with throughput picking up and a steady stream of new projects coming on line and generating cash flows. Unfortunately for US investors, Canadian limited partnerships strictly forbid foreign ownership in their charters. That’s true of Inter Pipeline, which in the past has gone so far as to threaten some US investors with legal action.

In my view, there are plenty of equally solid alternatives in energy infrastructure that have no such restrictions, such as Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF). Consequently, there’s no reason to risk the potential hassles of Inter Pipeline and other Canadian LPs. If you’re Canadian, however, Inter Pipeline is another good example of how a very solid company has navigated Canada’s trust tax, while keeping its shareholder returns robust.

What to Watch

So much for what not to worry about. There are, however, several things to be aware of going into 2011 to avoid surprises.

First off, if you own any of the trusts listed in the table “Dividends to Change,” make a note of what the new dividend rate will be. Each of these companies will continue to pay at their current rate up until they convert. That means basically anything declared in December, whether it’s paid in January or not.

The first dividend payment at the new rate will be what’s declared in January. That may be paid next month, or even as late as February. Don’t make the mistake of thinking there won’t be a change if you receive another payment or two at the old rate.

Rather, from now on look at each trust from the point of view of what the post-conversion yield will be, based on its current price. The game is still the same as it was back in November 2006. If you like the stock at the lower rate, there’s no reason to sell. If not, then move onto something else.

Second, make a note of which trusts have changed the frequency of their distributions from monthly to quarterly. To date, we’ve seen several converting trusts move from monthly to quarterly, including Conservative Holding Colabor Group (TSX: GCL, OTC: COLFF).

Each time, the move has sowed confusion with many investors, as an expected dividend wasn’t received. Popular quote services didn’t do anything to help the situation either, as many simply took the change to mean that dividends were eliminated entirely.

Others took months to sort out the actual rate, i.e. using the new quarterly rate to calculate an annualized rate for purposes of showing a percentage yield.

Most of the trusts that will convert on January 1 are sticking to a monthly payout. As a result, there should be no such confusion with either percentage yields or when it comes to rounding up dividend dates.

All 10 of the converting trusts in the table “Changing Frequency,” however, have the potential to cause headaches for investors who aren’t aware in advance of what’s going on. Note that FP Newspapers, Royal Host and The Keg haven’t told us the frequency of their future dividends, just as they haven’t set a specific dividend level.

I’ll continue to post dividend frequency and dividend date information for all 150-plus companies tracked in How They Rate, as it’s updated by our live quote service. In the meantime, the best source for information on dividend declarations for these companies as quarterly payers will be their websites, which can be accessed by clicking on their names as they appear in How They Rate.

With so many trust conversions taking place at the same time, it would take a minor miracle for there not to be at least some confusion on Jan. 3–the first trading day afterward. No doubt a great deal will be generated by US over-the-counter (OTC) listings.

One thing we’ve seen over and over is that five-letter OTC symbols are suspended for converting trusts at least initially. Sometimes, as was the case with Yellow Media, the OTC symbol has stayed the same after conversion, and trading under it has been resumed the same day it was interrupted. Hopefully, that will be the case with at least the majority of the converting trusts on Jan. 3.

Unfortunately in other cases it’s taken several days for OTC symbols to be fully tradable again. These have primarily been smaller converting trusts where symbols have changed. But confusion has reigned for a time even for some of the larger and more widely held converters, for example Pembina Pipeline Corp when it completed its conversion in October.

Changing or suspending trading in certain OTC symbols doesn’t mean an investor is dispossessed. It has no impact on ownership, ability to collect dividends or even ability to buy and sell, since the OTC shares are merely the Toronto-listed shares trading over the counter. And even on Jan. 3, investors will be able to find out exactly where their converted trusts are trading by looking them up on the Toronto Stock Exchange, though that will require dropping the “-U” or the “.UN” suffix.

To be sure, some investors’ brokerage accounts are going to show at least some converting Canadian stocks priced at zero for a day or two. And I’ve no doubt that our offices will be bombarded by calls and e-mails from worried investors, as will their brokers.

If you’re reading this now, however, realize that a suspended or changed OTC symbol on Jan. 3–or even one that lasts several days–is meaningless to shareholder returns. Even in the most confused situations, there will be a new OTC symbol by the end of the week. And if you really need a quote or have to bail out, liquidity will be unimpeded on the Toronto Stock Exchange.

For our part, we’ll get the new TSX and OTC symbols updated in How They Rate as soon as they are available. That’s not likely to be instantaneous on Jan. 3. But again, this isn’t something to panic over. In fact, it could wind up being a great opportunity to snag good companies cheap, if some investors really do freak out.

It’s also important to note that none of these trust conversions to corporations are taxable events, either in Canada or the US. In fact, the only conversion that was taxable in the How They Rate universe was that of Advantage Oil & Gas (TSX: AAV, NYSE: AAV) last year. That switch proved advantageous for investors, as it allowed shareholders to take a tax loss and hold onto the stock. Advantage Oil & Gas remains a promising play on natural gas and a buy up to USD7.

All you’re going to do is exchange a unit in a trust for a share of stock. Even in the more complicated cases like Northern Property, you’re just exchanging a unit of REIT for a single security. The fact that it’s a stapled share comprising part debt, part equity is irrelevant, other than it will lighten your tax burden, as debt interest from Canadian securities isn’t withheld from US investors’ accounts.

Whatever happens, one thing is certain: By mid-January at the latest, any issues regarding trust conversions to corporations will be resolved. That includes any confusion over dividend dates, dividend amounts, taxes and trading symbols. A four-year dark cloud will at last vanish over the former trusts, revealing a group of high-quality companies with great dividends paid in an inflation-proof currency.

I look for further gains for the former trusts as this new reality sinks in with investors. On the other hand, the dividend cut by Perpetual Energy (TSX: PMT, OTC: PMGYF) last month is a clear sign that a successful corporate conversion doesn’t guarantee there won’t be a dividend cut later on, if business conditions force it.

That means there’s no substitute for doing your research on the companies you own, and buying the business first and the yield second. But then, that’s always been the road to success in this group of stocks that’s seen so many highs and lows over the five and half years we’ve published Canadian Edge. And no matter how much investors and the media may want to focus on more headline-grabbing issues, that’s the way it always will be.