Halloween Massacre

What Was the Halloween Massacre?

The Halloween Massacre refers to the Canadian government’s 2006 decision to tax all income trusts domiciled in Canada. On Halloween, Oct. 31, 2006, Canada’s then-minister of finance, Jim Flaherty, announced that all income trusts would be taxed similarly to corporations at a rate of over 30% on taxable income, causing unitholders’ values to decrease dramatically virtually overnight.

Income trusts—which were permitted to make distributions to unitholders on a pretax basis under previous Canadian income tax laws—were a popular investment vehicle in the early 2000s, especially in Canada. The Canadian energy sector was hardest hit by the change, suffering an estimated loss of about 17.85% in value (about $35 billion) to investors over the 10 days following the announcement, giving rise to the term “massacre.”

Understanding Canadian Income Trusts

A Canadian income trust is an investment fund that holds income-producing assets and distributes payments to unitholders, or shareholders, on a regular basis. Distributions are usually made quarterly or monthly. A Canadian income trust must distribute a minimum of 90% of its net cash flows. Tax advantages to investing in a Canadian income trust include advantages to both the investor and the entity itself.

The investor receives a portion of the periodic payment as an untaxed return of capital and a portion as a taxable distribution. The trust distributes most of its cash to unitholders, leaving little to be retained by the entity, so there is little left to tax. The trust pays out most of the earnings to unitholders before paying taxes, and it is usually traded publicly on a securities exchange.

Understanding the Halloween Massacre

The change in Canadian tax law to tax income trusts the same as corporations—which was debated after the fact—was made to remedy a perceived loss of tax revenue. At the time, according to Bloomberg News, there were some 250 trusts listed on the Toronto Stock Exchange (TSX), with many offering enticing yields of 10%. The surprise move by the government shocked investors and caused an immediate 12% decline in the value of the trusts.

In the years since the Halloween Massacre, interest rates were low in Canada and the United States, as investors clamored for more yields like the kind that income trusts once provided. Nevertheless, as of 2022, income trusts were still available, many of them real estate investment trusts (REITs). These entities hold and maintain income-producing real estate—including office buildings, shopping centers, and hotels—that Canada still offers special tax treatment. When income flows through to unitholders, they don’t pay much, if any, corporate tax, and most of the distributions are taxed as ordinary income.

Recent Fallout from the Halloween Massacre

In the wake of the COVID-19 pandemic, the Canadian REIT market was hit hard. The second quarter of 2020 “brought the largest ever year-over-year decline for quarterly earnings at minus 13%,” according to Carolyn Blair, managing director of RBC Capital Markets Real Estate Group. As of the end of September 2020, Canadian REITs underperformed with a negative 20% return over the preceding 12 months.

The pandemic’s effect on real estate—including tenant insolvency, empty storefronts, reduced retail business, closed shops, restaurants, and more—was to blame. Canadian REITs, since then, experienced a major rebound, but then fell back. As of the end of September 2021, they had returned 43% over the previous 12 months, according to RBC. But some think, as of October 2022, that REITS may be softening.

The Bottom Line

Income trusts have survived the Halloween Massacre and the subsequent near-death experience of the COVID-19 pandemic. While not as lucrative as in the past, the sector is more than skeletal and very much alive.