February 11, 2010, 5:39 am

Canadian Income Trusts: The Last Round is Up!

by: The Financial Blogger    Category: Investment, Market and Risk
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It was a dark autumn night; the cold wind was whipping our red cheeks filled with blood to keep us warm. A few leaves were still dancing in the rain over the suburban cemetery exposing their dead sisters in front of each house. While a few monsters were crawling the streets in search of fresh and juicy candies…

But the worst was yet to come… Draguflaherty was arise from the dead and make a declaration: The Canadian Income Trusts will be taxed as a normal companies!

This happened on October 31st 2006 and swiped the Canadian market faster than the first snow of winter. Back in 2006, there was 254 income trusts. Since the dark reaper cut their throats, and now  there are only 170 income trusts left. Most of them will convert back to regular incorporations by the end of the year.
 
 
 
 
 
 

Income Trusts’ Tax implication will change in 2011

As of January 1st 2011, all income trusts will be taxed as regular incorporations. The major difference since its creation is that income trusts were able to distribute their dividends tax free and were getting taxed only on the money remaining after the dividend distribution.

The Canadian Government decided to put a stop to this madness as more and more companies were converting into income trusts taking away billions of dollars of tax revenue from the Government.

Real Estate Income Trust (REITs) will be the biggest winners

There is a survivor to this story and they are real estate income trusts. In fact, they are the only ones to keep their tax privileges. Therefore, even though investors already assessed the dividend cut from other income trust, we expect the remaining trusts to drop in value while REITs should show some interest.

Is there any alternative to high yield dividend paying income trusts?

 

#1 REITs

As previously mentioned, REITs’ tax situation will remain as is. Therefore, it is probably the best possibility in order to receive a high dividend. The housing market is good in Canada but it is not impossible to see a housing bubble in our country too. This is why I would not shove all my money into REITs. Nonetheless, they certainly have their place in a balanced portfolio.

#2 Oil Income Trusts

Oil income trusts are no different from other trusts as they will be taxed starting 2011. However, their major expenses in infrastructures will allow them a tax break for a few more years. Hence, this could be a way to “ride the wave” for a couple of years. There are very solid companies out there and those picks could help your fixed income to perform in 2010.

#3 Canadian Banks

While they are far from being treated as income trust, Canadian banks are among the most solid financial institutions arond the glob. As previously mentioned in my last update of the TSX 60 dividend yield, 4 out of the 6 biggest banks in Canada show a dividend yield over 4%. Their solid balance sheets also contribute to maintaining such a high dividend. According to me, they could be seen as the “small version” of an income trust ;-).

#4 Preferred Shares

Preferred shares can also become an interesting option. Less volatile than common shares, they also offer higher yield. You can find the major banks, insurance companies and oil corporations. They took a major hit in 2008 but most of them came back from the dead and their dividend payout is similar to income trusts (considering lesser risk to be assumed).

Final thoughts on Canadian Income Trusts

I have mentioned it several times on this blog: there is no free lunch in finance. Therefore, what used to be a free ride to high paying dividend investing products finally disappears. Investors will have to get back to investing basics by considering the financial fundamentals of a company instead of picking any double digit dividend yield without even looking at the income trust name!

image source: pingu1963

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Comments

by: Dr Mike Popovich | February 11th, 2010 (8:09 am)

A couple of comments.

” The major difference since its creation is that income trusts were able to distribute their dividends tax free and were getting taxed only on the money remaining after the dividend distribution.”

These were not dividends , they were considered interest income in the hands of the owners , which were the trust unit holders. We payed taxes on all distributed money at the interest tax rate –there was no dividend tax credit & as such our rate of taxation far exceeded the average corporate tax rate of 6.2% (form the Rev Canada web site)–as such there was no tax loss to the gov`t but there was a net tax positive.

“The Canadian Government decided to put a stop to this madness as more and more companies were converting into income trusts taking away billions of dollars of tax revenue from the Government.”

As I said above , the net result from trust taxes was a net positive when all interest payed into RRSP & other pension accounts was taken into account–the finance department failed to factor this into their calculations assuming that registered accounts were tax exempt when they are tax deferred (from the Rev Canada web site)—the gov`t s claim was a 400-500 million tax loss , not billions.

This tax was lobbied-for by CEOs attempting to protect their stock options & to boost their access to capital.

Dr Mike Popovich—Rodney , Ont

You should do some reseach before you open your ignorant trap on income trusts,Start with PricewaterhouseCoopers,BMO and HLB.
We pay tax at the personal rate on distributions.
Income trusts were bringing in a gusher of tax on business.
Income trusts threatened to democratize industry which hitherto had been subject to the rapacities of the top floor and a sycophantic board of directors happy to get their stipend and glad hand old friends.
Lobbying was intense as could be seen on ROBtv every day leading up to Halloween2006
By the way you sound like an idiot and if thats your picture you look like an idiot.

How do we access preferred shares? Is it via ETF? Currently, there is only one Canadian ETF for preferred shares (as far as I know), i.e. Claymore’s CPD; but it’s dividend is about 5% -> not much difference to the big Canadian banks.

Awesome thread! There’s not enough posts out there regarding income trusts.

Regarding REITs, it may be a safe haven for tax purposes come 2011, but be careful – some REITs will not be exempt. For example I have shares in both Riocan and Extendicare but from what I can gather, Extendicare will not be exempt because of the type of activities they do. I have other investments in REITs and other trusts, and the investor surely has to be careful this year as to what holdings they have and whether they want to offload of anything. At the same time, where there’s risk, there’s opportunity, so you never know what direction things can go. By compnanies converting to corporations, the dividends received will also be more favorably taxed in comparison to interest income in a lot of cases as well.
Cheers

by: The Financial Blogger | February 11th, 2010 (12:38 pm)

@ Dr Mike,

I should have explain myself in another way. Let me rephrase this:
For a normal company, dividend are paid to shareholder after they have paid taxes on on their income. As for income trust, they were able to pay dividend to shareholder (that are taxable in the hand of shareholders) without having to pay their tax first.

Therefore, there was a huge tax loss for the Government since they were getting tax only from the shareholder and not from both (as it is the case for a normal corporation).

@1stmilliondollar.net – There are a few ways to do it yes. You can of course buy the specific preferred shares that you like, as if they were regular stocks. And yes you are right, it is surprising that there are not more alternatives to pref shares ETF’s.

Lol.. Draguflaherty! =) I guess at least he redeemed himself somewhat and offered us the TFSA!

I have bought some income trusts for my TFSA this year to milk the distributions before they convert.. so thanks for the tips on alternatives!

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