Income Trusts –Current News

Much has been made of the Canadian government’s decision to tax income trusts. Before throwing this investment vehicle under the bus, it is important to understand the nature of income trusts and their potential for future growth.

Income trusts are actually business entities that buy assets on behalf of their investors. The money generated within the trust most often comes from royalties and operations. Income trusts have traditionally been viewed as lucrative investments, often distributing up to 80% of their cash flow to investors. To understand how income trusts generate this income, one must first understand the nature of the four different types of income trusts.

Real Estate Investment Trusts, or REITs, pool their investors capital into real estate ventures. The managers of these trusts search for lucrative investment properties and those that will produce a steady cash flow for their investors.

Utility Trusts invest in public utility operations such as light, energy and water providers. Because these are regulated services, Utility Trusts usually have a steady, stable cash flow.

A Canadian Business Trust is one based on a corporation or other entity in the manufacturing, industrial or service sector. As corporations realized the tax advantages of reorganizing and restructuring themselves as income trusts, the Canadian government was forced to take action, resulting in the Conservative government’s 2006 decision to tax income trusts contrary to their campaign promise that such an action would not occur. Had the largest corporations and businesses in the country converted to income trusts to avoid corporate taxes, billions of dollars would have been lost to the government and subsequently, the Canadian public.

Canadian Resource Trusts, much as the name suggests, resource trusts specialize in the natural resource industries of oil and gas, metals, minerals and lumber. The cash flow and distribution rates in these trusts can vary depending on their respective markets.

The subject of taxing income trusts caused much confusion and worry throughout 2005 and 2006 as investors, especially retirees invested heavily in income trusts, they feared that they would lose their investments to taxation. The issue actually became one of the platforms the Conservative government ran on in the 2006 election. After promising to leave the income trust tax rules as they were, Finance Minister Jim Flaherty announced new rules on October 31, 2006, that would end the tax benefits of the income trust structure for most trusts. Most classes of income trusts formed after that date will be taxed in the same way as corporations. A period of transition will extend into 2011.

The issue is far from over, as Canadians demand answers on facets of the new law that seem to impose double taxation on certain retirement benefits and within tax-deferred RRSP’s. Some say the measure was rushed and unnecessary, while others feel that unless huge corporations such as Bell and Telus, who were moving towards a conversion to income trusts, were to skirt corporate taxes, the action was crucial.