Canadian Income Trusts

Canadian income trusts, also called "business trusts," are similar to energy royalty trusts in that they avoid corporate income taxes if they pay out most of their profits to shareholders. However, unlike energy trusts, which own energy reserves; income trusts operate regular businesses such as retail stores, restaurants, oil drilling services and pulp paper factories.

Growth Stocks
Some are mature businesses that generate cash, but aren’t growing much. Others, however, have relatively strong dividend growth prospects. This is an advantage over royalty trusts, which depend mostly on rising oil prices for dividend growth.

Income trusts are relatively new kids on the block. Of the more than 200 existing trusts, most were formed since 2001. Some were established businesses that converted to the trust structure, while others only recently went public.

Most income trusts pay distributions (dividends) equating to 6% to 8% annual yields, but some go as high as 10% or 12%. 

Proposed Tax Law Changes Could Kill Trusts
Most Canadian trust share prices took a major hit in November 2006 after the Canadian government proposed taking away their special tax status (they currently pay no federal taxes) and taxing them the same as regular corporations starting in 2011.

While, in the U.S., such a proposal would have no chance of becoming law without major changes, the only significant opposition in Canada is coming from the trusts, themselves. It appears likely that the tax changes will become law as originally proposed, although many of the details are yet to be worked out.

However, most income trusts do not suffer from the depleting assets issue that is plaguing energy trusts. While their growth rates might slow, income trusts with solid balance sheets can continue to operate indefinitely without needing to raise more cash.

Research Info
The Toronto Globe & Mail’s investor site (globeinvestor.com) offers a short profile of each trust plus financial statement data going back three years (company snapshot), news headlines going back one-year, and detailed analyst earnings forecasts and buy/sell ratings (estimate snapshot).

The biggest danger of investing in income trusts is picking a trust that cuts its distribution while you own it. Should that happen, you get hurt twice. Besides for receiving lower than expected payouts, the share (unit) price is likely to drop. You can reduce your chances of experiencing that calamity by avoiding trusts where analysts are forecasting negative earnings growth for the current or next fiscal year.

The buy/sell ratings are in numeric format from 1 to 5, where 1 equates to ‘strong buy, 2 is ‘buy,’ 3 is ‘hold,’ 4 is ‘sell’ and 5 is ‘strong sell.’ In my experience, it’s best to avoid trusts that analysts are advising selling (ratings higher than 3).

For more information about trusts, download a report titled, “Income Trust Primer,” in the Investment Research section of “The Ritcey Team at ScotiaMcLeod” (www.ritceyteam.com).

Buying & Selling Trusts
Most income trusts trade only on the Toronto Stock Exchange (not on U.S. exchanges). You can trade them on the Toronto exchange using most major U.S. brokers, but you have to place your order by phone, which costs more than online.

You can trade Toronto-listed stocks online using Interactive Brokers (www.interactivebrokers.com), which charges low ($0.01 per share) trading commissions. But Interactive has a minimum $10/month charge, which equates to $120/year. That could be prohibitive, depending on your trading activity. Penn Trade (www.penntrade.com), an Idaho-based broker, also accepts online trades for Toronto-listed stocks for a $29.95 commission per trade.

Many income trusts have ticker symbols for the U.S. Pink Sheets exchange. You can look up the ticker symbols on Yahoo (finance.yahoo.com) or on your stockbroker’s site (all are five letters ending with F). You can usually trade using the Pink Sheets’ ticker for the same commissions as U.S. listed stocks. However, you should set a maximum (limit) price, otherwise you could end up overpaying.

Tax Considerations
Trust distributions may be designated as return of capital (not taxable until sold) or as dividend income. The trust determines the split between each category after the end of the calendar year. Otherwise, Canadian income trusts have similar tax issues as royalty trusts, including their dividends being subject to 15% withholding for taxes.

Income trusts are a controversial topic. Some experts think the category has already seen its best days. So, proceed cautiously.

Here's a partial list of Canadian Income Trusts.

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