Canadian Royalty Trusts

Canadian royalty trusts (CANROYs) are oil and natural gas producers. They grabbed dividend investors’ attention because of their high dividend (distribution) payouts. The trusts pay those dividends because they don’t have to pay corporate income taxes if they distribute their income to unit holders (shareholders). Now, that is changing.

Alarmed when major corporations began converting to the trust structure to avoid paying income taxes, the Canadian government changed the rules. As a result, starting in 2011, all existing trusts will pay taxes at the same rate as regular corporations. By that time, most trusts will have been acquired or converted to regular corporations.

While an acquisition or conversion would likely translate to a distribution (dividend) cut, based on recent transactions, share (unit) prices are likely to move up on the news. Although natural gas prices might weaken somewhat, the outlook for crude oil prices is still strong. Depending on the composition of crude oil vs. natural gas, the value of each trust's reserves, and hence the value of their shares, could still move up.

Background 
Canadian royalty trusts are different from U.S. royalty trusts. The U. S. trusts pay out the cash flow generated by their oil and gas properties, but they are not allowed to acquire new properties. Consequently, their cash flow declines over time as their assets are depleted. Canadian trusts, as mentioned above, try to replenish depleted properties with new acquisitions, and in theory, could operate indefinitely.

In terms of structure, a royalty trust typically controls an operating company, which purchases oil and gas properties using the trust’s capital. The trust then receives royalty and/or interest payments from its operating company.

Since Canadian trusts distribute most of their income to unitholders, they must raise cash to fund acquisitions either by borrowing or by selling more units. So although an acquisition grows a trusts total cash flow, it may not result in increased cash on a per-unit basis.

U.S. Tax Considerations 
For U.S. investors, the tax treatment of a Canadian royalty trust’s dividends depends on whether the trust is registered in the U.S. as a foreign partnership or as a corporation. The differences are too complicated to detail here, but often, the dividends qualify for the maximum 15% U.S. tax rate. However, U.S. brokers sometimes issue 1099DIV forms incorrectly showing those dividends as non-qualified. In those instances, you  have to ask your broker to issue an amended 1099DIV correcting that error.

Generally, the Canadian government applies a 25% non-resident withholding tax on distributions to non-residents of Canada. However, due to a tax treaty between the U.S. and Canada, the withholding for U.S. residents is 15%. Also, U.S. citizens can apply for to the U.S. IRS for a refund (foreign tax credit) for at least a portion of the amount withheld. 

Many Canadian trusts provide information for income tax filing instructions for U.S. unitholders on their Websites. Nevertheless, it can be a complicated process and U.S. investors should consult with a qualified tax advisor before investing.

Canadian Royalty Trusts Listed On U.S. Stock Exchanges

Most Canadian royalty trusts are listed only on the Toronto stock exchange. However, the following trusts are also traded on either the NYSE or AMEX.

• Baytex Energy Trust (BTE)

• Enerplus Resources Fund (ERF)

• Pengrowth Energy Trust (PGH)

• Penn West Energy Trust (PWE)

• Provident Energy Trust (PVX)

 Royalty Trusts Listed on the Toronto Stock Exchange

Here are the major oil and gas royalty trusts listed on the Toronto exchange. Trusts that have already converted to corporations, but still pay significant dividends, are included in the list.

• ARC Energy Trust (AET.UN)

• Baytex Energy Trust (BTE.UN)

• Bonavista Energy Trust (BNP.UN)

• Bonterra Energy (BNE)

• Canadian Oil Sands (COS.UN) 

• Crescent Point Energy Trust (CPG.UN)

• Daylight Resources (DAY.UN)

• Enerplus Resources Fund (ERF.UN)

• Freehold Royalty (FRU.UN) 

• NAL Oil & Gas (NAE.UN)

• Paramount Energy Trust (PMT.UN)

• Pengrowth Energy Trust (PGF.UN)

• Penn West Energy Trust (PWT.UN)

• Peyto Energy Trust (PEY.UN) 

• Provident Energy Trust (PVE.UN)

• Trilogy Energy (TET) 

• Vermilion Energy Trust (VET.UN)

• Zargon Energy Trust (ZAR.UN)

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Trusts Missing In Action

If you can't find a trust, it may have been acquired or converted to a regular corporation. Here's a list of trusts that have recently disappeared.

• Acclaim Energy and StarPoint Energy merged to form Canetic Resources.

• Canetic Energy was acquired by Penn West Energy.

• Esprit Energy was acquired by Pengrowth Energy.

• Fairborne Energy converted to a corporation.

• Find Energy was acquired by Shiningbank Energy.

• Focus Energy was acquired by Enerplus.

• Harvest Energy was acquired by Korea National Oil.

• Ketch Resources was acquired by Advantage Energy Income.

• Petrofund Energy was acquired by Penn West Energy.

• PrimeWest Energy was acquired by Abu Dhabi National Energy.

• Sequoia Oil & Gas was acquired by Daylight Resources.

• Shiningbank was acquired by PrimeWest Energy.

• Sound Energy was acquired by Advantage Energy.

• Thunder Energy was acquired by a private equity firm.

• Vault Energy was acquired by Penn West Energy.

• Viking Energy was acquired by Harvest Energy

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