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Canadian Trust Funds Explained – Trust Funds 101

Here are tidbits on trust funds:

What is a trust?: A company with a special legal structure that allows it to pass profits on to the people who own it without having to pay corporate taxes.

It’s a kind of corporate security similar to a share in a company.

A share of an income trust is called a “unit” and investors can buy and sell them like stocks — via a broker or discount brokerage.

Advantage: By paying little or no corporate taxes, the company can pass on more cash to its owners. Companies pay most of this cash to investors in monthly distributions.

Disadvantages: Less corporate tax payments. A report last month showed Canada’s tax-leakage problem doubled in two years, from $540 million annually in 2004. With more companies eyeing trust status, that amount threatened to rise.

What happens in Canada for Investors: Canadians who own trust units will now pay taxes on any gains made outside tax-protected RRSPs, pensions or other investments.

History: Once a sleepy investment sector, income trusts were largely confined to oil and gas companies and some real estate companies.

Popularity: The trust sector took off in the last decade as more and more companies decided to switch from corporate to trust status to reduce their tax burdens.

Investors followed. Seniors who needed steady income to live on, in an era when banks were paying miniscule amounts of interest, flocked to the trusts.

Extent: Canada has about 250 trusts worth about $200 billion in real estate, oil and gas, telecom, industrial, food processing and manufacturing sectors.

Companies: Pizza chains (Pizza Pizza), steakhouses (The Keg), mattress makers (Sleep Country), furniture stores (The Brick), sardine canners (Connors Bros.) and pet food makers (Menu Foods) are all companies that have switched to trust status. Telecom giants BCE and Telus have announced plans to switch over.

New rules: Ottawa would apply a new tax on the money distributed to unit holders by newly formed income trusts.

Corporate income taxes would be cut by 2011 to cushion the effects of the trust plan. Income splitting permitted for pensioners, whereby a high-income spouse moves some or all of his or her earnings to the spouse who earns less to benefit from a lower tax rate.

Transition: Existing income trusts would be given a four-year transition period, ending in 2011, that would allow them to adjust to the new rules.

What you should do now?: Experts say investors, especially those on fixed incomes, should be concerned. Income trust units could take a tumble in the markets because of the new plan.

You, along with millions of Canadians, probably have some money invested in income trusts – either on your own, through investment advisors, RRSPs or your company’s pension plans.

Pension plans are big buyers of income trusts, and tons of Canadian equity mutual funds have income trusts in them.

But it’s not all bad, couples can pay less tax by taking advantage of the new income splitting on pensions.

An example by another economist goes:

“Take an example of two couples, Both have $50,000 of pension income.”

Couple A has $50,000 in one spouse’s name, and nothing in the other’s.

Couple B, meanwhile, has $25,000 evenly split between the spouses.

Couple A will pay a lot more in taxes, because of our progressive rate structure that raises income tax for the highest wage earners.

“They get kicked into a higher tax rates. So if they’re able to split that, they will bring down their tax bill quite a bit and for a lot of (people) that would offset, I think, anything untoward happening on the income trust market.”

More advice: Something else investors should consider, said Drummond, are dividend-paying equities.

Dividends are cash payouts a company gives to stockholders. They’re a vehicle by which companies can reward investors’ loyalty and distribute profits.

The previous Liberal government attempted to curb the appeal of income trusts last year by cutting taxes on corporate dividends. But now, for some reason they act as if they LOVE trust funds and everyone who was hurt…. smart, great election ploy 😛

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