Income Trusts
Josh Cavers
Ian Herle
Ashish Mali
Lindsey Polishuk
Outline
Income Trust Characteristics
 Types of Trusts
 Associated Risks
 Prior Benefits
 Tax Law

Income Trusts

Similar to common stock


Tax Savings


Trusts are exchange traded equity instruments. “Trust” represents a tax
designation, a legal structure, and a capital structure.
The Trust evades income taxes by paying out all of its distributable net
income.
Passes income to “unitholders”

Beneficiaries of the trust that receive quarterly or monthly residual
distributions that are typically higher than stock dividends. Their units
are the right to the income and capital of the company.
Primary Roles

High yield investment alternative

The Income Trust market serves to distribute excess cash from
mature industries or businesses because:




Trapped capital creates overinvestment and slow growth business
Contributes to declining return on invested capital
Trust distributions stimulate productivity and economic efficiency
An alternative form of organization that is well suited to many
businesses and industries in which they operate

Businesses have proven to operate a Trust efficiently
Types of Trusts
4
3
1.Business Trusts
2.Energy Trusts
3.Real Estate Investment Trusts
2
1
4.Power & Pipeline Trusts
Source: Tsx.ca
Market Capitalization
Types of Trusts

Real Estate Investment Trust (REIT)

Provides an investment vehicle into real estate similar to mutual funds
investing in stock. Investors pool capital to purchase and manage
income properties.
 REITs: Boardwalk, H&R

Energy / Royalty Trust

Distributions in an energy trust will vary due to fluctuations in
production, commodity prices, royalty rates, and corporate costs.
 Royalty Trusts: Canadian Oil Sands, Builders Energy

Business Trust

Individual business that has converted their shareholder equity into an
Income Trust capital structure. Not a diversified pool of assets.
 Business Trusts: Boston Pizza Royalties
Risks

Income trusts are equity investments and they share many of the
risks associated with stock ownership.


Over-valuation:


the higher the yield, the higher the risk
Since distributions include return of capital, the investor is really
receiving his own capital back through the distributions. Units will be
priced above their economic value since the unit valuation is most
frequently driven by a multiple applied to the distribution as a whole.
Lack of income guarantees:

Income Trusts do not guarantee minimum distributions or even return of
capital. If the business starts to lose money, the Trust can reduce or
even eliminate distributions.
Risks

Interest rate risk:


Sacrifice of growth:


If interest rates in the rest of the cash/treasury market increase there is
the risk that trust units will decline in value. This risk is common to other
dividend/income based investments such as bonds.
Most income is passed on to unit holders rather than reinvested in the
business. Because many income trusts pay out more than their net
income, the shareholder equity may decline over time.
Exposure to regulatory changes:

The value of the Trust is driven by the deferral or reduction of tax, so as
we have seen, any change in government tax regulations to remove the
benefit will reduce the value of the Trusts.
Risks

Liability:

Depending on the local regulations, Income Trusts may be considered
partnerships that do not provide the same limited liability protection as
common stocks.
Who’s Interested?

The main attraction of Income Trusts is their ability to generate
constant cash flows for investors, which is especially attractive when
interest rates on bonds are low. They are especially useful for
financial requirements of institutional investors such as pension
funds.

Because the earnings from the business are distributed to investors
each month or quarter, with yields ranging anywhere from 6 to 20
per cent a year (typically higher than dividend yields) Income Trusts
are ideal for anyone seeking a constant cash flow. i.e. retired
persons.
Income Trust Prior to Tax Law
If the market value increased to $17/unit
$15
$1
$14
$1
unit
ROC
Adjusted Cost Base
ROC
$13 Adjusted Cost Base
$17
$13
$4
0.5
Selling Price
Adjusted Cost Base
Capital Gain
Inclusion Rate
$2 Taxable
The Tax Law

The federal government announced on October 31, 2006 that
Income Trusts will be subject to taxation.

However, there will be a transition period granted to established
trusts until 2011

Taxation will be Identical to dividends. (i.e. taxed on every
distribution)

REITs excluded
Tax Rate Comparison
Boardwalk REIT
Canadian Oil Sands
Boston Pizza Royalties
Thank You!
 Questions?
