This treatment affects the distribution of capital gains from taxable Canadian real estate sales, such as Canadian real estate and commodity real estate. As a result, the Canadian withholding tax of 25% (subject to contractual reductions) on investment income and dividends from investment funds applies even if the investment is not recognized as capital income by the unit holder in the tax jurisdiction. The 15% withholding tax is deducted from the distribution. Regardless of where the income funds derive their taxable assets, it is not subject to withholding tax for non-resident university holders.
Canadian income funds reinvest their cash flows into their dividends and are entitled to a dividend tax rate of 15%. By distributing most of their cash flow in dividends, Canadian income funds can avoid taxes, making the corporate structure more attractive. In addition, because only some of their distributions are considered returns on capital, they reduce the tax liability for investors and reduce the cost of distribution.
Canadian income funds flourished at the start of the decade, offering their investors significant tax benefits. Investors were exempt from Canadian income tax, even if they were not residents in Canada. Canadian income trusts could use the funds to buy new reserves or develop existing properties. Over time, the ability to increase their dividends made them attractive to many investors. As a result of the Canadian tax changes, which instituted a corporate tax on the Canadian Income Fund, this significant tax advantage has been abolished. It is expected that only a small number of Income Funds will exist after the tax changes come into force on 1 January 2011.
Canadian Income Trusts
This article describes the rise of income funds in Canada, why Canadian tax changes have led to a decline in income funds, what has happened since the rules were announced in the income fund market, and alternative structures that offer tax benefits similar to those of income funds. The term Income Trust means a publicly-traded trust fund for the residents of Canada, an investment fund or a trust fund for Canada’s Income Tax Act. A trust runs a business, a real estate portfolio, oil wells or a public utility in the same way as a typical company.
Companies pay corporation tax as required by national tax laws. However, in Canada, trusts are run by companies allowed to work without tax to the federal government because they pay their profits from the business directly to their university holders. As a result, fiduciary investors receive a fat payout without being taxed personally.
The closest analogy in the United States is the Business Royalty Trust or Master Limited Partnership. The tax advantages that trusts offer in certain countries fuel investor interest in this type of investment vehicle. Because fiduciary holders do not have intrinsically limited liability for the Company’s actions, the four major provinces of Canada have enacted laws granting fiduciary holders limited liability.
After the telecom giants Telus and Bell Canada Enterprises announced their intention to convert into income trusts on October 31, 2006, Treasury Secretary Jim Flaherty proposed new rules that would end income trusts’ tax advantages by restructuring most trusts. According to Brent Fullard of the Canadian Association of Income Trust Investors, if converted into a trust, Bell Canada would pay between $26 billion and $31.7 billion in corporate tax in the next four years. The Federal Government announced new rules for taxing specified investment flows on the same day.
In an essay dated January 12, 2007, Fortin outlined his concerns about allegations of tax evasion. Analyst Cameron Renkas examined the Treasury Department’s claim that the United States and Australia had taken steps to close the flow structures. Thanks to their ability to spin off money, Canadian mutual funds have suffered a rift in recent years.
This surge in popularity is even more remarkable because many investors had never heard of these trusts five years ago. Of course, many variations have developed from this simple theme, but the basic idea still applies.