Until October 31, 2006, income trusts were, by far, the fastest
growing segment of Canadian listed securities. On that date, the
federal government announced that the ability of existing listed
income trusts to deduct distributions made to their unitholders in
computing their taxable income would end on December 31, 2010. As a
result, there are few, if any, listed income trusts left in Canada,
other than real estate investment trusts (REITs) which were
exempted from the new rules. However, a new investment vehicle
– the unlisted income trust – is beginning to
gain popularity as a replacement for the listed income trust.
Unlisted income trusts work exactly the same way as listed
income trusts. Through an operating subsidiary, often a limited
partnership, the trust can invest in virtually any form of
business. Also, like listed income trusts, unlisted income trusts
are generally set up to qualify for beneficial tax treatment as a
mutual fund trust. The only difference is that the trust units are
not listed for trading on a stock exchange. This may make it
difficult, if not impossible, for the investor to sell the units.
While this is a clear downside to investing in unlisted income
trusts, fortunately most unlisted income trusts are set up as
"open-ended" trusts. This means that the investor can
require the trust to redeem the investor's units at any time.
The redemption amount is typically slightly below asset value and
there are monthly limits on the amounts that the trust can be
required to pay out on redemptions, but there is as least some
degree of liquidity.
However, unlisted income trusts are designed to be held, not
flipped, since they pay regular distributions to unitholders,
usually on a monthly or quarterly basis. These regular
distributions are what makes the investment attractive. Unlisted
income trusts are able to pay higher distributions than
corporations because, unlike corporations, they can deduct any
distributions they make in calculating their taxable income.
Normally, these trusts will make enough distributions in a year to
their unitholders so that they pay no income tax for the year.
Corporations, in contrast, must first pay corporate tax on their
income, and therefore have less to pay out to their
Units of unlisted income trusts are generally qualified
investments for tax-exempt savings plans such as RRSPs, RRIFs and
TFSAs. If unlisted trust units are held this way, the underlying
trust income is not taxed as earned, either in the plan or in the
unitholder's hands, but only when distributed out of the plan.
Holding unlisted income trust units in a TFSA is highly tax
efficient, as the underlying trust income is never taxed.
The increasing popularity of unlisted income trusts provides
numerous options to investors looking at participating in this
attractive investment vehicle.
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