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 shareholders.
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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