Jump to navigation Trust yourself PDF to search An income trust is an investment that may hold equities, debt instruments, royalty interests or real properties. The names income trust and income fund are sometimes used interchangeably, even though most trusts have a narrower scope than funds. Income trusts are most commonly seen in Canada. The closest analogue in the United States to the business and royalty trusts would be the master limited partnership.
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Income trusts are equity investments, not fixed income securities, and they share many of the risks inherent in stock ownership, but often not the same rights and responsibilities, especially concerning corporate governance and fiduciary responsibility. Valuation: When distributions include return of capital the investor is receiving excess capital back from operations of the trust. A trust unit with high return of capital distributions will often attract a higher market value because the return of capital portion of the distribution is tax deferred until the unit is sold. Lack of income guarantees: similar to a dividend paying stock, income trusts do not guarantee minimum distributions or even return of capital. Sacrifice of growth unless more equity is issued: because most income is passed on to unitholders, rather than reinvested in the business.
In some cases a trust can become a wasting asset. Exposure to regulatory changes: to the extent that the value of the trust is driven by the deferral or reduction of tax, any change in government tax regulations to remove the benefit will reduce the value of the trusts. See Canadian income trusts below on how changes in Canadian taxation rules diminished market values. Generally, income trusts carry the same risk levels as dividend paying stocks that are traded on stock markets.
In a typical income trust structure, the income paid to an income trust by the operating entity may take the form of interest, royalty or lease payments, which are normally deductible in computing the operating entity’s income for tax purposes. Where there is no double taxation, there can be the advantage of deferring the payment of tax. Where the distributions are received by foreigners, the tax applied to the distributions may be at a lower rate determined by treaty, that had not considered the forfeiture of tax at the corporate level. The effective tax an income trust owner could pay on earnings could actually be increased because trusts typically distribute all of their cashflow as distributions, rather than employing leverage and other tax management techniques to reduce effective corporate tax rates.
Certain investors, particularly those in the highest tax brackets, could be significantly worse off investing in income trusts compared to traditionally structured corporations. Royalty trusts, „resource trusts“ or „energy trusts“ exploit natural resources such as oil wells. The amount of distributions paid will vary from time to time based on production levels, commodity prices, royalty rates, costs and expenses, and deductions. Business income trusts are individual companies that have converted some or all of their stock equity into an income trust capital structure for tax reasons.