Income Trust Distributions and Taxation

There has been a little bit of confusion in the comments regarding how income trust distributions are taxed.  The confusion is in what the distributions are composed of.  Typically, when you look at a stock on the market with a distribution, you can safely assume that it’s a dividend.  Dividends are great as they are paid out of company pockets with after tax dollars which means a tax break when received by the investor.

Income trusts (stock symbols ending in .un) are different however.  Even though they have a distribution that appears like a dividend,  they are not always tax friendly.   Since income trusts flow through their pre-tax income to investors, it’s the investors who face the bulk of the taxation.

Income Trust Distributions and Tax Implications

Income trust distributions are typically made up of 4 components.

  1. Return of Capital – You may be surprised to hear that a large portion of some income trust distributions are based on return of capital.  What is return of capital?  It’s basically taking shareholder money and returning it back to the shareholder.  Return of capital is not taxed immediately but reduces your adjusted cost base.  In a taxable account, this defers the potential increased capital gains taxation until you sell.
  2. Other Income/Interest – Other Income (ie. interest) is also usually a large portion of the distribution.  Any interest received in a non-registered account is taxed 100% at your marginal rate.
  3. Dividends – This is typically a smaller portion of income trust distributions but is very tax efficient.
  4. Capital Gains – Capital gains is another popular method of distributions and is taxed 50% of your marginal rate.

Examples

Lets take a look at some popular real world income trusts and their distributions.  I typically look into a particular companies distribution by visiting the company website.

  1. Arc Energy Trust (AET.UN) – A popular energy income trust with distributions that consists of 97% income/interest and 3% return of capital (ROC).
  2. Calloway REIT (CWT.UN) – This is a popular REIT that specializes in commercial properties.  The distributions (2007) consist of 45.3% income/interest and 54.7% ROC.
  3. Yellow Pages (YLO.UN) – The distributions of this popular brand consists of a wide mix of income sources.  1% capital gain, 1% non-eligible dividend income, 5% eligible dividend income, 2% ROC, and 91% other income/interest.

Tax Efficient Strategies

As you can see from the examples above, there’s no set pattern as to how the distributions are divided.  As you can see though, other income is typically a large percentage of the distribution which in a taxable account, is taxed at your marginal tax rate.  In addition to that, any ROC distributions need to be tracked as it reduces the adjusted cost base of the held position in a non-reg account.

As the taxation (and tracking) of an income trust can be inefficient, I personally keep my income trusts in a tax sheltered account like an RRSP or TFSA.  In fact, one of my TFSA strategies is to create an income fund as the distributions can be withdrawn completely tax free.  As I have very little exposure in the REIT market, I may start my research there.

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Robert L.
10 years ago

I have a few income trusts (mostly related to the energy sector, CPG, KEY.UN, IPL.UN, ENF.UN, NAE.UN) within my RRSP, so I don’t have to keep track of anything with respect to taxation right now. I don’t have any non-registered investments. However, with income trusts having to convert back to corporations (like CPG has already done), do the converted entities still represent a good fit for RRSP holding as far as the different taxation “at source” impacts things?

Paul
11 years ago

Hey,

Thats what i thought as well. However when add up all the distributions that received for the year (taxable and trust) my T5 excludes the trust dividend and only includes taxable dividend. Don’t know why?

Paul
11 years ago

Hey guys,

I liked the discussion regarding Income trust, as I was looking for some advise on getting my taxation done for 2009. I had invested in some income trust companies in 2009 and sold some of them within the year. Lets say for example sake 2 companies i traded in 2009 and simillar distribution to “yellow pages” above and i am still holding on to one of them at the end of the year and the other one I sold it in november of 2009. Now my question is that, am I suppose to receive some sort of tax slip from my broker or the company, so i can complete my taxes or i need to go to find out on my own for each turst stock that I held during 2009, whichone is a trust distribution, capital or interest and calclate and recorded accordingly. If that is the case which schedule should I be using?

Thanks in advance.

Narajin
12 years ago

So the way I see it is ROC is deducted on the cost of investment. But you can reinvest the ROC right away and that wouldn’t lower your adjust cost base. Would that work?

Narajin
12 years ago

I don’t get how return of capital will affect my ROC?

Can anyone clarify that (maybe with an example)?

7
12 years ago

Nevermind… I read more about ROC…