Category: Canada

Income Trust Taxation in 2011

In Canada, income trust distributions will be taxable to the level where the trust would be roughly equivalent for them to convert into a corporation and distribute dividends from after-tax income. Because a simple corporate structure is easier to understand for most investors, in addition to being cheaper to maintain, it is likely that most conventional income trusts (except for the REITs, which will still have the same tax-free exemptions as existing trusts do) will convert into corporations before the conversion deadline.

There are a whole litany of tax issues involved with conversion (which can be read in the explanatory notes in the July 2008 legislative proposal), but the salient detail is that income trusts by the end of December 2012 will have to convert to corporations in order to prevent a deemed disposition (i.e. tax consequences for unitholders).

In the meantime, trusts will have a distribution tax, both a federal and provincial component. The Federal component will be based on the large corporation tax rate (16.5% in 2011; 15% in 2012 and beyond), while the provincial component will be based on a weighted average where the trust earns its distributable income and the respective province’s large corporate tax rate. In BC, this will be 10%. So in 2011, a trust that operates in BC will have a 26.5% distribution tax put on its distributions; the way to calculate “equivalent distributable income” is by dividing the pre-2011 distribution by one plus the distribution tax.

So for example, if an income trust distributed 100 cents a year of income in 2010, the equivalent will be $1.00*(1/(1+0.265)) or $0.7905/share in 2011; in 2012 this would be $1.00*(1/(1+0.25)) or $0.80/share.

It should be noted that the income coming from trusts will be considered eligible dividends in 2011 and beyond; as a result, the tax treatment to Canadians will more than offset the loss in trust income. At the low tax bracket, the marginal rate for a BC resident for trust income will be 20.06%, while eligible dividend income will be -9.42%. So a $100 trust distribution will end up as $79.94 after taxes for a low income earner, while a $79.05 eligible distribution will yield $89.50 after taxes. At the top tax bracket, $100 of income will end up as $56.30 after taxes, while a $79.05 eligible distribution will end up as $60.15 after taxes.

The take-home message is that once 2011 rolls around, there is going to be no excuse whatsoever to keep income trusts inside the RRSP; they should be immediately removed and placed into a regular taxable account. Alternatively they can be placed inside the TFSA, but one would surrender the tax benefit of the dividend tax credit.

August 2009 Fiscal Monitor Released

The Ministry of Finance released the August 2009 Fiscal Monitor today, which is the best at-a-glance fiscal picture of Canada. I covered the July month in a previous post.

The extra month of data continues to print a grim picture – while personal income taxes in the five months between April and August have dropped about 5% (and this does not account for the fact that the government has been reducing income taxes by increasing the basic rate and also increasing the lower two income thresholds in the previous federal budget), corporate taxes continue to fall off a cliff, down 37% in the equivalent period. Only 2% of that is explained by the small decrease in the corporate tax rate between periods.

On the consumer spending side, GST collections actually increased 6% on a month-to-month basis (which is relatively surprising), but the net collections over the five month period has been down about 20%.

Unemployment insurance benefit payments, another barometer of job loss, is up 54% over the equivalent 5 month period last year.

The total fiscal deficit for the 5 month period is $23.7 billion dollars, which if extrapolated, will suggest a total deficit for the fiscal year of approximately $57 billion.

The two take-home messages of this report is that corporate profits in Canada have dropped dramatically; paradoxically, the phased in reductions in income tax that will occur over the next few years (19% to 18% effective 2010; 18% to 16.5% effective 2011; and 16.5% to 15% effective 2012) will have less of an impact and will likely cause more investment to come into the country. The other message is that personal income tax collection seems to be down slightly, but unemployment is rising, but people continue to spend. It makes one wonder how much of a pool of savings there is for people to draw on when they are not working.

Inevitably, Canada’s fiscal situation is stronger than in the USA. If Canada were running deficits equivalent to the level of the USA’s economic output, we would be on track to run a $180 billion deficit for fiscal 2010.