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Two new income trust funds offer improved tax planning and choice for investors

by Wayne Cheveldayoff, 2003-09-14

Bay Street’s financial engineers, who are always hard at work creating new investment vehicles, have recently come up with two new income trust funds that offer unique advantages for investors.

One is a fund that invests only in specialty business income trusts. This offers investors a way to avoid the commodity risks associated with the energy trusts and the property risks connected with the real estate investment trusts. Both dominate the broad-spectrum, actively managed and index-linked funds that are currently available.

A second fund also breaks new ground by offering investors two separate units—one that will pay fully taxable income and another whose distributions will be regarded as tax-deferred return of capital. Distributions from most existing trust units are mixture of both.

This split-unit fund is being offered by Lawrence Asset Management Inc. and is known as the TOROS Trust. The trust will be an actively managed “income trust fund of funds.”

The fully taxable units, known as Income Securities, will have a targeted yield of 11 per cent per annum, paid monthly, while the Return of Capital Securities will have a targeted yield of 9.5 per cent per annum. Both units are targeted to repay at least the original investment amount in 10 years and will be listed on the TSX exchange.

Such a split structure is ideal for tax planning. The Income Securities, which would trigger an immediate tax liability, can be placed in tax-sheltered RRSPs, RRIFs and RESPs, allowing investors to defer income tax until the funds are withdrawn.

The Return of Capital Securities, which would not trigger an immediate tax hit, are best held outside of registered plans. In the case of distributions that are return of capital, no income tax is immediately payable. The distributions reduce the adjusted cost of the securities and they are effectively only taxed when the securities are sold and then only as a capital gain (the difference between the sale price and the adjusted cost base). Even this eventual taxation is favourable as only half of a capital gain is subject to normal income tax rates.

The new fund investing only in specialty business income trusts is called the Business Trust Equal Weight Income Fund, managed by the Brompton Group.

The specialty business income trust sector has expanded rapidly on the TSX in the past three years. There are now approximately 64 such income trusts (some are called income funds) with a total market capitalization of $23 billion, about a third of the total trust group.

They are involved in a wide variety of businesses, including propane distribution, yellow pages directories, cold storage, waste removal, sugar refining, meat processing, customs broking, trucking, seafood processing, household cleaners and pet food.

The new fund offers an excellent way for investors to get income trust exposure and cash distributions without being exposed to the cyclically driven oil and gas royalty trusts, which make up 52 per cent of the S&P/TSX income trust index. Since the oil and gas trusts make up such a large part of the index, broad-spectrum mutual funds that are measured against it would also have a heavy weighting of energy trusts.

The same analysis is true for the real estate investment trusts (REITs), which are the second biggest group within the index. While REITs have done well in the past year, some analysts are warning that they are ripe for a fall if interest rates rise further.

Another important feature of the Brompton business trust fund is that it will invest equal amounts (2.6 per cent) in the initial 38 trusts that it has targeted (those with float capitalization of $150 million or more) for investment.

This reduces the risk for investors compared to market-weighted situations where the amount invested depends on market capitalization. For example, in the S&P/TSX income trust index, the largest trust, which is an oil and gas trust, makes up 8.7 per cent of the index. If something negative happened to one or more of the larger trusts (a big drop in oil prices, for example), the index and index-linked investments would be hurt more than an equal-weighted fund.

As usual, investors interested in new funds can do their due diligence by reviewing the prospectuses, which can be found at, and speaking with a financial advisor.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at

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©2003 Wayne Cheveldayoff