U.S. Considers Raising Taxes on Income Trusts

Just when you thought the news on Canadian income trusts couldn't get any worse, the next wave of proposed taxation deals another potential blow to a distressed sector.

This time, it's the United States that's considering raising the tax bar on income trusts.

On October 31, 2006, the Canadian government, a conservative minority in Ottawa, shocked the income trust world by announcing the termination of favored tax status for these high-yielding securities starting in 2011. In the United States, income trusts, especially energy trusts, have been great investments over the last five years on the heels of a rising distribution payout, soaring trust prices as oil went through the roof and a rallying Canadian dollar. Indeed, a good chunk of total Canadian energy trust volume from 2002 to 2006 belonged in the hands of foreign investors, lunging at those fat monthly dividends and long-term capital gains.

Distributions from income trusts are now taxed at a rate of 15% in the United States. But Democrat Congressman, Richard Neal, of Massachusetts, recently filed a bill in the House of Representatives, which was then referred to the Ways and Means Committee, that would revoke the existing special tax treatment on dividends from certain foreign entities such as income trusts and real estate investment trusts or REITs.

Though we're just at the start of this long process, which might or might not result in a new tax ruling, it does bear bad news for Canadian income trusts and REITs. If the proposed changes become law, it would raise income trust taxes from 15% currently to 35%, a significant increase.

Both the Canadian and American governments seem bent on destroying a viable asset class that has provided critical income to retirees in a low interest rate world since 2003. Many of those individuals lost a great slice of their retirement pie last fall when Ottawa announced tax changes. Also, Canada's long-term oil and gas exploration projects are now at risk since tax rates for operations and profits will rise in 2011, further denting the country's most prosperous income generator.

For now, I'd avoid making new Canadian income trust and REIT investments. Governments on both sides of the border are not done rewriting the tax rules.

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