Tax Advantages

Income Trusts and the Advantages of Tax Deferral

Many income trusts offer a degree of tax-efficiency. This is due to the trust structure which allows the tax advantages to flow through to the investor, instead of being maintained within the entity as is the case with corporations.

A tax deferred distribution made by a trust is only taxed when the unit is sold by the investor and this amount is taxed as a capital gain, which is half of the investors normal tax rate. This can result in very substantial tax savings for your clients.

Example: Bond Investment Comparison

Consider $100,000 invested in a bond (fully taxable) paying 10% vs. the Faircourt fund, also paying 10%, but with 100% tax deferral. Gross income is $10,000 in each case. Assume the investor is a top tax bracket individual in Ontario (46.4%).

With the bond, the investor would be left with $5,360 for an after tax return of 5.36%. The Faircourt fund would leave the investor with at least $7,680 for an after tax return of at least 7.68%. Looking at it another way, the bond would have to pay about 14.3% to give the investor the same amount of after-tax income.

The above assumes that the investor sells the unit in the year of distribution, and therefore does not get the benefit of the tax deferral. If the investor holds the unit for more than a year, he will also benefit from the deferral of tax on the distribution. In our example, the investor would receive the entire $10,000 distribution tax-free and this entire amount would be available for re-investment (vs. only $5,360 available for re-investment with the bond).

Income Trust Investment Comparison

Many income trusts on the market provide partial tax deferral. While the deferral varies among issuers, there are general trends in each of the sectors. For example:

  • REIT’s – Average deferral of 67%, ranging from 90% to 10% with most in the range of 60-70%
  • Pipelines & Power – Average deferral of 72%, ranging from 15% to 100%
  • Business Trusts – Average deferral of 15%, ranging from 0% to 50%.
  • Commodities – Average deferral of 37%, ranging from 0% to 70%, with most in the 40% range.