The Truth About Canadian Income Trusts #1

The Rodney Dangerfields Of Canadian Investing

Pity the poor income trust, the popular income-producing investment vehicle that just can’t get “no respect” from Canadian politicians or the media. Income trusts are held in about as high esteem, by Canadian politicos and journalists, as Belinda Stronach attending a Mensa convention. And unfortunately investment vehicles can’t change their hair colour or date a hockey player to try and change their public image.

But what is the real truth about income trusts -- simultaneously hailed as the next best financial thing by income-starved retirees and GIC refugees, but politically maligned by two successive Canadian governments misled and manipulated by Finance Department bureaucrats?

In fact, like most things in life -- including flavoured latte confections and an underwear-challenged Britney Spears -- income trusts have their good and bad sides.

Fortunately, when it comes to income trusts, the good outweighs the bad by a long shot -- contrary to what you’ve heard from Canada’s misguided Finance Minister, or from ambitious would-be financial “experts” looking for their fifteen minutes of media notoriety.

The Good, The Bad & The Sometimes Ugly

Income trusts are good for Canada. They are good for investors who understand the risk involved in investing in these financial entities. And despite the bad rap trusts have been getting lately, they are superior generators of tax revenues to government -- it’s just that the tax is paid by the individual investors who receive income-trust income, rather than by the trusts themselves.

First off, it’s important to understand that there are several kinds of income trusts, including the original royalty trusts (energy trusts), real-estate investment trusts, infrastructure trusts (eg., pipelines and power generators) and today’s varied business trusts.

The very first form of income trusts, sanctioned by federal legislation, were royalty energy trusts. Talk about being good for Canada. By way of a unique confluence of economic factors, the first energy trusts sparked a productive wave of increased energy production, job creation, resource optimization, and government tax royalties for Canada’s Western provinces, particularly Alberta.

And along the way, this unique investment structure for generating investment capital and income -- an unprecedented fruition of the meeting of minds of government and the free market -- managed to provide individual investors (such as retirees and self-employed RSP contributors) with the enhanced income they needed to cope with inflationary pressures in today’s low-interest-rate income environment.

In other words, in an emerging new economic era -- in which five-year bank GICs paid under 4% per annum, and electricity, heating, real-estate tax and other costs of living soared -- investing in royalty (and later all) income trusts provided millions of Canadians with the income required to “scrape by” in retirement, or to save up for their future retirement.

This is an economic fact of life which today’s pampered Finance Department bureaucrats -- with their inflated six-figure salaries and guaranteed indexed pensions -- have never been able to grasp. But then again, when your work life revolves around indulgent expense-account lunches, dedicated to finding new ways of squeezing hard-earned dollars out of taxpayers to pay for the excesses and perks of government, why would you be aware of the struggle by ordinary Canadians to simply survive?

Oops! Business Trusts!

But speaking of the bad (and we believe revenue-hungry federal bureaucrats are bad for the country), let’s get back to the history of income trust themselves. Because after the success of energy trusts, and then real-estate investment trusts, Bay Street came up with a new twist on trusts -- business trusts.

Not that there aren’t some good business trusts. There are in fact a lot of them. But in the rush to “cash in” on the trust “golden cow,” Bay Street financiers, brokerage houses and corporate lawyers were not unwilling to take loser businesses, dress up their spreadsheets, and present them to the investing public as the newest and best thing in income trusts.

Not that these same Bay Street interests haven’t followed that same greedy and unethical M.O. in taking lame private businesses and converting them into conventional corporate equities (the kind our current Finance Minister reveres, even if these businesses are total turkeys, lose most of their investors’ money, and pay little tax to the government).

There have been, and still are, plenty of rotten apples like these in the conventional stock market. But unlike with income trusts, accounting experts and government bureaucrats don’t seem to mind, even if the Bay Street denizens have long been getting filthy rich sponsoring this kind of stock-market flim flam.

Regardless, welcome to the world of bad business trusts, the poster boys for what can go wrong, but usually doesn’t, with income trusts. These are the bad trust apples that have been used by critics to misrepresent the true nature of income trusts in general -- without ever mentioning the bad apples among regular stock equities.

As for the ugly, would you buy a used car from a Bay Street paper pusher who garnered millions of dollars in fees, bonuses and commissions from churning out business lemons? It may not be a bad way for these guys (and gals) to help pay for a new Porsche, Muskoka vacation home or Rosedale mansion, but it still has the ugly whiff of greed gone wild.

But let us emphasize one key point. This is the exception not the rule when it comes to income trusts. Most income trusts are well-run, money-making enterprises that benefit their unitholders and the geographic locales in which they are situated.

Yet, when today’s panic-stricken government leaders have stumbled and succumbed to the mistaken advice of their bureaucratic advisors on trusts, it is usually because our politicians have bought this exaggerated stereotype of trusts, hook, line and sinker. And consequently, they believe that all income trusts operate this way.

Nor do they usually have any idea that income trusts have become an essential income source for millions of ordinary Canadian retirees and savers who are struggling to keep up with increasing costs of living in Canada. But after taking bad advice from bureaucrats with a hidden agenda, government leaders would prefer to believe that any damage created by their mistaken actions has only impacted the rich.

Then there’s the issue of “tax leakage” -- taxes which income trusts allegedly don’t pay, in contrast allegedly to conventional business corporations like Telus (which incidentally has paid no tax to the Canadian government since 2000). Unfortunately, the myth of tax leakage is a complex subject which we’ll have to leave for a subsequent issue of “Income Trust Truth.”

Final Thoughts

In the meantime, please remember that it’s not wealthy “coupon clippers” who primarily benefit from the income-generating capabilities of income trusts. It’s the millions of ordinary Canadians (particularly pensionless retirees) who have had trouble living on reduced income from G.I.C.’s, bonds and other conventional savings instruments in a high-cost world.

And contrary to what your favourite Finance Minister has been mistakenly telling you, income trusts (and particularly energy trusts) have been good for Canada. Without them, much of the thriving energy bonanza in the Western oil patch, and profitable real estate developments right across Canada, would not have happened.

Thousands of jobs would not have been created, local economies would not have been invigorated, trust investors themselves would not have paid billions of dollars in taxes to various governments, and the nation would have been poorer for it had trusts not existed -- a few rotten apples notwithstanding.

That’s the truth about income trusts. And the whole truth (though condensed somewhat).

Not what you usually hear or read these days. But then again, if you were a politician, and if -- for political expediency -- you cynically broke a promise to the electorate for the wrong reasons, would you be telling the truth?

Not likely.

We’ll be back in coming days, to provide you with more detailed facts and figures behind the real truth about income trusts.

Let us know your own opinions and personal stories, regarding Little Jim's horrible Halloween hit on Canadian income trusts. --JWB