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A new investment beast: the high-yield corporation Add to ...

Income trusts, the sequel. Watch for it soon in an investment portfolio near you.

Income trusts as we know them will largely be gone by the time a new trust tax kicks in next year. In their place will be a new category of stock that in some cases will be more attractive to some investors than trusts were.

"I'm calling it the high-yielding corporation," said Harry Levant, the independent analyst behind the IncomeResearch.ca website. "It's a new beast that has come out of the income trust process and demand for income."

As an income trust, a business can distribute its earnings to shareholders and thereby pay no tax. Concerned by what it described as tax leakage, the federal government announced that trusts would have to start paying taxes in 2011 (real estate investment trusts meeting certain conditions were excluded).

Some trusts have already converted into dividend-paying corporations, and most others will follow in the next six months. What will end up distinguishing these trusts is the amount they pay out in dividends.

In the case of a select few financially strong trusts, the amount paid in dividends will be the same as was paid previously in distributions. In non-registered accounts, this is a significant improvement for investors.

Income trust distributions can in part be made up of dividends and a return of capital, but often they're straight income that gets no special tax treatment. Dividends, on the other hand, benefit from the dividend tax credit when held outside registered accounts.

Someone making $60,000 a year would pay a marginal tax rate on straight income of between 29 and almost 39 per cent, depending on the province or territory. On eligible dividends - that's what almost all publicly traded companies pay - the marginal rate would be 4.4 to almost 16 per cent.

"If a trust continues to pay out the same amount in dividends as they were paying in distributions, it's actually an increase," Mr. Levant said.

The difference in taxation on dividends and straight income is so pronounced that investors in non-registered accounts may end up with the same amount of after-tax cash even if a trust reduces its payout in converting to a corporation. In rough terms, $1 in dividends is equivalent after taxes to income trust distributions of anywhere from $1.20 to $1.40 or so.

Trusts converting to corporations are taking a variety of approaches to their dividend. IESI-BFC Ltd., previously known as BFI Canada Income Fund, cut its payout to 50 cents a share from $1.82 on conversion to a corporation, while Yellow Pages Income Fund has said it will maintain its 80-cent annualized distribution through 2010, then start paying dividends at an annualized rate of 65 cents next year.

And then there are trusts that have either converted into corporations and maintained their payout, or indicated they will do this once they make the conversion. According to Mr. Levant, this group includes Canadian Helicopters, Brookfield Renewable Power Income Fund, Colabor Group, Cineplex Galaxy Income Fund and Keyera Facilities.

Mr. Levant said he expects there to be at least three trusts left in 2011 - A&W Revenue Royalties Income Fund, Inter Pipeline Fund and Firm Capital Mortgage Investment Trust. Each has specific reasons why they're not immediately going corporate; Mr. Levant expects the net effect to be a no-change policy toward the distribution heading forward.

At their peak, there were about 265 income trusts listed on the Toronto Stock Exchange. Takeovers and privatizations will reduce the total number of high-yield corporations to around 90, in Mr. Levant's estimation.

High-yield corporations will occupy much the same niche in the investing universe as trusts do now. Yields will be well above what the typical blue-chip corporation pays, but with a higher level of risk of dividend cuts. Colabor Group and Premium Brands, a pair of former trusts that kept their payout intact when they converted to corporations, both have yields in the 9-per-cent range.

The concept of the high-yield corporation is one that has already caught the eye of the indexing people at Standard & Poor's. They're currently deciding what to do with the S&P/TSX income trust index and one option is to convert it into a benchmark for former trusts with high dividend yields.

"We're going to go away and do some research on that," said Tony North, S&P's director of index operations in Canada. "We already have the dividend aristocrats index, but we may create something other than that."

The S&P/TSX Canadian Dividend Aristocrats Index is a mix of common stocks and income trusts that meet various criteria, including a history of raising their dividends or distributions for five successive years. The yield for the aristocrats index was 5.2 per cent late this week, compared with 8 per cent for the income trust index.

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