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The wacky world of income trusts, American style

You won't know whether to laugh or cry when you see what a U.S. investing newsletter has to say about income trusts.

"Canada's government-authorized royalty checks [that's the term used for trusts] can ensure you never -- ever -- run out of money," says a promotion for the 12% Letter, which specializes in high-yield income investing. "Smart Americans cashing in on this program are pocketing $59,000 to $162,000 every 2 to 3 years."

What's laughable is how the 12% Letter offers up yet another example of the cockeyed view Americans have of this country. But there's a serious side to all of this, too. With its idealized picture of income trusts as a government-authorized investing bonanza, the newsletter highlights the way in which some investors in Canada misunderstand trusts. It also plays into some of the criticisms that the anti-trust crowd have raised.

According to the 12% Letter, income trusts are being referred to by some financial types south of the border as the "Canadian royalty checks program." Readers of the newsletter are advised to think of trusts as an example of the great social benefits of being a Canadian.

"You probably already know that Canada is famous for its huge social programs -- like free health care, the Guaranteed Income Allowance (otherwise known as 'The Allowance') and federal training and employment programs," the promo for the 12% Letter says. "What you may not know is that there's a unique situation right now in Canada that is allowing Americans to fund part or nearly all their retirement."

The 12% Letter is written by Craig Walters, a former equity analyst and currently the managing editor of Stansberry & Associates Investment Research, which is based in Baltimore. Those of you who are familiar with the wacky and wild world of investment newsletters will have an idea of what we're dealing with here. There are headlines about investments offering the moon and stars (43-per-cent bonds, for example) and breathless prose about opportunities.

The information about trusts -- sorry, the "royalty checks" program -- is a bit, um, garbled. But it does capture the gold-rush mentality that took hold of the trust market just before Finance Minister Ralph Goodale made it clear the government was taking a hard look at the trust sector.

Take, for example, this business of trusts being a government-authorized money tap. As recently reported by my colleagues Steven Chase and Patrick Brethour, the trust structure has never formally been adopted by Ottawa. The reality is that the government had almost no role in the creation of trusts, other than a technical tax ruling made two decades ago that authorized the trust structure.

And yet, we have the 12% Letter telling readers that in trusts, the Canadian government has found a way to redistribute money from wealthy corporations to average citizens. "It's like being put on the board of directors of the biggest and richest companies in Canada -- because the profits are sent directly to YOU," Mr. Walters writes.

Unfortunately, lots of investors have bought into the belief trusts were put on earth to help people who wanted investment income but couldn't live on the pitiful returns of bonds and term deposits.

No question, Ottawa fostered this belief by letting the trust sector grow to huge proportions before getting serious about controlling it. But the reality is trusts have always been vulnerable to government intervention.

One of Mr. Goodale's major concerns about trusts is that they deprive the government of hundreds of millions in tax dollars. Trusts pay no taxes themselves, instead passing on earnings to investors who are liable for taxes according to their personal circumstances.

The 12% Letter offers a direct provocation on the tax issue because it recommends trusts to American investors, who pay less tax on trust distributions than Canadians. An American trust unitholder would face a 15-per-cent withholding tax on money paid by a trust, whereas Canadians who own trusts outside a registered retirement account would face tax rates as high as 39 to 48 per cent, depending on the province of residence.

In the world of the 12% Letter, trust distributions are an almost magical source of money: "Some folks live solely off the checks . . . others reinvest the money . . . and some use the money for extravagant and exotic luxuries."

This hyperbole is a killer for trusts because it supports the contention by some critics that they're a moneymaker for the wealthy and meaningless to the regular folk. In truth, a wide swath of people have benefited from trusts through direct investments or indirectly through mutual funds and pension funds.

Misinformation is rampant on all sides of the trust debate, which means that finding the right balance between the needs of government and investors is going to be hard. Over to you, Mr. Goodale. The future of the Canadian "royalty checks" program is in your hands.

© The Globe and Mail

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