Goodbye income trusts, hello blue-chip dividend stocks.
If you're looking for a safe source of income, the changes to the taxation of dividends announced yesterday by the federal Finance Department make stocks like the big banks, utilities and pipeline companies a much better bet than they were before.
Income trusts will still have some appeal, but you now have a clear alternative if you're starting to get the willies about trusts because concerns about their ability to make their regular monthly cash distributions over the long term.
The essence of the changes announced by the Finance Department is to equalize the level of corporate and individual taxation on dividends with the level of tax paid on distributions from income trusts.
This is being done by reducing the amount of taxes that individuals pay on dividends.
Dividends paid by corporations will give you less pretax income than distributions from trusts in almost all cases.
For example, bank stocks currently yield about 3 per cent, while phone utilities and pipelines might get you into the high 4-per-cent range. Trusts, by comparison, offer yields of 5 per cent to more than 20 per cent.
The after-tax payout on dividends is improved somewhat through a slight tax break known as the dividend tax credit. Now, the dividend tax credit will be further enhanced so that dividends are even more attractive.
Put another way, the after-tax returns on dividends will be more comparable to after-tax returns from trust distributions, even if the trust has a higher yield than the dividend stock. Trust distributions may benefit from certain tax breaks as well, but often they're taxed as straight income, which has no tax advantage at all.
The grand theory behind the Finance Department's changes is to eliminate what's known as the double taxation of dividends. Trusts pay little or no tax at the corporate level and instead leave investors to pay taxes.
But a large company pays taxes on its income at the corporate level, and then its dividends are taxed a second time when they land in an investor's hand.
For investors, all of these changes are moot if they hold stocks and trusts in a registered retirement savings plan or registered retirement income fund.
In these cases, taxes on dividends or trust distributions are deferred until such time as a withdrawal is made.
For taxable accounts, though, investors will have more reason to look at the super-secure dividends paid by the banks, for example, as opposed to the shakier distributions paid by trusts. Whereas many blue-chip companies have been paying dividends uninterrupted for decades, most trusts are no more than a few years old and a small but growing number have cut or suspended their payouts.
Concern about trusts was heightened yesterday by the release of a report from Accountability Research Corp., an affiliate of Rosen and Associates forensic accountants, which said the trust market is overvalued by $20-billion. The report also questioned the ability of trusts to fund the cash distributions that have made them so popular with seniors and other investors focused on income.
© The Globe and Mail
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