Wednesday, September 30, 2009

Future of Canroys

Canadian Royalty Trusts are usually energy producers (e.g. oil and natural gas) The trusts give out high dividends because they don't have to pay corporate income taxes if they distribute their income to unit holders (shareholders). Canadian royalty trusts differ from U.S. royalty trusts in that U.S. trusts are not allowed to acquire new properties whereas Canadian royalty trusts can. Canadian trusts are not corporations, and in theory at least, unitholders have unlimited liability for the actions of the trust. In practice, however, most experts consider it unlikely that individual unitholders will ever be held liable for the trusts actions.

Now, that is changing. When certain large corporations announced their intentions to convert to the trust structure, the Canadian government (Tories) changed the rules as they feared a drop in tax income from loss taxes. By 2011, all existing trusts will have to pay taxes similar to that of corporations while newly formed trusts will no longer get any tax incentives that current trusts enjoy.

A trust has only limited oil and natural gas reserves and these reserves are slowly depleted. With the proposed changes and uncertainty looming, access to new capital might be difficult thus making new acquisitions harder. Trusts without sufficient reserves in the ground may be unable to maintain their current distribution levels. Once the tax incentives stop in 2011, trusts might opt to use their profits for capital expansion or new projects instead of distributing them..

So what will happen between today and 2011? Some trusts could convert to regular corporations during this period. Others might be left with no choice but to reduce their distribution as their oil and gas reserves are depleted. Those that are able to step-up their output substantially will also be able to carry on the high distribution.
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