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I'm hoping someone more knowledgeable can tell me in plain language what an income trust is. I'm looking at investing in CDZ (Claymore's Canadian dividend ETF) in my non-registered account. I read the prospectus and found that it will invest up to 30% in income trusts. Now, I remember hearing a lot about tax changes a couple years ago with regard to income trusts. Since I wasn't really investing at the time, I paid no attention. Basically I'm trying to figure out what concerns I should have with investing in income trusts as opposed to the blue chip stocks in CDZ.
 

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The most simple answer I have come across is that an income trust is basically a corporation that has to pay out most of its earnings as dividends while (in past) being able to dodge much of the taxation of its earnings. While I don't know all the specifics, I do know that the federal government has changed the rules to eliminate the tax advantage of income trusts (REITs excepted I think). I think this was done by imposing a tax on income trust profits in 2006.

The reason why income trusts had a tax advantage was that they were able to get around the double taxation of corporate dividends. The trust holding entity would somehow extract most of the earnings from the corporation (and the corporation would get a tax deduction) and distribute those earnings. In general, trusts do not pay tax on earnings distributed to their beneficiaries (the unit holders).

Despite the reduction or elimination of their tax advantage, not all income trusts are converting back to corporations. Many will continue more or less in their present form. They can still be good investments since they provide a steady stream of income, and generally have high dividend yields.
 

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When evaluating the fund against other dividend paying funds or the big indexes, the presence of a large amount of income trusts means that the distributions are not at all comparable.

Normal companies payout portions of their earned profits. Income trusts almost always pay out WAY more than their profits - often twice the profits. To do that they either take out more debt, or allow their fixed assets to wear out or they (used to be able to) issue more equity to fund the distributions. Not what I call good management.

The benefit from including income trusts in their basket is that it allows for some industry diversification (Oil&gasProducers) that would probably be lacking without the trusts.
 
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