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Taxation of Dividends from Trusts

4149 Views 7 Replies 3 Participants Last post by  Cal
I read the following link:

Although it was informative about where the money for the distribution comes from, and it gave some good examples of how various companies structure their dividends, it did not really show how the various forms would be taxed.

Especially when held in a non-registered account.

Like in the first example used: Arc Energy Trust, 97% income/interest, 3% return on capital.

Am I right then in assuming that if you were to have received $100 in dividends over the year, that $97 would be taxed at your marginal tax rate, and $3 would also be taxed at your marginal tax rate?

Any help in showing how the 3 examples in the link would be taxed in a non-registered account would be helpful.
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Thanks for the mention. Income interest, as you said, are taxed at your marginal rate. The ROC however, reduces your adjusted cost base of the stock, so you'll have to pay capital gains when you sell.

How Return of Capital works
Dividend Taxation
How capital gains work
So in the article 'How return of capital works' the example used was:

Purchase XYZ income trust for $10, it distributes an annual ROC of $1. Sell 1 year later for $20. The capital gain is: $20 - ($10-1) = $11

Then w per the original breakdown:

Purchase AET.UN income trust for $10, it distributes and annual income/interest of 97c, + 3c ROC, for a total distribution of $1. Sell 1 year later for $20. Then the capital gain is:$20 - (10 - .03) = $10.97

Is that right? The income interest is taxed differently than the ROC?? And at the end of the tax year you are taxed on the 97c portion of the distribution as per the formula in the 'Dividend Taxation' article.
Or would it simply be:

Multiply your grossed up amount by your marginal tax rate

distribution of $1 * marginal tax rate = w

Calculate Federal Tax Credit and Provincial Tax Credit

* $1450 * 18.966% (Federal rate) = x
* $1450 * 6.65% (NL) = y
* Total tax payable on $1000 worth of dividends: w - x - y = z

That seems a little simpler....I am under the impression that these calculations are supposed to be very complex and difficult to figure out if help outside of a registered account/

Any help out there? We can use the AET.UN example to keep it simple (97% income/interest, 3% ROC)
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Rookie ... the first thing you need to understand is that income trusts do not pay dividends ... they issue distributions ... there is a difference ... occasionally, there is a tiny amount of dividend included in a distribution, but the key word there is “tiny” ... in most cases, distributions are composed of some combination of income, capital gain, and return of capital ... each of those components is taxed differently.

The ROC portion you seem to have down ... the examples you posted are correct ... of course, if you didn’t sell 1 year later, then those amounts wouldn’t become taxable until some time in the future when you actually do sell.

The capital gain portion of the distribution is taxed exactly the same as any other realized capital gain ... half the gain is added to your income, and that half is taxed as ordinary income ... a capital gain distribution has no effect on your adjusted cost base ... there is no capital gain distribution in the example you are citing.

The income portion of the distribution is NOT taxed at your marginal rate ... it is taxed as ordinary income ... there is a difference ... there could actually be several sub-categories of income distribution that are all treated the same, taxwise ... domestic business income, domestic royalty income, interest income, foreign non-business income, foreign business income, etc., are all taxed the same way ... as ordinary income.

Sometimes, if there was any foreign income, there may also be a foreign tax withheld from the trust ... in that case, the foreign tax withholdings would also show up on your T-slip, and those can be entered as credits on your tax return.

Cdn dividends are in a whole separate category, tax-wise, but you generally won’t have to worry about that with income trusts, since so few of them distribute any dividends at all, and when they do, it is usually just a tiny, tiny fraction of the total ... there are no dividends in the example you are citing.

So in your example, the 97% that is income would simply be taxed as ordinary income. That's all there is to it.
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Yes. Thats why I am rookie.

Thanks for the help. I think that I have it.

Purchase AET.UN income trust for $10, it distributes and annual income/interest of 97c, + 3c ROC, for a total distribution of $1. Sell 1 year later for $20. Then the capital gain is:$20 - (10 - .03) = $10.97

And the 97c is added to my earned income, and is taxed accordingly.

If I don't sell, but simply buy and hold, do I get taxed on the accrued 97c earned income annually?

I was considering DRIPing this stock to accumulate more shares, and come retirement time, when I have a lower earned income, would stop the DRIP and utilize the $ distribution as income.
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Yes, the income portion of the distribution is taxable in the year you receive it ... if you DRIP the distributions, you'd still owe tax, so you'd have to come up with the money to pay that tax from some other source.

Incidentally, this is an ideal candidate to be held within a registered account ... very tax-inefficient otherwise.
Yes. I am starting to realize that. Thank You for your help. I have yet to add anything to my TFSA....

I have been waiting out the stock market it doesn't really seem to make sense based on the earnings.....and I know that the stock market corrects about 6 months prior to the economy....but I can't see that being much better in December....when jobs start to return...then the economy will return in my mind.
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