What is a Canadian Royalty Trust?

The instability of the stock market has investors looking for stable high yield investments. Canadian Royalty Trusts are a great alternative to traditional stocks.

A Canadian Royalty Trust, also known as a CanRoy, is a corporate trust that is set up to legally bypass high corporate taxes in order to funnel profits back to trust holders in the form of distribution payments. A CanRoy usually controls an operating company that uses the money invested in the trust to buy oil and gas producing properties. While approximately 40% of CanRoys invest in energy-related businesses, the remainder back other types of organizations. In this structure, money also flows the opposite way as the royalties and interest payments from the properties flow back through the operating company and into the trust. Eventually, these funds are paid out to investors in the form of distribution or dividend payments.

US Royalty Trusts vs. Canadian Royalty Trusts

While US Royalty Trusts are not allowed to purchase additional properties after they are initially formed, CanRoys have the advantage of being able to continually add new properties to their portfolio. The result of this difference is that all US Royalty Trusts will eventually deplete their oil and gas resources which will result in declining cash flows over time. On the other hand, Canadian Royalty Trusts could theoretically continue forever.

CanRoys Make an Attractive Investment Option

The extremely high dividend or distribution payments that are typically paid on a monthly or quarterly basis to the shareholders or unit holders make Canadian Royalty Trusts an extremely attractive investment option compared to other Canadian dividend stocks. In fact, the yearly rate of return can sometimes be as high as 10% of your investment, and this payout could continue as long as you own trust units. How could any company pay dividends like that and continue to make a profit? The secret is that a Canadian trust doesn’t have to pay any corporate income taxes if they distribute all of their income to their investors. This means that almost 100% of the money that a CanRoy receives from the oil and gas properties in the form of royalties and interest payments is paid out to the people who have purchased shares or units in the trust.

Choosing a CanRoy Investment

If you have the basic knowledge to invest in the stock market, you don’t need to know anything additional to choose a CanRoy. However, investors need to make sure that they are not blinded by a Canadian Royal Trust’s most recent distribution payment and choose hastily. A smart investor will make sure that they research the trust to determine if the dividend income they receive will be stable. Once you determine that a CanRoy is stable, the most important thing to consider is the dividend coverage ratio or yield. After all, the yield is your final goal with this investment. In basic terms, if a CanRoy reports a 10% yield last year, their investors received distribution payments equal to 10% of their investment value.

CanRoy Tax Implications

For Canadians, the tax implications are virtually the same as with any other investment income. However, there are a few things that US taxpayers should consider. Typically, a CanRoy dividend will qualify for the maximum US tax rate of 15%. However, Canada will apply a 25% non-resident withholding tax on distributions to anyone who does not live in Canada. This is usually dropped to 15% for US residents due to a treaty between Canada and the US, and investors can recoup a portion of the total by applying for a foreign tax credit when they file their yearly income tax return. New Canadian laws that will take effect in 2011 will mean that most trusts will have to start paying corporate taxes. This could mean that their yield will drop dramatically.

Bio: Guest post submitted by Dividend Stocks Online, covering high dividend stocks and value investments.