Income Fund 101

Business trusts – Income trusts are exchange-traded equity investments making regular (usually monthly) cash distributions to holders of their trust units (unitholders). The trust structure is particularly suited to participants in mature industries having steady cash flow.

Business trusts are one major category of income trust in Canada. The others are energy trusts, real estate investment trusts (REIT) and power & pipeline trusts. Energy trusts and REITs were historically the dominant categories of income trust. Over the past several years, the number of business trusts in Canada has grown substantially.

The principal business of a business trust’s underlying asset is in the manufacturing, service or general industrial sectors. These three sectors cover a broad range of industries, including transportation, technology, retail, financial services, consumer products and communications/media. Trimac Income Fund is a Canadian business trust in the transportation sub-sector of the industrials sector.

Financial and legal structure – Income trusts are a different legal entity from corporations, as they are not incorporated. A trust’s equity investors are generally known as “unitholders” or “unit holders”, or in a few cases “securities holders”. They hold trust units that have different legal attributes then common shares of a company.

Income trusts enable unitholders to participate in indirect equity ownership through the purchase of trust units (which do not provide direct ownership of operating assets). Trust units trade on various stock exchanges and currently provide investors with similar market liquidity to other publicly traded securities. 

Assets – Income trusts derive their revenue from the cash flow generated by operating assets. These assets can be held through a wholly owned subsidiary or partnership, through securities in an operating company, or through a royalty arrangement. The details of this relationship can be complex and vary from trust to trust. Often the underlying assets are held in a separate entity in which the trust holds an interest.

Given the current diversity of income trusts in Canada, the underlying assets can be in almost any sector capable of generating steady cash flow – transportation, energy, manufacturing, industry, real estate, services, utilities, natural resources, investment banking, and many others.

Distributions – Cash distributions, allocated on a per-unit basis, are made by most income trusts on a monthly or quarterly basis. This is the primary way that income trusts generate investment returns for their unitholders. Distributions are not guaranteed and can vary from year to year. Capital gains or losses through fluctuations in the unit price are also possible.

Acquiring assets – In many cases an income trust’s initial base of assets comes from the conversion of an existing operating business structured as a corporation into an income trust. Income trusts’ assets are generally acquired using a combination of equity raised from the sale of trust units and bank debt (and possibly convertible debentures). 

Risk levels – Although income trusts tend to operate established businesses with a substantial operating track record and a history of cash flow generation, income trusts remain subject to normal business risks. The economy, industry conditions or government regulations can all change to the detriment of any business. A trust’s operating business(es) may experience declining activities or interruptions, either of which may reduce revenue and cash flow and, consequently, cash distributions to unitholders.

Like publicly traded companies, income trusts are exposed to market risk through fluctuations in their unit value. In particular, the trading prices of trust units are highly sensitive to distribution cuts and interest rate increases.

Important dates for unitholders – There are three major dates involved with paying distributions.

A declaration date is the day on which the board of directors publicly announces that the Trust will pay a certain level of distribution on particular dates in the future.

A distribution record date is the date on which a trust’s transfer agent examines its records to determine the list of unitholders of record. Only unitholders of record are eligible to receive distributions in the following month. To qualify and receive a cash distribution, a unitholder must have purchased his/her trust units at least two business days before this date. This allows enrolment documentation to go from the financial institution where the investor purchased the trust units to the transfer agent that performs unitholder administration on behalf of the trust.

A distribution date is the date on which the trust sends cash distributions (in the form of a cheque) to registered trust unitholders, either directly or to the brokerage or investment company that manages the beneficial trust unitholder’s account(s).

Non-residents of Canada – Unitholders who are not residents of Canada for income tax purposes are encouraged to seek advice on distribution taxation from a qualified tax adviser in their country of residence. Monthly distributions paid to non-residents of Canada are typically subject to a withholding tax, according to the Income Tax Act of Canada. This withholding rate may be reduced under the provisions of the tax treaty between Canada and a unitholder’s country of residence.