Please investigate investment suitability and your own tax implications before investing in Royalty trusts. The details i have provided may be incomplete or inaccurate.


What is a Royalty Trust?
Royalty Trusts are natural resource companies that because of their company structure do not have to pay taxes at the company level as long as they pay out 90% or more of their earnings to shareholders. Canadian Royalty trusts pay very high dividends typically in the range of 10-20%. Canadian trusts (unlike US trusts) are set up to perform exploration and development and/or aquire new proporties to replenish their reserves. They are set up to operate indefenitely.

Whats this new Tax Rule I hear about and what effect will it have?
The finance minister has a proposal that starting in 2011 all existing trusts should pay corporate taxes.

If the proposal goes thru, in the 4 years till 2011 you will recieve back 40-72% of your investment in the form of dividends. While the company is paying out 90% of its earnings there is very little left to aquire additional reserves. After 2011 most of these companies will use the money to fund expansion of their resource base. The dividend payment will drop to about 3-5% because the companies dont need to pay out their income. However because of increases in reserves dividend payments in the future will grow at a much faster rate. If the proposal does not become law (the trusts are lobbying against it or asking for an extension to 10 years) companies will keep paying dividends at these high rates and the stocks will climb as dividend investors pour back in.

List of CanRoys

My favourite is Penn West Energy (PWE) the largest energy trust in North America. It is an exploration and production company which converted to a trust in 2005 to increase shareholder returns. I think the company can increase their production significantly without the need for additonal capital. It has 89% working interest in 4 million acres of undeveloped land which is suitable for oil and natural gas exploration and production. The management is also very good at making acquisitions. To top it all Murray Edwards who used to be chairman of PWE is still one of the biggest shareholders in the company. Since the company has a history of being an exploration and production company it should do well post 2011 compared with other energy trusts.


What about taxes?
The Canadian government applies a 15% non-resident withholding tax on distributions to U.S. investors. You can apply for a refund of a portion of the amount withheld. If you hold the shares in a taxable account (non IRA) then you can claim it on your US tax return as a foreign tax that you paid. You can claim the foreign tax credit on your 1040. The limit is $300.00 single or $600.00 filing jointly per year. If the amount is greater than what you can fill out on your 1o40 then you need to use IRS Form 1116. If your marginal tax bracket is over 15% you should get a full refund. If below 15% then you will only get a partial refund.

For more details check IRS publication 514 (You need to select the document from the list and then retrieve it)

Conflicts: I do not own shares in any of the companies mentioned but am considering PWE.