"What are the Kinds of Canadian Income Trusts"

Although they're often grouped together, there are different kinds of Canadian income trusts:

1. Real Estate Investment Trusts or REITs

This type of company may be familiar to American investors, since U.S. law has allowed real estate companies to organize themselves as trusts since the early 1960s. American REITs also do not pay federal taxes so long as they pay out at least 90% of their post-operations profits to unit holders.

So Canadian REITs are basically the same.

2. Business Trusts

This is really a catch-all category. Just about any type of business can convert itself into a unit trust. However, to succeed they must be fairly well-established, and not need all their cash to remain in operation or to stay up with competition.

Current business trusts include the Canadian Yellow Pages, manufacturers, fisheries, and entertainment.

3. Trademark Royalty Trusts

I've read of Canadian income trusts all referred to as Canadian "royalty" trusts, but this is not strictly true. Some trusts own and operate businesses directly -- category number 1 above.

However, some trusts are set up so that they don't operate the underlying business, they just own the rights to the company's trademark, and they license it back to the company. In return, they receive a fee for each product sold. This is the income with which the "CanRoy" pays dividends to its unit holders.

The company itself continues to make the overall business decisions.

So this is legally separating two aspects of a business. We're not used to thinking of a business as separate from the right to operate under its business name. Coca-Cola, for example, owns all rights to the names of its sodas and other products.

However, in Canada, the A and W Root Beer company runs the hamburger and root beer stands, but pays a fee on all franchise profits to an income trust (A and W Revenue Royalties Income Fund), which then pays its unit holders.

This seems sort of cumbersome, but it does allow investors to receive a higher amount of dividends than if they simply owned shares of A and W Root Beer stock.

4. Oil and Gas Royalty Trusts

This type of trust is the major category of income trusts in Canada, and that was probably the original intent of the law -- to encourage the development of Canada's rich supply of natural resources. For the good of Canadian investors and the overall Canadian economy.

Oil and gas royalty trusts own the rights to profit from the oil or gas in a proven well. As long as the world needs these commodities, the well will generate income by selling what's in the well.

The process of exploring for new oil and gas wells is usually spun off to a separate company, since this is a risky business that may not see a profit for a long time, if ever.

5. Funds of Income Funds

These are basically mutual funds that hold nothing but the best (in the manager's estimation) of the available Canadian funds. You can buy units in these companies, which are themselves set up as trusts.

The choice of fund of funds does get complicated, however. Some of them are called income and growth funds and also invest in many other types of securities, including stocks and bonds.

Some, such as the Strata Income Fund, are split share fund of funds. They issue different classes of units, which have different tax characteristics.

Equal weight fund of funds, such as the Brompton Equal Weight Income Fund, invests the same amount of money into every income fund in which it invests.

There are also energy trusts, which deal with energy fuels or distribution, and utility trusts, which generate electricity.

Why you maybe should invest in Canadian income trusts.

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