Canadian royalty trusts were a boon for the Canadian energy sector, but the Halloween massacre in 2006 scared a lot of people away. However, there's still great income and growth up north, says Elliott Gue of Energy and Income Advisor.
Gregg Early : I am here with Elliott Gue, editor and publisher of Energy and Income Advisor. Elliott, I wanted to ask you about what is happening with our northern neighbor, Canada. There was some pipeline news a few months back and now the dollar seems to be in a place where maybe it might weaken, but Canada has been doing fine. How is the energy market doing up there?
Elliott Gue: The Canadian energy market has been doing very well also. I think that it's a market that has been a little bit out of focus for many investors.
Several years ago-back about a decade ago-we saw a lot of companies in Canada in the energy side began to list as royalty trusts. Basically, royalty trusts were a class of investment that was tax-advantaged; they did not pay any tax at the corporate level in Canada, and they simply passed through the earnings that they had, the cash flow that they had in the form of typically monthly dividends or distributions to unitholders.
They offered very high yield and plenty of tax advantages. If you happened to be an American investor, Canada has a 15% withholding tax rate. They do not hold taxes on dividends paid into American individual retirement accounts. So these were extremely popular yield-oriented investments.
But then of course, in 2006 the Canadian government-in a move that has since come to be known as the Halloween Massacre-actually changed the taxation of trust and said that trusts would no longer have this favorable tax treatment starting in 2011. So after that happened and after 2011 rolled around, a lot of people forgot about Canada and forgot about Canadian energy stocks.
But the reality is that even though many of them are currently listed as corporations now, several of them still pay dividends on a monthly basis and offer yields of 7% or even 8% in many cases. And many of them have also built up a number of tax credits over the years-that means that they don't really pay corporate taxes anyway.
Obviously there are still a large number of very fast growing oil and gas producing fields in Canada; it's the largest source of foreign oil in the United States. I think that there is still a lot of opportunity up there. These stocks are pretty cheap because a lot of people are ignoring them, because they think that there aren't opportunities there anymore after the change in the trust taxation.
Gregg Early: And the yields are two or three times higher than a lot of the companies down in the United States. Is there still a tax-deferred advantage?
Elliott Gue: The withholding tax for Canada is still 15%, so even after 2013, assuming that some of the tax hikes go into effect in the wake of the fiscal cliff; the Canadian government is still only going to withhold 15% of your dividends, which is among the lowest in the world.
In addition, they will continue to not withhold dividends on monies paid into an IRA account, an individual retirement, or a tax-deferred account. It's still a huge advantage for investors that want to hold these assets in a tax-deferred account.
For example, the equivalent structure in the United States would probably be a Master Limited Partnership, and those can be a little bit difficult to hold in an IRA account because they generate unrelated business taxable income. Kind of a quirk in the US tax law means that you might actually owe tax even if they are held inside an IRA or a 401(k) account
But several of these Canadian energy companies pay monthly distributions, have a low withholding tax, do not withhold taxes for IRAs, and offer yields equivalent to MLPs in that 7% or 8%-plus range.