Dividend Watch List

Superior Plus Corp (TSX: SPB, OTC: SUUIF) will reduce its monthly distribution to CAD0.10 per share, effective with the March payment. That’s a cut of approximately 26 percent from the former level of 13.5 cents Canadian and represents the first and only reduction since the company converted to a corporation in 2008.

Superior’s move triggered a two-day drop in its stock from a Feb. 16 close of USD12.53 to a Feb. 18 intraday low of USD10.67, with a subsequent recovery to about USD1 higher since. The cut was accompanied by a reduction in 2011 full-year profit guidance for adjusted operating cash flow per share (AOCF) to CAD1.40 to CAD1.75, a level that if hit would produce a payout ratio of 68.6 percent to 85.7 percent, based on the lower dividend rate.

Prior guidance had been for AOCF of CAD1.75 to CAD2. That would have covered the old monthly dividend rate of 13.5 cents Canadian with a payout ratio of 81 percent to 92.6 percent. Fourth-quarter AOCF covered the old rate by a 1.3-to-1 margin, while full-year 2010 AOCF of CAD1.29 produced a payout ratio of 125.6 percent. Fourth-quarter 2010 AOCF was 20 percent lower than 2009 levels, while full-year AOCF was 28.3 percent lower.

Superior’s management has couched the dividend cut as part of taking a “more conservative view of the business throughout 2011.” The company has three basic business lines. Energy Services distributes propane and refined fuels, such as heating oil. Profit depends principally on efficiency of operations, the cost of raw materials and weather, which impacts customers’ demand. The winter months are prime time for this business, which generates lesser profit the rest of the year.

Specialty Chemicals includes processing and sales of several industrial chemicals, particularly Chloralkali and Sodium Chlorate. Profits are sensitive to the level of pulp market activity, which affects both demand and price. This was strong in the fourth quarter, though offset by a higher cost of inputs to produce the chemicals.

The third division, Construction Products, has been the weakest of the three the past couple of years, mainly due to the continuing slump in the US residential and commercial construction markets. The company has acquired several valuable North American franchises in this industry the past couple years and Canadian operations appear to be growing. The US business has also been restructured to take out costs. But until the US construction business does improve, this division will be a drag.

The other point of weakness at Superior is debt taken on to fund a furious pace of acquisitions in recent years. Interest expense in the fourth quarter surged to CAD16.5 million from CAD6.7 million a year ago, a drain on cash flow that will be tough to reverse barring a recovery in the operating businesses.

The good news is these new projections do appear to be quite conservative. Despite the challenges faced, cash flow from operations was actually up 1.5 percent for all of 2010, 8.1 percent for the fourth quarter. That wasn’t enough to overcome the impact of the added debt and the 9 percent boost in shares outstanding. But it’s indicative of a steady business, particularly the Energy Services segment, which now accounts for more than 60 percent of gross profits.

The new dividend rate is also conservative, as it would have been covered by AOCF in 2010. There are no debt maturities in 2011or 2013, and the CAD175 million coming due Dec. 31, 2012, is only 14.4 percent of market capitalization and therefore should be manageable. It’s a convertible security with an interest rate of 5.75 percent and so could potentially be refinanced at a lower rate.

At this point management could be faulted on several counts, particularly investing so aggressively in the US in the past couple of years. It’s a move many other Canadian companies made to take advantage of the Canadian dollar’s purchasing power, with mixed results. At this point, however, there appears to be little downside to cash flow, the remaining dividend or the stock. I’m not ready to recommend this one until we actually see a set of numbers that show improvement. But from this low baseline, Superior Plus Corp rates a hold.

Note that as of press time Superior’s dividend cut is not yet reflected in the percentage yield shown in How They Rate. That puts the actual yield at about 10.7 percent. I expect to see the adjustment made after the next scheduled distribution is declared on Mar. 10. The Mar. 15 payment (declared Feb. 10) will be at the old rate of 13.5 cents Canadian.

Unfortunately, as I pointed out last month, Superior isn’t alone in quoting an inflated yield. In fact, there are still seven How They Rate companies with quoted dividend rates that are still based on pre-2011 payouts. That’s despite most of them announcing cuts months ago as part of their conversions to corporations.

Two that now reflect their proper disbursements are Bell Aliant Inc (TSX: BA, OTC: BLIAF) and Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF). As Canadian Edge readers are no doubt aware, Bell Aliant converted to a corporation on Jan. 1, at the same time slashing its payout from a monthly rate of 24.17 cents Canadian to a quarterly disbursement of 47.5 cents, a 35.5 percent reduction. The company also bizarrely cashed out its US investors, though as it turned out at a reasonable price of a little under USD27 per share.

At this point, anyone on either side of the border should be able to buy Bell Aliant on the Toronto Stock Exchange, though volume has indeed seemed to dry up on the US over-the-counter (OTC) market for the symbol BLIAF. The key question, however, has to be who would bother buying this stock now, particularly after the 23.1 percent drop in distributable cash flow per share in the fourth quarter.

The drop in distributable cash flow is due to the combination of continued basic line losses–the consequence of ever-more competition from cable television operators and wireless phones–and the capital expense of building a fiber-to-the-home broadband network. Management is encouraged by a lower line loss rate in the fourth quarter and the fact that capital spending on fiber will peak this year. And the payout ratio is low relative to what the company calls distributable cash. But with a yield of barely 7 percent with little prospect for growth, there are better options. Sell Bell Aliant.

Boston Pizza has made good on earlier statements to reduce its monthly distribution to 8.4 cents Canadian from the prior level of 11.5 cents. That’s not reflected in the current yield of 7 percent plus shown in How They Rate. The company, which has elected to remain an income trust, reported a 1.3 percent boost in same-store sales and a 5.2 percent increase in distributable cash flow for the fourth quarter of 2010. That’s a good sign for the long-term strength of the business, and solid assurance the recent dividend cut will be the last. Hold Boston Pizza Royalties Income Fund.

Here’s a discussion of the remaining seven members of the Watch List and what their true dividend yields are. Not all of them are sells. In fact, one is actually a Portfolio member and a buy. But before you jump, take note of what the actual dividends are.

Big Rock Brewery Inc’s (TSX: BR, OTC: BRBMF) CAD0.10 monthly distribution will become a CAD0.20 quarterly dividend when the company makes its first declaration as a converted corporation. That should happen any day now, at which time the dividend yield will drop to a little less than 5 percent. Fourth-quarter earnings aren’t due out until Mar. 24. The lower rate should be secure, but the stock now looks priced for the current level. Hold Big Rock Brewery, but be prepared for a dip following the declaration.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF) is still shown with a yield of 17.5 percent, based on the pre-corporate conversion monthly rate of CAD0.25 per share. During the pulp producer’s fourth-quarter and full-year 2010 earnings call, however, management again stated its intention to cut the payout to a quarterly rate of CAD0.35. That’s a 53.3 percent cut from the prior rate and would leave Canfor Pulp with a dividend yield of little more than 8 percent after the stock’s run-up this month to an all-time high.

Fourth-quarter and full-year 2010 earnings were hardly blockbuster either, with rising costs offsetting record revenue. I’ve changed my recommendation on the stock once again to sell. If you weren’t cashed out at conversion now’s the time to take the money and run from Canfor Pulp Products.

Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) declared a year ago that it would reduce the 15.33 cents Canadian it paid monthly as an income trust to a quarterly rate of CAD0.30 when it converted to a corporation on Jan. 1. As I noted last month, the company is making two payments during the calendar first quarter of 2010: the 15.33 cents Canadian per share paid out on Jan. 31 and an additional, “special” dividend to be declared on Mar. 8 when the company releases its fourth-quarter and full-year 2010 results.

That’s a confusing arrangement and it’s bound to leave at least some investors befuddled about what exactly the provider of business forms to Canada’s banks is actually paying. That should be sorted out when the first quarterly payment is declared, probably in May. Until then, Davis + Henderson’s real yield is 5.5 percent. I’m holding my buy target at USD20.

Futuremed Healthcare Products Corp (TSX: FMD, OTC: FMDHF) went the same route as Davis + Henderson in early 2010, announcing it would go quarterly with its payout at a reduced rate. The level set then was 16.875 cents Canadian, a 27 percent reduction from the prior monthly rate of 7.71 cents. The new dividend rate equates to a yield of about 9.4 percent. That’s a strong payout, especially considering the company has now renewed long-term contracts with four of Canada’s largest owners and operators of long-term care facilities. That’s critical given the competition the company faces in the disposable nursing supply market.

Unfortunately, the stock is still being quoted with a yield of nearly 13 percent, based on the old rate. The fourth quarter and full year earnings release is due March 10, at which time we may see the first quarterly dividend declared and the quote correct. Hold Futuremed Healthcare Products Corp.

North West Company Inc’s (TSX: NWF, OTC: NWTUF) posted yield certainly doesn’t look inflated at just 6.3 percent. But it is almost two full percentage points higher than the actual yield, based on the post-conversion dividend cut announced by the company last year. That’s what will show up at the next projected declaration date of Mar. 17, which coincides with the Mar. 18 projected date for its fourth-quarter and full year 2010 earnings release.

There’s not a lot of risk here to operations. But neither is there much attraction given slow growth prospects and a yield of well under 5 percent. Hold.

Royal Host Inc (TSX: RYL, OTC: ROYHF), the corporation formerly known as Royal Host REIT, has been clear that it intends to cut dividends this year, now that it’s converted. What management hasn’t said is how much it’ll reduce the 2.5 cents per share Royal paid monthly as a trust, when they switch to a quarterly payout. The release of fourth-quarter earnings around Mar. 9 is very likely when we’ll hear the plan.

The 14 percent yield is pricing in a large cut. But until there’s a solid figure, there’s no way of knowing what a fair valuation of the stock is, particularly given the economic challenges faced by the underlying hotel and resort business that generates all the cash flow. It’s a hold for speculators only.

Ten Peaks Coffee Company Inc (TSX: TPK, OTC: SWSSF) is quoted with a yield of nearly 10 percent, based on the CAD0.03 per share monthly dividend it paid as a trust. Management, however, has stated clearly it intends to pay quarterly at a rate of 6.25 cents Canadian a share, a yield of 6.8 percent. That’s a level that certainly appears to be sustainable. And the stock, at 66 percent of book value, looks cheap enough to attract a suitor.

Management will reveal fourth-quarter and full-year 2010 earnings on Mar. 24, at which time it’ll likely declare a dividend that brings the yield to a proper level. Hold Ten Peaks Coffee Company.

With conversion-related dividend cuts now well known, the Dividend Watch List’s primary focus is on companies with potentially dividend-threatening challenges at their core businesses. The good news about fourth-quarter and full year 2010 earnings so far is that relatively few companies are coming up vulnerable to cuts. Here are the current companies to Watch, along with current advice.

• Brompton Stable Income Fund (TSX: VIP-U, OTC: BVPIF)–Hold
• Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–SELL
• Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Hold
• Futuremed Healthcare Products Corp (TSX: FMD, OTC: FMDHF)–Hold
• InterRent REIT (TSX: IIP-U, OTC: IIPZF)–SELL
• Royal Host Inc (TSX: RYL, OTC: ROYHF)–Hold

Bay Street Beat

Here’s an update, in summary form, of Bay Street opinion on CE Portfolio Holdings. Where appropriate, we’ve taken note of analyst response to fourth-quarter and full-year 2010 earnings. It’s hard to draw conclusions from these data, as it represents a summary of an aggregation by Bloomberg that standardizes sometimes archaic financial industry-speak in ways that may obviate any meaning that may have nevertheless filtered through.

At the very least, we can see that Bay Streeters are a cautious bunch who won’t get too far off the virtual reservation established by and among their peers. It’s also evident that prices for specific issues have reached levels that leave analysts even more cautious than their nature dictates under standard operating conditions.

Aggressive Holdings

Ag Growth International (TSX: AFN, OTC: AGGZF) will announce earnings Mar. 14. Bay Street has two “buys,” five “holds” and one “sell,” with an average target price CAD52.59.

ARC Resources Ltd (TSX: ARX, OTC: AETUF) reported earnings Feb. 10, and 13 of 14 analysts who follow it maintained their ratings. The current tally is six “buy” ratings, eight “holds” and zero “sells.” The average target price is CAD27.17.

Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) was the subject of a single downgrade since its Feb. 23 earnings announcement, to “hold” by TD Newcrest. Zero analysts rate it a buy, four say “hold,” and not one says “sell.” The average is CAD15.31.

Daylight Energy Ltd (TSX: DAY, OTC: DAYYF) announced Mar. 2, but Bay Street hadn’t digested the numbers by press time. Thirteen analysts rate the stock a “buy.” There are four “holds” and zero “sells.” The average target price for Daylight is CAD12.35.

EnerCare Inc (TSX: ECI, OTC: CSUWF) is the subject of one “buy” rating and one “hold” rating, positions that haven’t changed since its Feb. 23 announcement. One analyst has a target of CAD7.75, the other CAD6.

Enerplus Corp (TSX: ERF, NYSE: ERF), which announced Feb. 25, has two “buys,” 10 “holds” and one “sell.” Eleven analysts have maintained ratings since numbers were revealed, and the average target price is CAD31.27.

Newalta Corp (TSX: NAL, OTC: NWLTF) announced yesterday, but Bay Street is still weighing the numbers. Five say “buy,” two say “hold” and nobody says “sell.” Newalta’s average target price on Bay Street is CAD14.54.

Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) won’t reveal fourth-quarter and full-year 2010 numbers until Mar. 14. Bay Street has to “buys,” one “hold” and one sell, with an average target price of CAD11.19.

Penn West Petroleum Ltd’s (TSX: PWT, NYSE: PWE) earnings report on Feb. 18 led 13 analysts to maintain their current posture; there are 10 “buys,” five “holds” and zero “sells” on the stock on Bay Street. The average target price is CAD28.86.

Perpetual Energy (TSX: PMT, OTC: PMGYF) will reveal fourth-quarter and full-year 2010 results next week. Bay Street has one “buy,” six “holds” and four “sells,” with an average target price of CAD4.11. FirstEnergy Capital upgraded the stock to “market perform” on Feb. 25.

Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) will announce on Mar. 9. Meanwhile, eight Bay Streeters have “buy” ratings on the stock, while one says “hold” and zero say “sell.” The average target price is CAD21.56. Nine analysts have reiterated their ratings since the February Canadian Edge went to press.

PHX Energy Services Corp (TSX: PHX, OTC: PHXHF), which was downgraded to “hold” by Canaccord Genuity on Feb. 9, will report on its fourth-quarter and full-year 2010 results any day now. Nine analysts rate it a “buy,” three call it a “hold.” None say “sell.” PI Financial established coverage on Feb. 3 with a “buy” rating.

Provident Energy Ltd (TSX: PVE, NYSE: PVX) has two “buys,” five “holds” and zero “sells” ahead of its Mar. 9 earnings announcement. The average target price for Bay Street analysts is CAD8.04.

Vermillion Energy Inc (TSX: VET, OTC: VEMTF), which announced on Feb. 28, has six “buys,” six “holds” and zero “sell” ratings on Bay Street. Eleven of the 12 who cover it maintained ratings following earnings. The average target price is CAD52.45.

Yellow Media Inc (TSX: YLO, OTC: YLWPF) announced on Feb. 10. As noted in Portfolio Update, the reaction on Bay Street was muted, as 10 of the 11 analysts who cover the stock maintained their postures. One says “buy,” nine say “hold,” one says “sell.” The average target price is CAD5.91.

Conservative Holdings

AltaGas Ltd (TSX: ALA, OTC: ATGFF) reported on Feb. 24, after which six analysts announced they were maintaining their ratings. There are now three “buys,” two “holds” and one sell on Bay Street, with an average target price of CAD23.88.

Artis REIT (TSX: AX-U, OTC: ARESF) reported Mar. 2, though analysts haven’t issued any new advice. Bay Street has three “buys,” five “holds,” zero “sells” and an average target price of CAD13.82.

Atlantic Power Corp (TSX: ATP, NYSE: AT) will report in mid-March, besting its traditional final day of the first quarter standard. There’s not a lot of overt love on Bay Street, many of whose analysts refuse to acknowledge the project-to-payout relationship Atlantic’s adept management executes. There are zero “buys,” four “holds” and three sells, with an average target price of CAD13.58.

Bird Construction Inc (TSX: BDT, OTC: BIRDF) should reveal numbers by mid-March. One Bay Streeter says “buy,” five say “hold” and none say “sell.” The average target price is CAD35.38.

Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF) reported on Feb. 16, generating nine “maintain” reports on Bay Street. FirstEnergy Capital downgraded the stock to “market perform” (with a target of CAD22.95). Six say “buy,” five say “hold” and not a one says “sell.” The average target price is CAD25.95.

Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) announced on Feb. 22. Canaccord Genuity downgraded the stock to “hold” with a CAD19.10 price target, while National Bank Financial upgraded it to “outperform” with a CAD20.25 target. Six Bay Street analysts call the REIT a “buy,” three rate it a “hold” and zero say “sell.”

Cineplex Inc (TSX: CGX, OTC: CPXGF) lulled its 11 analysts to sleep; following its run-of-the-mill Feb. 10 earnings report it still has four “buys,” seven “holds” and not a single “sell” on Bay Street. The average target price is CAD24.32.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF), prior to its Mar. 4 announcement, had zero “buys,” seven “holds” and zero “sells” on Bay Street, with an average target price of CAD11.88.

Colabor Group (TSX: GCL, OTC: COLFF) will announce early next week. Two Bay Street houses rate the stock a “buy,” three say “hold” and none say “sell.” The average target price is CAD13.

Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) will report Mar. 8. It has one “buy,” six “holds” and zero “sells” on Bay Street. The average target price is CAD19.79.

IBI Group Inc (TSX: IBG, OTC: IBIBF) should report by mid-March. Seven analysts call it a “buy,” five rate the stock a “hold” and zero say “sell.” The average target price is CAD16.02.

Innergex Renewable Energy (TSX: INE, OTC: INGXF) will report on Mar. 23. Three Bay Street analysts rate the stock a “buy,” five rate it a “hold” and zero rate it a “sell.” The average target price is CAD10.53.

Just Energy Group Inc’s (TSX: JE, OTC: JSTEF) Feb. 10 earnings announcement triggered four reiterations from analysts; there are one “buy,” four “hold” and zero “sell” ratings on the Street, while the  average target price is CAD15.85. Just Energy was subject to one downgrade, to “sector perform” (with a target of CAD15.25) by Scotia Capital.

Keyera Corp (TSX: KEY, OTC: KEYUF) reported on Feb. 17, with eight analysts maintaining advice. Three analysts call the stock a “buy,” four say it’s a “hold” and one rates it a “sell.” The average target price is CAD36.03.

Macquarie Power & Infrastructure Corp (TSX: MPT, OTC: MCQPF) will report Mar. 10 on its fourth-quarter and full-year 2010. It now has one “buy,” six “holds” and zero “sells” on Bay Street. The average target price is CAD8.34. TD Newcrest downgraded the stock in February, to “hold” with a CAD8.50 target.

Northern Property REIT (TSX: NPR-U, OTC: NPRUF) will report Mar. 9. Now with four “buys,” five “holds” and zero “sells” on Bay Street, numbers are unlikely to sway opinion too much. The average target price is CAD29.02.

Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF) should be out with numbers any day now. One analyst rates the stock a “buy,” while six call it a “hold.” Three rate Pembina Pipeline a “sell.” The average target price is CAD19.90.

RioCan REIT (TSX: REI-U, OTC: RIOCF), which announced on Feb. 28, splits Bay Street down the middle. Of the 10 analysts covering the stock, five say “buy,” five say “hold,” and all 10 reiterated advice since fourth-quarter and full-year 2010 numbers were revealed. The average target price is CAD25.44.

TransForce (TSX: TFI, OTC: TFIFF) has four “buy” recommendations, one “hold” and zero “sells.” The average target price is CAD17.40. Cormark Securities recently downgraded the stock to “market perform” with a CAD15 target price.

Tax (and Baseball!) Season

Editor’s Note: The information below isn’t exhaustive of all possible US income tax considerations nor is it intended to provide legal or tax advice to any particular holder or potential holder of Canadian income or royalty trust units or common stock of Canadian corporations. Holders or potential holders of Canadian income or royalty trust units or common stock of Canada-based corporations should consult their own competent legal and tax advisers as to their particular tax consequences of holding Canadian income or royalty trust units or common stock issued by Canada-based corporations and the most beneficial way of reporting the distributions or dividends received and Canadian withholding tax paid to the appropriate taxation authorities located in the various jurisdictions.

When the curtain closes on the 2010 filing year so will major operations on the long battle for cross-border tax clarity. Theoretically, by operation of the Fifth Protocol to the US-Canada Income Tax Treaty and supporting materials, dividends paid by basically all Canadian companies that pay entity-level tax will be considered “qualified” for US tax purposes.

There will be work to do, described below, to claw back amounts improperly withheld from distributions made in respect of shares/units held in US IRA accounts, but progress is slowly being made.

Here’s where we stand as April 15 approaches.

Qualified v. Not Qualified

This issue is resolved–on a trust-by-trust basis–once a trust’s conversion to corporate status is complete. Dividends paid by Canadian corporations are, generally, qualified. Circumstances where this is not the case are rare, particularly in the CE coverage universe.

In the US, the 2003 Jobs Growth and Tax Relief Reconciliation Act (the 2003 Act) established that a dividend paid to an individual shareholder from either a domestic corporation or a “qualified foreign corporation” is subject to tax at the reduced rates applicable to certain capital gains, in most cases 15 percent. This lower rate was recently extended for two years, through 2012.

A “qualified foreign corporation” includes certain foreign corporations that are eligible for benefits of a comprehensive income tax treaty with the US, which the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program.

If the Canadian trust or corporation is listed on the New York Stock Exchange (NYSE), it’s dividend is probably qualified because of the Treasury Dept’s “readily tradable” test: “A foreign corporation not otherwise treated as a qualified foreign corporation is so treated with respect to any dividend it pays if the stock with respect to which it pays such dividend is readily tradable on an established securities market in the US.”

Not qualified according to the 2003 Act is any entity that can be classified as a passive foreign investment company (PFIC). This is a fact-sensitive determination that can only be made on a year-by-year basis after all the beans have been counted.

Within the meaning of the 2003 Act, a non-US entity treated as a corporation for US federal tax purposes is a PFIC if in any given taxable year if either: at least 75 percent of its gross income is “passive”; or at least 50 percent of the average value of its assets is attributable to assets that produce passive income or are held for the production of passive income. For the most part, however, the trusts and corporations recommended in the Portfolios and covered in How They Rate are operating businesses.

You can report distributions paid by a Canadian trust in 2010 as qualified if: the trust has made a public statement to the effect that the units “will be, should be or more likely than not will be” treated as equity rather than debt for US federal income tax purpose; and, the security is considered “readily tradable on an established securities market in the US” or “the foreign corporation is organized in a country whose income tax treaty with the US is comprehensive….”

CE has provided links to statements issued by income trusts in its coverage universe in the Income Trust Tax Guide; these statements typically include language along the lines of the following:

In consultation with its US tax advisors, TrustCo believes that its trust units should be properly classified as equity in a corporation, rather than debt, and that dividends paid to individual US unitholders should be “qualified dividends” for US federal income tax purposes.

As such, the portion of the distributions made during 2008 that are considered dividends for US federal income tax purposes should qualify for the reduced rate of tax applicable to long-term capital gains. However, the individual taxpayer’s situation must be considered before making this determination.

Of course, any trust or corporation listed on the New York Stock Exchange is readily tradable. As for those issues traded on the US over-the-counter (OTC) market, the final piece of the “qualified” equation is provided by the United States-Canada Income Tax Convention.

Review 1099s from your broker carefully. Check out individual trusts’ statements on the US tax status of their distributions. The best source of information–as indicated by the willingness of the IRS to rely on the tax status interpretation of the trusts–is the particular trust. We’ve heard many stories of CE subscribers successfully dealing with their brokerage firms on this issue.

If there’s no statement published on a website, contact the investor relations (IR) representative of the particular income trust via e-mail or phone. If the Web statement or your contact with IR reveals the trust believes its distributions to be qualified–it’s best to get it in writing–give this information to your broker.

Use the Qualified Dividends and Capital Gain Tax Worksheet of Form 1040 to determine the amount of tax that may be applicable.

The bottom line is this: The IRS will waive penalties with respect to reporting of payments if individuals required to file Form 1099-DIV make a good faith effort to report payments consistent with the law.

IRAs

In the December 2010 Canadian Edge we advised–via headline, no less, as well as in that issue’s Tips on Trusts–to choose Schwab for proper treatment of withholding from distributions/dividends paid by income trusts, SIFTs and converted trusts now operating as corporations. We regret that we were overzealous in our endorsement. Though we acted then on information received from multiple subscribers, we have since gotten word that Schwab’s official policy remains to withhold from amounts paid to US IRAs, without regard to changes wrought by the Fifth Protocol to the US-Canada Income Tax Convention and explanatory documents.

Our inquiries into the reason for the contradictory anecdotal evidence about treatment of distributions from SIFTs and former Canadian income trusts that have converted to corporations made in respect of units or shares held in US IRAs have revealed a “culprit,” and it’s Citigroup (NYSE: C), which, through an affiliated clearing corporation, continues to improperly withhold. SIFTs and converted corporations that clear through the Depositary Trust Company (DTC) are, according to several brokerage-house back offices, being properly handled. Dividends paid by Atlantic Power Corp (TSX: ATP, NYSE: AT), for example, which clears through DTC, are being handled properly. On the other hand, Citigroup handles Colabor Group’s (TSX: GCL, OTC: COLFF) dividends, and US investors who hold it in an IRA have been getting the shaft since Colabor started paying entity-level taxes in 2007.

One way to pursue relief is to write a letter to the Canada Revenue Agency (CRA), the Great White Northern equivalent of our Internal Revenue Service (IRS), to request a Letter of Exemption under Article XXI of the US-Canada Income Tax Treaty. Your brokerage, as the custodian of the relevant account–the IRA of which you are the beneficiary–should write this letter, but this is one of the onerous service it’s refusing to engage in on your behalf.

Include your name, the name of your brokerage, the account number of the IRA, and an explanation of why there should be no withholding from dividends paid by Canadian SIFTs and Canadian corporations that converted from income trusts in respect of units or shares held in a US IRA account.

The argument, articulated here before and based on the contents of a letter to US Representative Phil Gingrey (R-GA) signed by Elizabeth U. Karzon, Branch Chief, Branch 1, Office of Associate Chief Counsel (International), US Dept of the Treasury, Internal Revenue Service, dated June 17, 2010, is as follows.

It’s a general rule of US federal taxation that an individual isn’t liable for US taxes on amounts earned through an IRA until those amounts are distributed. But US tax law can only defer US tax. US tax authorities have no power to influence a foreign country’s imposition of tax on income that the IRA derives from that country.

Distributions from Canadian income and royalty trusts therefore may be subject to tax in Canada depending on Canadian tax law and the terms of the US-Canada Income Tax Treaty (the Treaty).

Certain US entities that are generally exempt from taxation in a taxable year in the US–such as IRAs–are exempt from taxation on dividend income arising in Canada in that same taxable year, according to Article XXI of the Treaty, “Exempt Organizations.”

Based on a 2005 change in Canadian tax law, Canada began imposing a 15 percent withholding tax on distributions from income and royalty trusts to US residents. Canadian tax law didn’t initially treat these distributions as dividends, however, and so they weren’t exempt from Canadian tax under Article XXI of the Treaty.

In 2007, Canada amended its domestic law again and began taxing certain of these trusts as corporations and treating distributions from these trusts as dividends for purposes of both their domestic law and their tax treaties.

Canada and the US signed an exchange of diplomatic notes in 2007, on the same day the two parties signed the Fifth Protocol to the Treaty, that include what we’ve often referred to as “Annex B.” These notes confirmed, among other things, “that distributions from Canadian income trusts and royalty trusts that are treated as dividends under the taxation laws of Canada shall be considered dividends for the purposes of [the Treaty].”

However, Canadian law–the Tax Fairness Act–provides that Canada won’t tax income and royalty trusts already in existence as of Oct. 31, 2006, as corporations until Jan. 1, 2011. Until then, Canadian tax law won’t treat distributions from such trusts as dividends. Distributions from these pre-existing trusts won’t be exempt from Canadian tax under Article XXI of the treaty until 2011–when these income and royalty trusts will become “Specified Investment Flow-Throughs,” or SIFTs, taxed at the entity level.

The IRS acknowledges that investors who hold Canadian trust units in IRAs may not claim a foreign tax credit for the Canadian taxes withheld on the income paid in respect of those units. This is consistent with a general rule that foreign tax credits may not be credited against an individual’s tax liability unless the individual is liable for the tax. Nor can the IRA make use of a foreign tax credit because it’s exempt from tax in the US.

This may ultimately result in double taxation when the IRA distributes this income to the unitholder. The 2007 Tax Fairness Act, when it and the Fifth Protocol have full effect, will generally eliminate the 15 percent Canadian withholding tax on dividends paid by income and royalty trusts in respect of units held in US IRAs.

It may be helpful to attach to your letter a copy of Karzon’s letter to Rep. Gingrey; I’m happy to provide a pdf copy to anyone who requests it via e-mail to ddittman@kci-com.com.

Once the Letter of Exemption is issued you–or your broker–on behalf of your IRA must inform the transfer agent of the Canadian SIFT or former income trust that’s now a corporation from withholding for Canadian tax purposes.

The address for the Canada Revenue Agency is:

Non-Resident Withholding Accounts Division
International Tax Services Office
Canada Revenue Agency
2204 Walkley Road
Ottawa, ON
K1A 1A8
Canada

You can also call the CRA at 1-800-267-3395 or 1-613-952-2344. The fax number is 1-613-941-6905.

You should copy Citigroup as well as the company that’s paying your dividends.  Citigroup’s Global Transaction Services unit can be reached through an online form; our attempts to speak to someone in authority have thus far gone unrewarded. Contact information for your holdings is available on company websites, accessible via How They Rate. In addition to attaching a copy of the Karzon letter to your correspondence with the CRA, Citigroup and your companies, carbon copy your US congressman.

There’s no question this is an uphill battle. You’re likely to be told by the CRA that the brokerage, as the custodian of the IRA, must submit the request. That’s why we’re copying the folks on Capitol Hill. Let’s see, first, how accountable brokerages, transfer agents and government agencies are to self-directed investors and, second, whether the new wave of responsiveness washing over DC results in Congress correcting what should be an easily fixed problem.