"Tax-Free Holiday" Creates Dividend Yields of up to 18.5%

     Ever wish you could take a break from paying taxes? During this "tax holiday" you wouldn't have to deal with cumbersome rules and regulations, deductions and exemptions, or returns and refunds. You wouldn't have to spend hours (if not days) poring over your financial statements from the past year. And best of all, you'd end up with considerably more cash in your pocket.

     Well, although I can't eliminate your personal taxes, I've found the next best thing -- and it could add thousands of dollars to your bank account. 

     In today's issue I'll bring you an in-depth look at an asset class that is enjoying a three-year corporate tax holiday. But despite this enormous tax advantage, these securities have gotten caught up in the recent global market sell-off, making today's valuation levels dirt-cheap for new investors. And thanks in large part to their tax-free status, this compelling asset class is now showering investors with dividend yields of up to 18.5%.

     So, what highly attractive asset class am I talking about?

     Canadian income trusts.

O Canada
     On any global tour of high-income investing destinations, Canada is an essential stop. Let's take a look at our neighbor to the north -- and the special securities that help make it a happy hunting ground for high-yield investors like you and me.

     Canada is one of the world's wealthiest countries based on per-capita income, and it boasts the world's eighth-largest economy. It's primarily a service economy, but Canada has a much larger natural resources base than its counterparts in the U.S. and Europe. It has huge reserves of natural gas and oil, vast amounts of timber and rich deposits of a wide range of metals -- it's the world's top producer of zinc and uranium, and a major gold producer. Like the U.S., Canada is an agricultural power too, exporting a great deal of wheat and other grains throughout the world.

     Over the past few years, demand from fast-growing emerging markets, as well as developed markets experiencing solid economic growth, has pushed the prices of all kinds of commodities higher. That has directly benefited commodity-rich Canada. In particular, rising oil prices have boosted profits and cash flows for the country's many oil producers. Even with oil likely to continue to retreat from its recent historic highs, these companies remain comfortably flush with strong cash flows.

     Because of its close trading ties with the U.S., Canada's economy is expected to slow in 2008 alongside ours. However, its natural resources sector should help cushion the blow; recent estimates call for GDP growth of +1.8-2.0% in 2008, versus little or no growth in the U.S.

     And Canada's natural resources account for its status as a terrific source of high-yield investments. Many Canadian companies with long-lasting, steady-production assets -- such as oil and natural gas reserves -- are organized as income trusts. Under the present law, these trusts can avoid corporate taxation as long as they pass their profits directly to shareholders (called "unitholders" in trust lingo).

     As a result, Canadian trusts have an incentive to pay out large distributions, and many individual trusts pay solid double-digit yields. (Note that many Canadian trusts have the word "fund" in their name, but they should not be confused with mutual or closed-end funds.)

     Unfortunately for investors, on October 31, 2006, Canadian Finance Minister Jim Flaherty announced a surprise plan to end this tax benefit for Canadian trusts; his concern was that too many companies were converting to trust status, hurting government tax revenues. Despite an uproar and controversy, Flaherty's plan has now become policy. Starting in 2011, Canadian trusts will be taxed as corporations at a 31.5% rate.

     Although most trusts effectively will pay a much lower tax rate -- as in the U.S., corporations use deductions, exemptions, credits and accounting techniques to lower their tax bills -- there's little question that distribution amounts will be reduced.

     The good news for those considering a purchase today is that the Canadian income trust sector took a big hit after the Halloween surprise, and it has not fully recovered -- the impending tax is now reflected in most trusts' share prices. Meanwhile, buyers today will receive abnormally large yields between now and 2011 -- during what is essentially a three-year tax holiday.

     Another big plus: the Canadian dollar is in the middle of a long-term uptrend vs. the U.S. dollar:


     With U.S. interest rates falling, the U.S. dollar is unlikely to stage a rally in 2008; in fact, I expect the Canadian dollar to continue to gain ground on the American greenback this year -- and probably beyond. That's great news for U.S. investors with Canadian holdings because the value of their investment -- and dividend payments -- will get a nice boost as the Canadian dollar rises.

     Now, investors can't just pick a trust to invest in at random. Some trusts make better investments than others. Those with rock-solid assets that generate steady cash flows will fare better than those with assets that might decline in value over time or whose income is highly variable for some reason, including economic sensitivity.

     That said, most trusts in the energy sector should be solid choices. I remain bullish on the long-term prospects for energy prices because worldwide demand is rising faster than supply. Natural gas also should benefit from stricter environmental regulations on the burning of coal; new electric-power plants in North America are much more likely to be gas-fired than coal-fired over the next two decades. Therefore, trusts backed by high-quality energy assets are attractive. Also potentially solid picks: trusts backed by utility operations with strong balance sheets and at least average growth prospects.

     With these points in mind, I recently went on the prowl for high-yielding Canadian trusts. And thanks to the recent market sell-off, I discovered that many are now trading at extremely attractive valuation levels.

     My search uncovered two trusts that would knock the socks off of anything found in the U.S. Among them, a Canadian oil and gas trust sporting a 12.4% yield.  But better yet, this organization controls one of the world's most valuable oil sands reserves. As oil supplies around the world are being drawn down, oil sands deposits represent the world's best hope for substantial new oil production over the next century -- which should be very profitable for this firm.

     I also found another trust specializing in transportation services. With a stable, diversified business model, this security offers investors a yield of 18.5% at its current price. (How many stocks in the U.S. offer that sort of yield?) And since the dividend is doled out in Canadian dollars, U.S. investors are likely to earn even more from their investment.

     If you'd like to learn the name of these trusts -- plus receive a steady stream of foreign stocks, funds and other investing ideas with abnormally high dividend yields each and every month -- then I'd like to extend you a personal invitation to try my premium international investing newsletter . . . High-Yield International. Visit this link to learn more.

      Thanks for joining me on my search for today's highest-yielding securities!

-- Nick Lanyi
Editor, High-Yield International