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A royalty trust is a corporation that is involved in mining or the production of oil or gas. These types of corporations are not taxed at a traditional corporate level because profits are usually distributed to stakeholders. This allows the profits to be claimed as personal income and taxed at a lower rate. The concept of a royalty trust is a fairly new one that has become popular primarily in Canada and the United States.
A royalty trust is managed by a bank and can be traded like stocks to achieve high investment returns with low interest rates at a limited risk. Royalty trusts generate profits from the production of limited natural resources, such as coal and oil. The fluctuation of the market, changes in price, and availability of the resources can contribute to a trust’s high yield. These same factors can also cause unpredictability in terms of the return that may be generated.
Although a royalty trust can be lucrative, it also poses some financial risks. As natural resources continue to be heavily used, there is a chance that they will eventually become depleted, meaning that no further income will be created. The income earned and lost can fluctuate significantly from day to day, similar to a stock because of the frequent changes in the market, demand for the product and competition. Despite the unpredictability, trusts typically yield high returns because oil and gas are in high demand. When the demand for resources is high, the price of them is also high.
A royalty trust can be a Canadian trust, a United States trust, a foreign partnership or a corporation with the laws governing royalty trusts differing in both countries. Royalty trusts are taxed differently depending on how and where the trust was originally registered, but there is a tax agreement between the US and Canada related to royalty trusts. Those that own royalty trusts in either country may be eligible for additional tax credits, incentives and advantages because they are unique in nature.
United States trusts are limited. In other words, once the royalty trust has been formed, it cannot be changed. This means that when the resources are depleted, the trust will eventually disappear. As a result, the cash flow that was generated from the trust will also become non-existent.
In Canada, royalty trusts are managed like any other business. As a business, they are allowed to acquire property and employees and add new shares. The freedom to add shares and change the structure of the trust allows them to grow and change as the market changes. Unlike a United States royalty trust, when the resources of a Canadian trust are depleted, the owners can actively work to add more properties to offset the loss.
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