Double or nothing—for both sides

How do split shares work? It’s not exactly like having your cake and eating it too. You do give up something to double your dividends or double your capital gain.

Split shares can boost your yield while still maintaining a high safety level, and that’s something that is attractive to income investors: more income without going out on the risk spectrum.

What’s better is that this higher yield is in the form of eligible dividends, which means the dividend tax credit taxes them more gently. But how do split shares ‘work’ exactly?

Here’s an example. A corporation, which we’ll call SplitCorp, is formed with the sole purpose of buying and holding $10 million of bank stocks. Let’s say SplitCorp is going to buy $2 million worth of each of the big five banks.

To raise the $10 million to buy the bank stocks, SplitCorp sells $5 million of SplitCorp Preferred A shares, and $5 million of SplitCorp common shares, in an initial public offering, to the investing public.

The SplitCorp Preferred A shareholders are entitled to receive all of the initial dividends paid from the $10 million of bank stocks held by the company. Note that the preferred shareholders have only contributed $5 million to the portfolio, yet they get dividends from the whole $10 million.

Essentially, they’re getting twice as much in dividends as a regular investor in those same five bank stocks. And on top of that, they get to use the dividend tax credit on all these ‘double’ dividends.

You get dividends, or capital gains

On the other hand, the preferred shareholders are not entitled to any of the capital gains generated on the portfolio. That’s the deal with a split share: if you want double the dividends, you don’t get any of the capital gains.

So what’s in it for the common shareholders? Owners of SplitCorp common shares will get any dividends left over, if there are any, after the preferred shareholders get their dividend. They’re also entitled to all of the capital gains generated by the portfolio.

The common shareholders have only put up $5 million, but they get all the capital gains on the whole $10 million in bank stocks. They get ‘double’ capital gains, along with any residual dividends left over after preferred shareholders are paid.

Tax considerations you should think about

Here are some further thoughts on split shares.

If you can use the dividend tax credit (for example, you have money outside of your RRSP to invest), you might consider buying the preferred shares of a split corporation. If capital gains are more suitable to your tax situation and objectives, the common shares of a split corporation may be more to your liking.

Split share corporations generally try to have an equal number of preferred shares and common shares outstanding, one for one. But some let the common shareholders redeem their shares back to the corporation on specific dates, such as one day per year. So if a bunch of common shareholders elect to redeem their shares on that day, it’s possible that the split share corporation will pick some preferred shareholders by lottery and redeem their shares as well, at par value. But on balance, split preferreds are usually a pretty good investment.

About our split shares

At present, we have two preferred split shares that we recommend in our fixed-income Facts and Advice Sheet. They are Allbanc Split II (TSX—ALB.PR.C) and Partners Value Split (TSX—PVS.PR.D). Allbanc’s common share counterpart is its Class A capital shares (TSX—ALB). Partners Value Investments Inc. is the counterpart of Partners Value Split. It owns all of the capital shares.

Allbanc Split’s portfolio consists of common shares of Canada’s five big banks. The split corporation is a Scotiabank sponsored company and has about 490,000 units outstanding, with a market capitalization of $13 million. Dividends are paid quarterly.

Allbanc’s current dividend yield to call is 3.03 per cent.

The current term of the portfolio expires on February 28, 2021, at which time all shares will be redeemed. But is has been renewed in the past.

Partners Value’s portfolio consists of the Class A limited voting shares of Brookfield Asset Management (TSX—BAM.A). Partners Value Investments is a subsidiary of Partners Value Investments LP (TSX—PVF.UN), a publicly-traded limited partnership that owns about 86 million BAM shares.

PVS.PR.D has a market cap of $201 million and pays dividends quarterly. It will be redeemed on October 8, 2021.

This is an edited version of an article that was originally published for subscribers in the March 13, 2020, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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