We’re not talking about the results of a share split when we talk about split shares. A split share corporation is established for the specific purpose of transforming the dividends and capital gains of the shares it owns into income streams for two different groups of investors. And for either group, split shares can really boost your yield.
Split shares can really 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 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, not 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 recommended split shares
At present, we have two preferred split shares that we recommend in our fixed-income Facts and Advice Sheet. They are 5Banc Split Inc. (TSX—FBS.PR.C) and Partners Value Split (TSX—PVS.PR.D). 5Banc’s common split share counterpart is its Class B shares (TSX—FBS.B). Partners Value Investments Inc. (TSXV—PVF) is the common split share counterpart of Partners Value Split.
5Banc Split’s portfolio consists of common shares of Canada’s five big banks. The split corporation is sponsored by Timbercreek Asset Management. Dividends are paid quarterly.
The current term of the portfolio expires on December 15, 2016, at which time all shares might be redeemed. But is has been continued several times in the past. Hold for now.
Partners Value’s portfolio consists of the Class A limited voting shares of Brookfield Asset Management (TSX—BAM.A). Partners Value Split Corp. is a holding company sponsored by Brookfield. Dividends are paid quarterly.
The Series D preferreds of Partners Value Split will be redeemed on Oct. 8, 2021, but could be redeemed after Oct. 8, 2019 at $26, or before this date at $25 if capital shares are retracted or there is a takeover bid for Brookfield. Buy.
Money Reporter, MPL Communications Inc.
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