Deferred preferred shares resemble strip bonds in many ways. They pay no dividends and the return is the difference between purchase price and price at maturity. The ratio of the two is known as the income premium. In contrast to a strip bond, the income premium is considered dividend income for tax purposes. Holders are not required to declare a dividend portion each year as they are with the interest portion of a stripped coupon. If the preferred is sold before maturity, the proceeds are normally deemed a capital gain. The advantage of a deferred preferred is deferral of income tax. It may be an attractive vehicle for a taxable account whose holder expects to be taxed at a lower rate at maturity of the preferred. On the other hand, investors must consider that it is very illiquid on the secondary market. This will be a consideration if the aim is to sell before maturity to maximize the tax advantage of turning the income premium into a capital gain. Very often the spread between bid and ask price will be wide enough that the holder will decide to keep the shares to maturity.

Mounir R. El-Ayari, CIM, FCSI, C.h. P. Strategic Wealth
Investment Advisor
Associate Portfolio Manager
e-mail: mounir.el-ayari@nbf.ca