Common examples include American Mortgage Real Estate Investment Trusts (mREITs) and Business Development Companies (BDCs). Both are likely to be heavily leveraged and structurally complex, and total returns rarely tell the entire story. The same applies to master limited partnerships or MLPs.
What is a master limited partnership?
MLPs occupy the midstream segment of the energy sector. This a part of the industry focuses on the transportation, storage and processing of oil and gas relatively than manufacturing or retail. Canadian investors are already accustomed to midstream firms through TSX-listed firms corresponding to TC Energy and Enbridge. The difference is that these Canadian firms are traditional corporations and never partnerships.
An MLP is a US-specific pass-through structure for generating income from energy-related assets. Because an MLP operates as a partnership relatively than a company, it avoids corporate taxes and distributes nearly all of its money flow on to shareholders. This structure is the explanation for the striking returns. This can also be why MLPs have long been popular with income investors within the United States.
From afar, Canadians can easily assume that these investments might be transferred across the border. The capital markets are similar, the businesses are familiar and the returns look attractive.
The crux of the matter is taxation. Differences between Canadian and U.S. tax rules make MLP ownership an advanced matter for Canadian investors, often leading to reduced after-tax returns and ongoing administrative burdens. These tensions are more essential than most investors realize.
Here’s what Canadian investors have to learn about U.S. MLPs, why they’re normally best avoided, and what alternatives provide exposure to similar firms without the identical tax complications.
The Tax Issues of MLPs for Canadian Investors
For Canadian investors, the issues with U.S. master limited partnerships boil right down to two foremost issues: withholding taxes and reporting requirements.
Most Canadians are already accustomed to how US withholding tax works. If you own US-based stocks or exchange traded funds (ETFs), 15% of dividends are typically retained at source. Thanks to the Canada-US tax treaty, this withholding tax might be avoided by holding these securities in a Registered Retirement Savings Plan (RRSP).
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MLPs are treated very in a different way. You don’t profit from this contractual treatment. Distributions from MLPs are fully subject to US withholding tax. Worse, the speed will not be 15%. It’s as much as 37%. This hold also applies inside registered accounts, including RRSPs.
Source: r/CanadianInvestor
This signifies that greater than a 3rd of any distribution can disappear before it ever reaches your account. This is especially damaging because nearly all of MLPs’ long-term return comes from reinvested distributions relatively than price appreciation.
It doesn’t stop there. When you sell an MLP, the Internal Revenue Service (IRS) charges an extra 10% withholding tax on the gross proceeds because MLPs are classified as publicly traded partnerships. This will not be a capital gains tax. The amount is retained no matter whether you sell at a profit or loss.
There are quite a few real-world examples of how Canadian investors discovered this the hard way. Some have bought and sold the identical MLP multiple times only to seek out that 10% was withheld from each transaction.
Source: r/PersonalFinanceCanada
The final complication is tax reporting requirements. If you own a typical US stock, you’ll receive a 1099-DIV form that summarizes your income. You should not a shareholder in an MLP. You are a partner. This means you’ll receive a Schedule K-1.
A K-1 reports your share of the partnership’s income, deductions and credits. It is much more complex than a normal dividend certificate and creates a tax return requirement within the US. In theory, you need to file a U.S. tax return to properly report this income to the IRS.
