I was looking to place a trade the other day on Equinor (EQNR). It’s a Norwegian energy company, and I was looking to place a speculative derivative trade on for a net credit. As I was trying to execute the trade, Interactive Brokers prompted me with a warning message saying that this was a Master Limited Partnership (MLP), and that there may be various tax implications if I own or trade it as a Canadian resident. It’s been a very long time since I’ve encountered an MLP, as I typically don’t own them, but it got me thinking about who would own this type of investment and why, and hence the motivation for this next lesson topic.
Master Limited Partnerships (MLPs) are publicly traded partnerships that combine the tax benefits of private partnerships with the liquidity of publicly traded companies. MLPs are primarily found in industries that depend on stable cash flows while having consistently high capital needs to maintain business operations. Such industries include energy and natural resources sectors, infrastructure, and real estate.
Quick side track:
Owners of MLPs own “units” of the partnership, and are referred to as “unitholders”, as opposed to “shareholders” who own shares of a corporation. I thought this was a funny distinction, so I dug a little deeper to understand why this distinction exists.
The term originated with the creation of MLPs and has been maintained to distinguish this unique investment vehicle from traditional corporate structures. Unlike corporate shareholders, MLP unitholders are considered partners for tax purposes. MLPs pay out "distributions" to unitholders, not dividends to shareholders. This distinction is important for tax treatment. MLPs are pass-through entities, meaning the partnership itself doesn't pay corporate taxes. Instead, tax liabilities pass through to the unitholders.
Using "unitholder" helps maintain clear distinctions between MLPs and corporations in financial and legal documents, ensuring compliance with regulations specific to partnerships. While similar to shareholders, unitholder rights can differ slightly, particularly regarding management decisions and voting structures.
End of side track.
Companies incorporate as MLPs to primarily benefit from tax efficiencies and public market access. MLPs avoid corporate income taxes by passing profits directly to unitholders, reducing overall tax liabilities. By being publicly traded, MLPs can raise funds more easily than private partnerships, which is critical for capital-intensive industries like energy and infrastructure. General partners retain management control, unlike corporations that are accountable to shareholders. MLPs are also required to distribute most of their cash flow to investors (aka limited partners) as tax advantaged income, making them attractive for income-focused investors.
As an investor, there are a few things to be mindful of when considering buying an MLP. Advantages of investing in MLPs include:
Tax Benefits: MLPs avoid corporate taxes, and distributions are largely tax-deferred until units are sold.
High Yields: MLPs often provide higher yields compared to traditional stocks and bonds due to their tax-efficient structure.
Liquidity: Units trade on public exchanges, offering easy buying & selling access.
Stable Income: As mentioned above, MLPs often generate steady cash flows, making them attractive for income-focused investors
On the flip side, there are several disadvantages of investing in MLPs, namely:
Complex Tax Filings: Investors receive a Schedule K-1 (an IRS tax form issued annually for an investment in a partnership), which can complicate tax reporting, especially for those investing in multiple states.
Limited Growth Potential: Like many high dividend paying stocks, MLPs focus on income distribution rather than capital appreciation.
Sector Concentration: MLP investments would be limited to specific industries like energy and real estate, which would not be ideal for an investor who’s looking for portfolio diversification.
As a Canadian investor, investing in MLPs may subject oneself to potentially facing withholding taxes on U.S.-based MLP distributions and additional complexities when filing cross-border taxes. In addition, income from an MLP is subject to currency exchange rate fluctuations between USD and CAD.
Unlike Canadian investors, US investors benefit from deferred taxes on distributions, but must account for state-level taxes where the MLP operates. US investors may also be able to classify a portion of their MLP investment income as a qualified business income deduction.
Overall, I would say that MLPs are best suited for long-term, income-focused investors who are comfortable with tax complexities. Furthermore, I would say that they are best suited for investors based in the US. Given the added tax complexity, as a Canadian investor, investing in MLPs may not be worth it, and if income generating stocks are your thing, then there are plenty of other Canadian and US stock investments out there that offer the same income benefit.
Personally, I don’t find MLPs attractive at all, and I would rather own an investment that 1) doesn’t require a room full of CPAs to figure out its proper treatment on your personal income tax filings, and 2) doesn’t hamper its own growth by paying out the majority of its net income and free cash flow to hungry dividend income mavens.