Felix Salmon

Investing in loopholes, MLP ETF edition

By Felix Salmon
June 30, 2010

Remember the Master Limited Partnership tax loophole? Well it turns out that a lot of investment companies seem to be trying to take full advantage of it. Tadas Viskanta notes that everybody and their mother seems to be trying to roll out stock-market-traded funds structured as MLPs, some with valuations north of $1 billion. Essentially, if you list a pipeline corporation directly, there’s much more tax to be paid than if you set it up as an MLP and then list the MLP in ETF form.

Tadas says that investors should be cautious here: “You should be more discerning in your approach to MLPs now that they have been discovered by the crowd”. That makes sense: there’s a very real risk, now that everybody knows about this loophole, that it will be closed. I hope it will be, anyway.

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However, it appears that by putting MLPs inside an ETF (a corporation), the ETF is obligated to pay income tax on the income from the MLP. (see Tadas’ links to the IndexUniverse articles on MLP ETFs which include such statements from the ETF creator)

So sure, the MLP itself doesn’t pay income tax, and if an individual owns the LP units then the income is only taxed once, at the LP owner level (a individual).

However, if the LP owner is an ETF (a corporation) then the ETF must pay income tax on the MLP distributions the ETF receives before distributing those proceeds to the ETF owners – and you’re back to double taxation, defeating one of the main upsides of the MLP structure to begin with.

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