How Are MLPs taxed in Canada?
A master limited partnership (“MLP”) is a publicly-traded limited partnership. They payout a high level of cash income investors because of their unique tax structure. Because of this, MLPs are considered “high yield” investments; most suitable for income-oriented investors.
How are MLPs taxed?
MLPs are not required to pay federal income tax if they meet certain conditions also. Similar business forms, like Real Estate Investment Trusts (“REITs”) exist in Canada, but MLPs are unique to American markets since certain types of energy businesses are permitted to take the MLP business form.
For an MLP maintain its pass-through status, at least 90% of the MLP’s income must be “qualifying income”. This means the income realized from the exploration, production, or transportation of natural resources or real estate. Typically, this means most MLPs are energy (oil & gas) pipelines.
How are MLP investors taxed?
By distributing most of their income to limited partners, MLPs avoid being taxed directly on the income they earn. But, unitholders will pay tax on the distributions they receive. Other tax items such as depreciation can also be passed along by the MLP to unitholders like other partnerships.
MLPs are popular with American income-oriented investors because they provide a high yield with some tax benefits. But, investors should be strategic about how they invest in MLPs.
What about Canadian MLP investors?
Unfortunately, Canadian investors holding MLPs in a taxable account will see their distributions subject to IRS withholding tax. This means that if a Canadian investor holding an MLP in a taxable account receives a taxable distribution of $100, more than 30% or more than $30, will be withheld by the IRS.
Investors are subject to withholding tax on MLP distributions held in all account types – both registered (like an RSP) and non-registered.
Normally, US dividends received from public company shares are exempt from withholding tax when they are owned in certain registered accounts like RSPs. But, this exemption does not include MLPs. So Canadian investors beware.
In addition to the taxes withheld and levied by the IRS, Canadian investors might also be subject to other filing and administrative requirements. MLPs held by Canadian investors might be considered US domiciled assets. This means Canadian investors might be required to add their MLP assets to foreign reporting requirements and might also require them to file US tax returns and subject their estate to US estate taxes.
Bottom Line
At first blush, MLPs might seem like attractive investments because of their high yields. But Canadian investors should avoid MLPs because we don’t qualify for many of their tax benefits. Instead of MLPs, Canadians should consider other investments for their RSP such as high dividend paying stocks (whether in Canada or the US), fixed income, Real Estate Investment Trusts (“REITs”), Mortgage Investment Companies (“MICs”), and certain high yield ETFs.