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article imageOp-Ed: Taxation of U.S. MLP Distributions for Canadian Taxpayers

By Monty Spivak     Jun 7, 2014 in Business
U.S. Master Limited Partnerships are an interesting opportunity for Canadian, yield-oriented investors. Most of them provide distributions above 6%. Unfortunately, many Canadians have been incorrectly informed about tax reporting requirements.
Interested in earning moderate-risk, 6% or higher yields? Canadian yield-oriented investors should consider U.S. Master Limited Partnerships (MLPs) as an investment. Unfortunately, many Canadians have been concerned by the alleged complex tax reporting requirements. In fact, these allegations are false. Canadians will have simple Canada Revenue Agency (CRA) tax reporting for their U.S. MLP distributions using the T5s (tax forms provided to investors and CRA for tax filing purposes) that they receive from their brokers.
The American MLP has the characteristics of our now-defunct Canadian business trusts. Income is not taxed in the MLP; rather it is passed-through and taxed in the hands of the investor. Thanks to our tax treaty between Canada and the U.S., the taxation and record-keeping for Canadians is not as complex as one may believe.
American investors are required to maintain complex records:
1. The distributions (not dividends) are a return of capital.
2. They receive a K-1 (a special form that identifies the revenues, costs, and sources, of the distributions) for each MLP at the end of each taxation year in order to assign income to the correct categories in their tax returns.
3. The Internal Revenue Service (IRS) tax return requirements are many and complex - there are several schedules, forms, and worksheets that must be completed to properly report MLP income.
For Canadians, it is a lot easier, although not as tax-effective. I telephoned my broker, and the Canada Revenue Agency to confirm the tax treatment of U.S. MLP income for Canadians.
These are the tax-impacting facts for Canadian tax-payers:
1. The distributions are treated as Foreign Investment Income (in other words, there is no return of capital calculations; no Cumulative Net Income Loss/Gain, and no elaborate tax accounting). The distributions are treated as foreign income and the appropriate taxes on the income are applied.
2. Usually, the U.S. withholds 15%. However - and this is a "biggie" - the IRS withholds (i.e., taxes) 39.6% of the distribution as it is a distribution from a U.S. uncontrolled partnership.
3. The only thing that a Canadian Investor in U.S. MLPs needs to do is file their T5, as usual - use CRA's T2209 form - it is treated as dividend income.
4. Do not forget that the withholding tax in excess of 15% can be deducted from income on line 232 of the personal tax return.
5. For clarity, file the U.S. MLP income taxes with the CRA, not the IRS (there is conflicting information about this). One may also need to complete the Provincial form for foreign income, if there is insufficient Federal foreign tax relief.
6. The taxation impact compels one to invest in the U.S. MLPs outside of tax-sheltered accounts.
Canadian dividends - on the Canadian securities - enjoy the gross-up tax credit (the CRA instituted this to avoid double taxation of dividends) on the T5s. Minimizing Income Taxes on Your Investments can provide Canadians tax rates on different financial investments. With this model, the Canadian effective tax rate on dividends is only 12%, which makes the hurdle high for the after-tax impact of the U.S. MLP investments (which is effectively at your marginal tax rate).
Why am I explaining the taxation and accounting for U.S. MLPs and Canadian dividends? Your investment return should be calculated after-tax, and given the disparity between taxation of eligible Canadian dividends and foreign, MLP income, the impact is substantial.
That said, the yields on the U.S. MLPs far-exceed those of the comparable Canadian stocks. It will often be beneficial to incur the much higher tax liability, rather than accepting a lower return. The actual tax return process - which is no more complex for an American MLP than for any other investment - should not be a deterrent to Canadian investors.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of DigitalJournal.com
More about Taxes, Taxpayers, Income tax, MLP, master limited partnership
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