Investing in Energy: The Benefits of Master Limited Partnerships
Posted November 10, 2015 in Articles
Master Limited Partnerships or MLPs are attractive investment vehicles that can provide several benefits to their investors. In the energy sector, many companies have found the use of the Master Limited Partnership structure to be a successful business strategy that allows the company to raise the capital it needs to develop and expand its operations.
How Master Limited Partnerships Work
Master Limited Partnerships (MLPs) are taxed as partnerships but their ownership interests are publicly traded. However, unlike a publicly traded C corporation where profits are taxed at both the corporate and shareholder level, the MLP pays no corporate tax with its income only being taxed at the shareholder level. The MLP essentially serves as a pass through investment vehicle with the partnership’s income being passed through to its investors who are known as unitholders. Since the MLP is treated as a partnership for tax purposes, its investors/unitholders avoid the “double taxation” associated with C corporations - tax on the both the corporation’s profits and shareholder dividends.
There are two types of partners in an MLP: the limited partners (investors/unitholders) who provide capital and receive periodic income distributions and the general partners who are responsible for managing the MLP’s operations and in return receive compensation linked to the partnership’s performance.
Development of MLPs
The first MLP was established in 1981 by the Apache Oil Company in an effort to raise capital by offering investors the tax benefits of a partnership investment with the liquidity of a classic corporation. The success of the Apache MLP resulted in companies throughout the oil and gas industry, and in many other industries, seeking to form MLPs to attract investors.
In 1987 Congress enacted legislation that set forth rules for MLPs with the tax code limiting MLPs to partnerships that derive 90 percent of their income from qualifying sources, including mining and natural resources activities such as exploration, development, production and transportation. Congress took such action in an effort to address concerns that many of the companies forming MLPs were only doing so in order to take advantage of the MLPs’ favorable partnership tax treatment.
MLPs and the Energy Sector
Today there are well over 100 Master Limited Partnerships with the vast majority of MLPs involving energy-related businesses. According to the Master Limited Partnership Association (MLPA) the largest number of MLPs are mid-stream MLPs which gather, process, transport and store oil, natural gas and refined petroleum.
Under the law, 90 percent of an MLP’s gross income for the taxable year must consist of “qualifying income.” Section 7704 of the Internal Revenue Code generally defines “qualifying income” to include “income and gains derived from the exploration, development, mining or production, processing, refining, transportation or marketing” of certain approved minerals and natural resources. While the current IRS regulations fail to provide companies with clear guidance as to whether a certain activity will meet the “qualifying income” requirement, the IRS issued proposed guidelines in May 2015 which are intended to provide clarity on this issue and include a list of qualified activities and several tests that companies can use.
Mithras Investments, LLC advises and guides our clients to make sound business and investment decisions. Our global network of consultants can help you explore MLPs and other investment opportunities. Contact us today.