This Q&A article, from law firm Latham Watkins, is authored by C. Timothy Fenn.
Question: What are the major changes in MLP taxation in 2013?
Fenn: First, from an administrative standpoint, there have been a number of private letter rulings issued by the Internal Revenue Service (IRS), which have had a positive effect on different assets that can be contributed to an MLP. A few of these rulings provided clarity with respect to the types of end-products that are qualifying and have touched on turning natural gas into liquefied petroleum gas, natural gas into methanol, and natural gas into diesel — all types of processes that increase the quantity of non-oil sourced fuel products. The IRS has ruled favorably that these types of processes can be operated in an MLP.
Second, from a legislative standpoint, there is legislation under consideration to allow certain renewable energy resources to be included in MLPs. This will have a longer term impact on the scope of MLPs. Both of these developments make MLPs more attractive to investors.
Question: How are MLP structures changing and what does this mean for investors?
Fenn: MLP structures continue to be adapted to fit the different types of assets being owned and operated by MLPs. So, for assets that have more commodity exposure, the structure has been adapted recently to better fit the cash flow attributable to those types of assets. More specifically, this means that the asset cash flow is more variable — it can go up, it can go down — and therefore the structure is meant to accommodate those types of assets. This is in contrast with very steady cash flow assets, which are more attuned to the traditional MLP structure.
What guidance would you give to investors looking to buy MLPs right now?
Fenn: From a legal standpoint, they should carefully consider the types of assets in the MLP and the structural considerations associated with the assets that they are purchasing, as opposed to simply looking at the yield as a means to make a purchase. In other words, just because a particular MLP has a higher yield than another MLP doesn’t necessarily make it a better or worse investment.
If there is a desire to hold the MLP for a longer period of time, there are factors other than the yield that should be taken into consideration when making the purchase. These include, whether the MLP has common units and subordinated units, whether the MLP has incentive distribution rights, the economic rights associated with the incentive distribution, the length of the subordination period, and the term of any underlying commercial agreements that generate cash flow for the MLP.
Latham & Watkins