Rise of the distorporation
Comment of the Day

November 06 2013

Commentary by Eoin Treacy

Rise of the distorporation

Thanks to a subscriber for this article from The Economist highlighting the evolution of the MLP sector. Here is a section
For MLPs, the definition of “mineral or natural resource” is elastic. These days, for example, it is not just income from coal that qualifies; money made from rolling stock that carries coal on railways qualifies too. Allan Reiss, a lawyer at Morgan Lewis, notes that a year ago the IRS issued a ruling allowing the processing, storage, transport and marketing of olefins, a type of synthetic polymer, to be included as qualifying income. In 2007 private-equity firms seized on another clause in the tax law on interest and dividends that enabled the MLP structure to be used for publicly listed components of Apollo, Blackstone, Carlyle, KKR and other private-equity companies.

These days the limitations on becoming an MLP seem to be tied more to legal dexterity and influence than any underlying principle. Politicians want to extend the benefits of partnerships to industries they have come to favour either on the basis of ideology, or astute lobbying, or a bit of both. Sporadic interest in closing the loopholes companies use to twist themselves into such structures tends to sputter out, whether through genuine concern at the economic fallout or as a result of corporate emoluments spread over the appropriate constituencies. Meanwhile the regulatory burdens on C corporations that make people look for alternatives in the first place grow apace.

Eoin Treacy's view The burden of regulation, intrusion, reporting and taxation has increased substantially over the decades with the result that corporations have learned how to manipulate their activities, to make the best use of the environment they are active in. The unintended consequence from the perspective of law makers is that companies now do whatever they can to ensure earnings do not fall within high tax jurisdictions and they structure their companies to avoid what they deem overzealous reporting requirements.

The musical chairs foreign earnings are put through before being reported are a consequence of the same environment. Likewise the proliferation of pass-through entities is a direct response to what some regard as onerous corporate taxes and reporting obligations. At present there does not appear to be any impetus behind seriously reforming the US tax code. However, if momentum were to materialise around this issue, with lower corporate taxes on offer, a reassessment of how pass through entities are treated and what types of businesses qualify could also come up for debate. This would probably be more of a threat to private equity funds than pure energy plays.

The JPMorgan Alerian MLP Index ETN currently trades at a premium of 3.52% and has a dividend yield of 4.87%. The majority of its constituents are involved in pipelines and storage. In addition to their favourable tax treatment, these types of companies have been some of the main beneficiaries of unconventional oil and gas supply growth across the USA. The ETN has been ranging since May and most recently found support in the region of the 200-day MA from October.

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