Why Canadian Investors Should Avoid Master Limited Partnerships

Many Canadian investors still screen potential investments by dividend yield. When they look beyond Canadian stocks, they can be drawn to parts of the U.S. market that appear attractive on the surface but are often misunderstood.

Examples include U.S. mortgage real estate investment trusts (mREITs), business development companies (BDCs), and Master Limited Partnerships (MLPs). These vehicles are frequently highly leveraged or structurally complex, and headline yields rarely tell the full story.

What is a master limited partnership?

MLPs operate primarily in the midstream segment of the energy sector, focusing on transporting, storing, and processing oil and gas rather than producing or retailing it. Canadian investors already know midstream businesses from TSX-listed corporations such as TC Energy and Enbridge, but those are conventional corporations rather than partnerships.

A master limited partnership is a U.S.-specific pass-through entity designed to distribute income generated by energy infrastructure. Because an MLP is a partnership rather than a corporation, it often avoids corporate-level income tax and distributes the majority of its cash flow directly to unitholders. That pass-through structure helps explain the high yields that attract income-seeking investors.

At first glance, Canadian investors may assume MLPs are a straightforward way to access familiar midstream assets in the U.S. Capital markets and business models can look similar, and the income looks appealing. The crucial difference is taxation: U.S. tax rules treat MLPs differently in ways that can reduce after-tax returns and add administrative burden for Canadian investors.

This article explains what Canadian investors need to know about U.S. MLPs, why they are often best avoided by Canadians, and which alternatives provide similar exposure but with fewer tax complications.

The tax headaches of MLPs for Canadian investors

For Canadian investors, the tax complications of U.S. MLPs boil down to two main problems: withholding taxes and complex reporting requirements.

Most Canadians are familiar with U.S. dividend withholding: when you own U.S.-domiciled stocks or ETFs, a 15% withholding typically applies to dividends, and this can usually be avoided for holdings inside an RRSP thanks to the Canada–U.S. tax treaty. MLPs, however, are treated very differently. Distributions from MLPs do not receive treaty protection; instead they are fully subject to U.S. withholding tax, and the effective withholding can be far higher than the typical 15%—in some cases up to 37%. This applies even inside registered accounts such as RRSPs.

Source: r/CanadianInvestor

That means more than one third of each distribution can be taken before it reaches your account. That is especially harmful because a large portion of the long-term return from MLPs typically comes from distributions that are reinvested rather than from capital gains.

There is also a mandatory 10% withholding applied to gross proceeds when a non-resident sells an interest in a publicly traded partnership. The Internal Revenue Service withholds this amount regardless of whether the sale produces a gain or a loss. Some investors have been surprised to find 10% withheld each time they sold the same MLP, compounding the drag on returns.

Source: r/PersonalFinanceCanada

Beyond withholding, MLP investors receive a Schedule K-1 rather than the simpler 1099-DIV used for typical corporate dividends. A K-1 details your share of partnership income, deductions, and credits and often creates a U.S. filing obligation. Technically, non-resident investors are required to file a U.S. tax return to properly report partnership income. Ignoring this requirement is risky: retroactive compliance with cross-border tax rules can be time-consuming and expensive.

Source: r/cantax

Given the high withholding on distributions, the withholding on sales, and the ongoing reporting burdens that apply even inside registered accounts, U.S. MLPs are often a poor fit for Canadian investors despite tempting headline yields.

MLP alternatives for Canadian investors

The simplest alternative is to target midstream energy exposure without using MLPs. Canadian-listed corporations such as Enbridge, TC Energy, and Pembina Pipeline operate fee-based energy infrastructure with long-term contracts tied to oil and gas volumes. These businesses mirror many of the economic characteristics of U.S. MLPs at the asset level, but they are taxed as corporations.

Those Canadian firms pay eligible dividends that qualify for the dividend tax credit in Canadian taxable accounts. Holding them avoids U.S. withholding, removes the need for U.S. tax filings, and still offers above-average yields from essential infrastructure assets. You can also gain diversified exposure by using Canadian ETFs that focus on pipeline and midstream companies.

Source: Global X Canada

If you specifically want exposure to U.S. MLPs, ETFs provide two main structural options, each with trade-offs.

One option is a pure-play MLP ETF structured as a corporation. These funds own primarily MLPs but are taxed at the corporate level. As a result they often accumulate deferred tax liabilities tied to depreciation and unrealized gains of the underlying partnerships. That deferred tax can create meaningful tracking error relative to the MLP index and can both damp gains in up markets and cushion losses in down markets. A notable example historically is an ETF that has lagged its benchmark due in part to these deferred tax effects and a relatively high expense ratio.

Source: ALPS Funds

Lower-cost corporate-structured MLP ETFs exist as well, and some disclose an effective tax rate to illustrate the drag these deferred taxes can impose. Even with lower fees, the deferred-tax mechanics remain a factor.

Source: Global X

The other ETF structure limits direct MLP holdings to 25% or less so the fund can qualify as a registered investment company (RIC) and receive pass-through tax treatment. These funds therefore avoid corporate-level deferred tax liabilities, but they also deliver less pure MLP exposure. Their portfolios typically mix MLPs with incorporated midstream companies such as ONEOK, Kinder Morgan, and Williams, as well as U.S.-listed shares of Canadian firms.

An ETF using this approach will usually have a lower headline yield than a pure-play MLP fund, but it offers simpler taxation and fewer structural drags on total return.

Taxes are inevitable, so at least keep it simple

Both ETF structures are preferable for Canadian investors compared with owning MLPs directly because ETFs generally issue 1099-DIV forms instead of Schedule K-1s and they eliminate the steep 37% withholding on distributions and the 10% withholding on sales. Instead, investors typically face the usual 15% U.S. withholding on dividends, which can be avoided for holdings inside an RRSP.

If you want some MLP exposure with minimal hassle, U.S.-listed ETFs are the least painful route. For most Canadian investors, however, domestic and U.S. midstream corporations provide similar economics with far fewer cross-border tax complications and administrative burdens.

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