In February, I purchased 150 shares of Enterprise Products, a U.S. oil and gas infrastructure company, in my registered retirement income fund. I was expecting a dividend yield of about 7.6 per cent. However, I was surprised to see that the quarterly dividend of 45 US cents a share was reduced by a non-resident withholding tax, so instead of receiving US$67.50 in dividends I ended up with US$42.53. Why am I paying withholding tax? I have held other U.S. dividend stocks for years and have not encountered this.
I hate to give you another surprise, but Enterprise Products Partners LP (EPD-NYSE) is not a dividend stock. It’s a U.S. master limited partnership (MLP) that is subject to different tax rules than a regular corporation. Instead of paying tax at the corporate level, MLPs – many of which operate in the energy business – distribute most of their cash to unitholders.
For U.S. investors, one advantage of MLPs is that their distributions (they are not called dividends) consist largely of return of capital (ROC), which is not taxed in the year it is received. Rather, ROC is deducted from the adjusted cost base of the units, which defers tax until the units are ultimately sold.
For Canadian residents, however, the tax treatment of MLPs is far less favourable. In addition to being treated as foreign income and losing the tax-deferral benefit, MLP distributions are subject to non-resident U.S. withholding tax at the highest U.S. federal marginal rate, which is currently 37 per cent.
What’s more, withholding tax applies whether the units are held in a registered or non-registered account. This differs from U.S. dividend stocks, which – under the Canada-U.S. tax treaty – are exempt from withholding tax in registered retirement accounts and benefit from a reduced withholding rate of 15 per cent in non-registered accounts, tax-free savings accounts and registered education savings plans.
There’s even more bad news. Because you hold your units in a registered account, you are not able to claim a foreign tax credit for the tax withheld. Even if you held the units in a non-registered account, the process of claiming a foreign tax credit for MLPs can be complex and may require the filing of a U.S. tax return, as I have written previously.
“We believe that Master Limited Partnerships are not the right investment for everyone. There are risks and tax-reporting issues that need to be fully understood before an investor considers owning an MLP,” Robin Diedrich, an analyst with Edward Jones, said in a recent note.
In recent years, the MLP sector has “significantly lagged” the broader U.S. market, Ms. Diedrich said. Low commodity prices and distribution cuts by several MLPs have hurt sentiment toward the sector, and investors have become less enamoured of the MLP financing model, “which relies on continual equity and debt issuance to fund growth capital,” she said.
Bottom line: Make sure you understand what you are getting into before you jump at the high yields of U.S. MLPs.
I own Toronto-Dominion Bank shares in my TD brokerage account and in my Scotia iTrade account. Obviously, the average costs for the shares in each account are not identical. Question: If I sell some or all of the TD shares in the TD account, for capital gains purposes do I use the average cost that shows in the TD account, or do I use the average cost across both accounts?
You would need to calculate the average cost across all non-registered accounts in which you hold TD shares. Any TD shares held in registered accounts should be excluded from the calculation as they are not subject to capital gains tax.
“Under the ‘identical property’ rule in the Income Tax Act, where a taxpayer buys and sells several identical properties, such as common shares, at different prices over a period of time, the taxpayer has to calculate the average cost … to determine the adjusted cost base (ACB),” said Jamie Golombek, managing director, tax and estate planning, with CIBC Private Wealth Management.
Brokers typically provide “average cost” or “book value” figures for clients, but these numbers don’t apply when identical shares are held in multiple non-registered accounts, Mr. Golombek said.
The good news is that calculating the average cost should be relatively painless. Just add up the total cost of your TD shares (including trading commissions) and divide by the number of TD shares you own. If you were to then sell, say, 100 TD shares, you would multiply the average cost by 100 to determine the ACB of the shares sold. Next, subtract this from your sale proceeds (minus commissions) to determine your capital gain (or loss). Only half of capital gains are included in income for tax purposes.
One other thing to note: When you sell a portion of your shares, the average cost of the remaining shares does not change.
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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