Master Limited Partnership (MLP)– Rise of the Distorporation: Shift in Company Ownership Structure– Rethinking Capitalism?

Master limited partnership (MLP) is a limited partnership that is publicly traded on a securities exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities…

A master limited partnership (MLP) is a type of company that combines characteristics of a corporation and a partnership. It has a substantially simpler structure than a corporation, and it doesn’t have to pay taxes on the company level as a corporation does. It also differs from other partnerships in that its ownership comes in units– similar to shares of corporate stock– that owners can trade.

Despite advantages the structure comes with certain risks, for example; government regulations place limits on the types of industries in which MLPs can do business, MLPs often rely on continuing investment to allow them to expand operations. This becomes a problem because legal issues and the nature of the investment structure limit the supply of potential investors… One of the most crucial criteria that must be met in order for a partnership to be legally classified as an MLP is that the partnership must derive most (~90%) of its cash flows from real estate, natural resources and commodities.

The National Association of Publicly Traded Partnerships estimates there are more than 100 MLPs currently being traded on major exchanges, primarily focused on energy-related industries and natural resources. Midstream oil and gas projects– gathering, processing, pipelines, and distribution– account for the majority of current MLPs. Of the estimated $445 billion in MLP capital currently in the market, approximately $400 billion (89%) has gone into qualifying energy and natural resources. Of that, just under 80% has gone into midstream oil and gas pipeline projects.

Collectively, distorporations such as the MLPs have a valuation on U.S. markets in excess of $1 trillion. They represent 9% of the number of listed companies and in 2012 they paid out 10% of dividends; but they took in 28% of the equity raised. These statistics underplays the true scale of the shift. Structures like MLPs are used to house the management of big private-equity companies, thus sitting atop industrial empires of much greater worth.

Among all firms, in 2008 ‘pass-through’ structures accounted for 23% of companies and 63% of profits, according to the latest data available from Internal Revenue Service (IRS). According to Rodney Chrisman; such businesses account for more than two-thirds of new companies.

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Master Limited Partnerships Parity Act is a straightforward, powerful tweak to federal tax code that could unleash significant private capital into the energy market… An MLP is a business structure that is taxed as a partnership but whose ownership interests are traded like corporate stock on a market. Whereas profit from publicly traded C-corporations is taxed at both the corporate level and the shareholder level, income from MLPs is taxed only at the shareholder level because it is treated as a partnership for tax purposes.

An MLP consists of limited partners (investors) and general partners (managers). The limited partners— who can number in the thousands– provide capital and receive quarterly required distributions generally equivalent to shareholder dividends in a C-corporation. They play no role in the operation of the MLP while general partners manage the MLP daily operations.

General partners can take the form of– another company or group of individuals, typically holding a 2% ownership stake. In essence the MLP Parity Act simply expanded the definition of  ‘qualified’ sources to include clean energy resources and infrastructure projects and energy technologies that qualify under Sections 45 and 48 of tax code, including; wind, closed and open loop biomass, geothermal, solar, municipal solid waste, hydropower, marine and hydrokinetic, fuel cells, and combined heat and power.

The legislation also allows for transportation fuels to qualify including; cellulosic, ethanol, biodiesel, and algae-based fuels, as well as energy-efficient buildings, electricity storage, carbon capture and storage, renewable chemicals, and waste-heat-to-power technologies. The MLP Parity Act does not affect any current MLP entity and all projects currently eligible to structure as MLPs would continue to qualify exactly as they would under existing law.

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In the article Rise of the Distorporation– Master Limited Partnership by The Economist writes: MLP is part of a larger shift in the way businesses structure themselves and is changing how U.S. capitalism works. The essence is a move towards types of firm which retain very little of their earnings: ‘pass-through’ companies which every year pay out more or less as much as they take in.

Many of the standard rules that corporations, which retain their earnings, have to follow when dealing with shareholders do not apply to such firms. And, crucially, so long as they distribute earnings such set-ups can largely avoid corporate tax… Mindful of that last point, the U.S. government has in the past restricted the use of such structures but the restrictions have eased, and more and more businesses are now twisting themselves into forms that allow them to qualify as ‘pass-through’: The corporation is becoming– the distorporation…

The shift to the distorporation comes at the expense of the C-corporation, the formal name for the familiar limited-liability joint-stock structure that emerged a century ago… This shift in how companies are governed and raise money; and it’s bringing with it structural change in U.S. capitalism: A change that should be matter of great debate. Are these new businesses with their ability to circumvent rules, which apply to conventional public companies, merely adroit exploiters of loopholes for the benefit of a plutocratic few? Or, do they reflect the adaptability on which U.S.’s vitality has always been based? Alas, it’s a debate the country is either blithely or studiously failing to take up.

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The biggest reason for a company to organize in the MLP structure is tax avoidance. While shareholders in a corporation face double taxation– paying taxes first at corporate level, and then at the personal level when those earnings are received as dividends– whereas, owners of an MLP are taxed only once, at the individual level. There is no partnership equivalent of corporate income tax, and not just any company can qualify for MLP status.

According to National Association of Publicly Traded Partnerships; MLP structure is limited to companies that receive 90% or more of their income from interest, dividends, real estate rents, gain from sale or disposition of real property, income and gain from commodities or commodity futures, and income-gain from mineral or natural resources activities. While there are a few exceptions, the vast majority of MLPs operate in energy industries…

The first MLP to be launched was one by the Apache Oil Company in 1981. Its purpose was to tap smaller investors for capital while allowing them to become partners. This was soon followed by other oil and gas companies and following suit with real estate companies joining in as well. Legislators became concerned with meteoric rise in MLPs, e.g., restaurants, hotels, amusement parks and even the Boston Celtics going down this route in order to save on corporate tax…

As a result, new tax laws were formulated: Tax Reform Act of 1986 and Revenue Act of 1987 put in place restrictions that effectively eliminated preferential tax treatment for all MLPs except those with 90% of their incomes derived from ‘natural resource’ activities, such as; oil and gas exploration, production, transportation, and so on… Consequently, many of the earlier MLPs ceased to exist and others transformed themselves back to corporations…

According to Andrew Morriss; this structural shift is an entrepreneurial response to a century worth of governmental distortions made through taxation and regulation. At the heart of those actions were the ideas set down in The Modern Corporation and Private Property, a landmark 1932 study by Adolf Berle and Gardiner Means. As Berle would later write; shift of two-thirds of industrial wealth of the country from individual ownership to ownership by large, publicly financed corporations vitally changes the lives of property owners, lives of workers… and almost mandates a new form of economic organization of society.

In the late 19th century industry had a voracious need for capital; and it found it by listing shares publicly on exchanges. The problem with this, Berle observed, was that over time big successful corporations would come to finance themselves out of retained earnings and have little need for investor-supplied capital. So while ownership structure provided liquidity for shareholders– they could easily exchange rights for cash– it did not give them the authority tied to conventional ownership, because the company did not need to maintain their support…

Management thus becomes, Berle wrote, in an odd sort of way, the uncontrolled administrator of a kind of trust… The SEC was established two years after the book by Berle and Means was published, and reflected just this same sort of thinking. Notwithstanding, with several minor retreats, the government’s role in publicly listed company has expanded relentlessly ever since. Recent attempts by some legislators to exert more power over companies have, unsurprisingly, led to legal entrepreneurialism on the private side: Hence the distorporation…