On December 22, 2017, President Trump signed a sweeping tax reform bill with wide-ranging implications for individuals and businesses across the country. The headline aspect of the new bill includes a cut to the federal corporate tax rate from 35% to 21%.
Given that ETFs/Mutual Funds/Closed End Funds with greater than 25% exposure to MLPs are taxed as 'C-Corporations' (C-Corps), the natural question is how this change to the corporate tax rate will affect these funds.
One immediate impact is that MLP C-Corp funds will change their tax accrual rates. For example, in fiscal year 2017, the Global X MLP ETF (NYSEARCA:MLPA), which is our only MLP C-Corp fund, had an effective tax rate of 36.94%. This rate included deferred federal and state income taxes as well as franchise tax expenses. Given the passage of this tax bill, the new accrual rate has been set to 23.49% going forward.
Given that MLPA currently has a deferred tax asset (DTA), the change in the tax accrual rate is expected to have no immediate impact on the fund's NAV. However, should the fund return to a deferred tax liability (due to future price appreciation in the fund's holdings, or another reason) the fund would experience less of a 'tax drag' at the new 23.49% rate, than it would have at the older 36.94% rate.
To learn more about how tax liabilities may impact MLP C-Corp funds, explore our whitepaper on the topic.
Impact Of Tax Drag On Hypothetical MLP Index Fund Returns
Deferred Tax Liability: Deferred tax liability is a future tax liability associated with the capital appreciation of a fund’s investments. The deferred tax liability represents an estimate of a fund’s potential tax expense if it were to recognize the unrealized gains in the portfolio.
Investing involves risk, including the possible loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Investments in securities of MLPs involve risks that differ from investments in common stock including risks related to limited control and limited rights to vote on matters affecting the MLP. MLP common units and other equity securities can be affected by macro-economic and other factors affecting the stock market in general, expectations of interest rates, investor sentiment towards MLPs or the energy sector, changes in a particular issuer’s financial condition, or unfavorable or unanticipated poor performance of a particular issuer (in the case of MLPs, generally measured in terms of distributable cash flow).
MLPA invests in the energy industry, which entails significant risk and volatility. The Fund is non-diversified. Furthermore, the Fund invests in small and mid-capitalization companies, which pose greater risks than large companies. The Fund has a different and more complex tax structure than traditional ETFs and investors should consider carefully the significant tax implications of an investment in the Fund. The Fund also pays distributions, which are generally treated as a return of capital for tax purposes rather than from net profits and shareholders should not assume that the source of distributions is from the net profits of the Fund.
The potential tax benefits from investing in MLPs depend on them being treated as partnerships for federal income tax purposes. If the MLP is deemed to be a corporation then its income would be subject to federal taxation at the entity level, reducing the amount of cash available for distribution to the Fund, which could result in a reduction of the Fund’s value.
The Fund is taxed as a regular corporation for federal income tax purposes, which differs from most investment companies. Due to its investment in MLPs, the fund will be obligated to pay applicable federal and state corporate income taxes on its taxable income, as opposed to most other investment companies. The fund expects that a portion of the distributions it receives from MLPs may be treated as tax-deferred return of capital. The amount of taxes currently paid by the fund will vary depending on the amount of income and gains derived from MLP interests and such taxes will reduce an investor’s return from an investment in the fund. The fund will accrue deferred income taxes for any future tax liability associated certain MLP interests. Upon the sale of an MLP security, the fund may be liable for previously deferred taxes, which may increase expenses and lower the fund’s NAV.
The information presented here is for informational purposes only. It was prepared on information and sources that we believe to be reliable, but we make no representations or guarantees as to the accuracy or the completeness of the information contained herein. This information is not intended to be individual or personalized investment or tax advice. Please consult a financial advisor or tax professional for more information regarding your tax situation.
Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Indices are unmanaged and do not include the effect of fees, expenses or sales charges. One cannot invest directly in an index.
Carefully consider the Fund’s investment objectives, risks, and charges and expenses. This and other information can be found in the Fund’s summary or full prospectuses which may be obtained by calling 1-888-GX-FUND-1 (1.888.493.8631), or by visiting www.globalxfunds.com. Please read the prospectus carefully before investing.
Global X Management Company LLC serves as an advisor to Global X Funds. The Funds are distributed by SEI Investments Distribution Co. (SIDCO), which is not affiliated with Global X Management Company LLC. Global X Funds are not sponsored, endorsed, issued, sold or promoted by Solactive, nor does Solactive make any representations regarding the advisability of investing in the Global X Funds. Neither SIDCO nor Global X is affiliated with Solactive.