And then there were three. The listing of Global X MLP ETF (MLPA) today (4/19/12) makes it the third ETF structured as a C-corporation, thereby subjecting its shareholders to the heavy burden of double-taxation on taxable income received from the fund and all capital gains.

Like its two predecessors, Alerian MLP ETF (AMLP) [see AMLP’s Dirty Little Secret [1]] and Yorkville High Income MLP ETF (YMLP) [see YMLP: Another Abomination of the ETF Wrapper [2]], MLPA exploits a suspected loophole in SEC regulations [3].

This loophole apparently allows these C-corporations to claim objectives of seeking “investment results that correspond generally to the price and yield performance, before fees and expenses, of the…underlying index” while simultaneously allowing these funds to not adequately disclose the huge performance impact of the tax liabilities. And even more egregious, all three MLP ETFs claim “other expenses” of zero percent instead of the actual 38% daily clipping of changes in the index.

Unlike traditional ETFs and mutual funds that do not incur any entity level tax liabilities, these three C-corporations masquerading as ETFs are subject to the 35% corporate federal income tax rate (plus various state income taxes) on all capital gains and other taxable income. This is a significant expense borne by the shareholders.

The fact sheets and primary web pages for these funds generally make no or insufficient disclosures about these tax liabilities, while at the same time touting the tax advantages of MLP investing. This appears to go well beyond the definition of misleading. Only when you dig into the prospectus documents do you start to find some disclosures, but they do not begin to address the magnitude of the tax expense impact.

According to the AMLP website [4], as of 4/18/12 its shareholders have already coughed up more than $99 million of incurred tax liabilities (total market value minus total net assets) while the fund continues to claim a “total expense ratio” of 0.85%. A few weeks ago, this number topped $122 million. Where did the other $23 million go, and how is this ongoing liability and expense accounted for in the creation and redemption process?

If you enjoy shouldering a double taxation burden on tax-advantaged MLP assets, then you should consider one of the three MLP ETFs.

The new Global X MLP ETF (MLPA) seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Solactive MLP Composite Index of 30 MLPs. It claims a best in the industry total expense ratio of 0.45%. However, it considers the nearly 38% daily difference in its return versus the index to be a “tracking error” instead of an expense.

Neither the fund summary page [5] nor the fact sheet [6] (pdf) provide any indication of the C-corporation structure or the tax ramifications of that structure. To see a few disclosures on that subject, you will need to dig into the prospectus [7] (pdf). Therein, you might come across tidbits like:

  1. “Other Expenses” does not reflect deferred income tax liability to be incurred by the Fund.
  2. The Fund will accrue deferred income tax liability for its future tax liability associated with the capital appreciation of its investments and the distributions received by the Fund on equity securities of MLPs considered to be return of capital and for any net operating gains.
  3. The Fund’s accrued deferred tax liability will be reflected each day in the Fund’s net asset value per share.
  4. The Fund is taxed as a regular corporation for federal income tax purposes. This differs from most investment companies, which elect to be treated as “regulated investment companies” under the Code in order to avoid paying entity level income taxes.

Disclosure covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.