The authors wish to acknowledge the contributions of Jared Mackey of Bennett Jones LLP in the preparation of this paper.

CANADIAN PETROLEUM TAX JOURNAL Vol. 26, 2013-5 Forming U.S. Master Limited Partnerships with Canadian Assets: A U.S. and Canadian Tax Perspective Greg Johnson, Bennett Jones LLP (Calgary), and Tim Devetski, Sidley Austin LLP, (Houston) The authors wish to acknowledge the contributions of Jared Mackey of Bennett Jones LLP in the preparation of this paper. 1. Introduction On October 31, 2006, the Minister of Finance announced measures that fundamentally altered the taxation of income trusts and other flow-through entities in Canada. These "specified-investment flowthrough" or "SIFT" rules contained in the Income Tax Act (Canada) 1 generally operate to tax certain flow-through entities as corporations. Prior to that time, the prevalence of income and royalty trusts was rapidly growing in Canada, peaking at a market capitalization of over $200 billion. 2 These entities offered considerable tax-efficiencies and high-yield distributions. Since the enactment of the SIFT rules, the supply of yield oriented investments within the Canadian market has declined dramatically prompting many companies to seek alternative structures to maximize unitholder value. One structure that is being increasingly considered is the U.S. master limited partnership ("MLP"). 3 MLPs are publicly traded U.S. limited partnerships or limited liability companies ("LLCs") that combine the tax benefits of a partnership with the liquidity of publicly listed securities. With a primary goal of providing unitholders with cash distributions, MLPs have the potential to be powerful vehicles for companies with stable growth and high cash flows. This would include many oil and gas companies with long-term productive assets, storage companies, processing facilities, terminals, and pipelines. In this article, the authors discuss the U.S. and Canadian tax implications of forming an MLP with Canadian assets. Following a review of the essential components and structure of MLPs, the authors explore the fundamental taxation issues confronting MLPs from the U.S. and Canadian perspectives. Next, the authors discuss tax-efficient alternatives for transferring assets to MLPs, and structuring options for acquiring and operating Canadian assets through an MLP. Finally, the authors address tax and compliance issues applicable to U.S. and Canadian investors in MLPs. This article will demonstrate that with careful planning, an MLP can be a powerful and tax-efficient vehicle to operate Canadian assets for many companies. 2. Overview of Master Limited Partnerships MLPs are limited partnerships 4 or LLCs electing partnership taxation that have issued a publiclytraded class of partnership interests or units on a national securities exchange. MLPs combine the affordability and liquidity benefits of publicly traded securities with the tax benefits of a partnership. MLPs are considered desirable by investors as they pay regular cash distributions while offering the potential for growth.

There are over 100 MLPs currently on the market, 5 and they are primarily used for encouraging investment in energy and natural resource assets. Section 7704 of the United States Internal Revenue Code ("IRC") determines the entity classification of MLPs for federal income tax purposes. In order to qualify for MLP status, a partnership or LLC must satisfy a "qualifying income" test in paragraph 7704(c)(2) of the IRC pursuant to which at least 90% of the entity's gross income must consist of "qualifying income". "Qualifying income" includes income from "exploration, development, mining or production, processing, refining, transportation or marketing of any mineral or natural resource". 6 The term also includes dividends, interest, real estate rental, and certain other types of income. If the "qualifying income" test is not satisfied, the partnership will automatically be treated as a corporation for U.S. tax purposes. 7 MLPs must be distinguished from other publicly traded partnerships that operate as investment funds rather than active businesses. These funds are not considered MLPs. An MLP formed as a limited partnership typically has a general partner, which holds approximately 2% of the limited partnership s outstanding equity (in the form of a general partner interest), as well as a special class of partnership equity (incentive distribution rights or "IDRs") that entitles the general partner to an increasing share of distributions as the amount paid on equity grows. The remainder of the MLP s equity is owned by limited partners who are passive investors, with limited voting rights. The general partner of the MLP is responsible for managing the business and is reimbursed for operating and administrative expenses. In contrast, the limited partners have little control over the activities of the MLP. The entity that forms the MLP is generally referred to as the sponsor. In most cases, the sponsor contributes assets to the MLP, organizes and controls the general partner of the MLP and retains a majority of the limited partner interests in the MLP upon its initial public offering ("IPO"), in the form of both "common units" and "subordinated units" (described below). Once the sponsor contributes assets, the MLP issues common units to public investors for cash. The MLP may retain some or all of this cash, but it typically distributes a significant portion of the contributed cash, diluting the sponsor's ongoing interest in the MLP. Basic Structure of an MLP Common units and subordinated units are both limited partner equity interests in the MLP. These units provide their holders with very limited voting rights, but entitle the holders to share the 2

company's success through cash distributions. The sponsor's subordinated units generally permit the sponsor to share in distributions after distributions have been made on the common units equivalent to a minimum quarterly distribution (the MQD ) per unit that is set forth in the MLP s governing documents. Distributions on the subordinated units remain subordinated for a "subordination period" which is typically three years from the date of the MLP's initial public offering. When the subordination period expires, the subordinated units convert to common units on a one-for-one basis. An MLP is generally required by its partnership agreement to distribute the majority of its "available cash flow, typically on a quarterly basis. Available cash flow generally refers to cash on hand for a particular quarter, less reserves as established by the general partner to carry on the business. Common units and the general partner's interest generally have priority to cash distributions up to the MQD. Once the MQD is reached, holders of subordinated units are then paid, up to the MQD. Any distributable cash above the MQD is then distributed pro rata to the holders of common units, general partner interests, and subordinated units. Upon achieving another distribution threshold, the general partner s IDRs begin receiving distributions, and these distributions increase (as a percentage of the overall distributions paid by the MLP) upon achieving even higher thresholds. The IDRs generally are intended to incentivize the general partner and the sponsor to "grow" distributions to the public. As noted above, occasionally MLPs elect to register as LLCs. LLCs have members rather than partners. Accordingly, there is no general partner, although a managing member may be appointed to serve a similar function. LLCs are extremely flexible legal entities, and thus can accommodate the same classes of equity described above (including IDRs), although some MLPs organized as LLCs do not have IDRs. 3. U.S. Taxation of Master Limited Partnerships 8 The tax treatment of MLPs differs from corporations at both the enterprise level and the investor level. A. Flow-Through Like other partnerships, most MLPs are flow-through entities for U.S. federal, state and local, income tax purposes. Instead of paying corporate income tax, an MLP's tax liability is passed on to its public investors. MLPs are, however, tax reporting entities and must file an annual partnership return. 9 MLP investors receive year-end tax statements (IRS Form 1065, Schedule K-1) setting out their share of the MLP's taxable income for the year and are generally obligated to pay U.S. federal, state, and local income tax, as applicable, on this amount. Under section 702 of the IRC, the character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share is to be determined as if such item were realized directly. Investors pay tax on the MLP's profit, even if the profits are retained in the business. Notably, U.S. tax exempts and non-u.s.-residents generally are also obligated to file U.S. federal tax returns and pay taxes on their share of the MLP's operating income. B. Adjusted Cost Base When investors buy units of an MLP, their adjusted cost base is equal to their purchase price, increased by: (1) their share of the MLP's operating income; and (2) their share of the MLP's debts. In contrast, their adjusted cost base is decreased by: (1) their share of the MLP's losses; (2) any 3

reduction in their share of the MLP's debts; and (3) any distributions received from (capital taken out of) the MLP. Thus, for example, if an investor contributes $20.00 to an MLP for one unit, and his share of the MLP's income is $1.00, the investor will be taxed on the $1.00 without regard to whether the investor receives any distributions from the MLP. This has the same effect as if the investor had invested $21.00 for his unit, and his cost base is adjusted accordingly. C. Returns of Capital and the "Tax Shield" Benefit In contrast to dividends received by shareholders of a corporation, MLP investors generally do not pay tax on the cash distributions they receive (unless the amount of the distribution exceeds the investor s tax basis in his units). Instead, these distributions are considered tax-deferred returns of capital that reduce the investors' adjusted cost base in the MLP units. 10 A significant benefit of MLPs is that investors can receive cash payments greater than the amount of their taxable income until they have fully recovered their invested capital. This result arises because MLPs typically have much higher distributable cash flow than they have taxable income, mainly due to non-cash deductions for depreciation, particularly where the MLPs invest in natural resource infrastructure assets, such as pipelines. The availability of these depreciation deductions generally results in limited net income flowing through to public investors. This effective tax-deferral benefit is referred to as a "tax shield". The amount of the tax shield is generally expressed as the percentage of the expected cash distributions that exceed taxable income allocations. As an illustration of how the "tax shield" benefit operates, assume an investor in an MLP purchases one common unit for $20.00. In the first year, the investor receives $4.00 of cash distributions, but the investor's share of the MLP's taxable income is only $1.00 due to depreciation deductions. Accordingly, the investor only reports $1.00 of taxable income. At the end of the first year, the investor's tax basis in its MLP units is $17.00, being the initial basis of $20.00, plus $1.00 of income, less $4.00 of distributions. Any returns of capital are treated as reductions in the investor's cost basis, essentially deferring tax on the excess cash distributions until the investor sells its MLP interest. D. Passive Loss Rules On occasion, an MLP's depreciation and other expenses may exceed its revenue. In this case, the MLP will have an operating loss. Although the MLP is a flow-through entity, individual unitholders can only claim the benefit of these deductions up to their respective shares of the MLP's income. 11 Under the IRC, an individual investor's operating losses can only be deducted from businesses in which a taxpayer is actively engaged. Accordingly, the deductions are not available to reduce the MLP unitholders' other income if they exceed their shares of the MLP's income. The additional loss is carried forward and can only be used (1) when the partnership has taxable income in the future, or (2) when the taxpayer sells its interest in the partnership, given that the loss will reduce the taxpayer's adjusted cost base. 4

E. Recapture and Zero Basis As discussed above, any taxable income of an investor is treated as an increase in the cost basis of the MLP units, while distributions and losses will reduce the cost basis. When an investor sells his or her MLP interest, he or she must pay tax on any gains arising from the disposition. However, as a result of the tax shield benefit, an investor's tax basis is generally reduced each year and is frequently less than the original investment amount at the time of sale. At the time of sale, this generally results in the investor recognizing more income (effectively "recapturing" the tax shield benefit at the time of the sale). Any gain on the sale is "ordinary income" to the extent depreciation deductions exceed actual economic depreciation in the assets of the MLP. The remaining gain is generally a capital gain. Continuing from the earlier illustration, the investor's tax basis at the end of the first year is $17.00. If the investor then sold its common unit for $22.00, he or she would recognize a gain of $5.00. Of this gain, and assuming no economic depreciation in the MLP s assets, $3.00 would generally be expected to be treated as ordinary income (i.e., recapturing excess tax depreciation), and $2.00 would be treated as a capital gain. If an investor's adjusted cost base is reduced to zero through tax shielded distributions, any distributions beyond that point will be fully taxable to the investor as ordinary income. Where an investor purchases common units in the secondary market (i.e., other than from the MLP itself), the investor gets an effective tax basis "step-up" in his or her share of the MLP's assets. An IRC section 754 election for the MLP allows an adjustment under section 743(b) of the IRC to a partner's share of the tax basis of partnership assets, referred to as "inside basis", to render it equal to the tax basis of his or her partnership interest, referred to as "outside basis". This is occasionally referred to as a "refreshening" of the tax shield benefit to a new investor. In the absence of the section 754 election, no adjustment can be made to the inside basis of partnership assets unless a mandatory adjustment is required. For the purchaser in the prior example, future tax depreciation deductions may be determined based upon a price of $22.00 paid for the units. F. Corporate Treatment Many MLPs own subsidiary entities that are treated as corporations for U.S. federal tax purposes. In some cases, these corporate subsidiaries may be affirmatively established by the MLP in order to conduct operations that do not generate qualifying income. Further, in the case of a non-u.s. subsidiary that is organized to conduct operations outside of the United States, there may be limited consequences to corporate treatment. Because the U.S. generally imposes federal income tax only on certain U.S.-connected income earned by a non-u.s. corporation, non-u.s. subsidiaries of an MLP may be exempt from U.S. federal income tax regardless of whether they are treated as corporations or are fiscally transparent. Nonetheless, corporate treatment of a non-u.s. subsidiary may have adverse effects on the tax shield benefit described previously and can severely limit U.S. federal tax planning. Certain MLPs that own primarily non-u.s. assets have themselves elected to be treated as corporations for U.S. federal tax purposes. These MLPs have been organized under the laws of a jurisdiction outside of the United States, so as not to be treated as U.S. domestic corporations, which would be taxable on all earnings regardless of source or origin, and instead to be treated as non-u.s. 5

corporations, which are generally taxable only on U.S. business income or U.S. source payments received. This type of arrangement may be ideal for an MLP investing primarily in Canadian assets. As indicated above, a corporate election eliminates qualifying income as an issue for the MLP, as the MLP has confirmed its status as a corporation and is not intending to be treated as fiscally transparent. A corporate election MLP also is beneficial for U.S. tax exempt investors, who generally are exempt from tax on dividends but taxable on their shares of business income, because the corporate election causes the MLP s distributions generally to be treated as dividends for U.S. tax purposes. Individual investors may also benefit, because dividends are taxed at lower rates than operating income, although the corporate election limits the tax shield benefit previously described as there is no refreshening of the tax shield benefit to new purchasers. Because most MLPs have not made the corporate election, and because the corporate election limits an MLP s flexibility to acquire U.S. assets, the discussion that follows focuses primarily on MLPs that have not made this election (for themselves or their Canadian subsidiaries) and are treated as partnerships for U.S. federal tax purposes. 4. Canadian Taxation of Master Limited Partnerships From a Canadian perspective, holding Canadian assets in an MLP must have a reasonable value proposition. The holding must unlock value for the MLP and/or gain access to capital. Canadian taxes may impact this value proposition and raise a number of challenging issues. A. Flow-Through Most MLPs are formed as U.S. limited partnerships. Under Canadian law, a partnership is not a separate legal entity, but simply a legal relationship between two or more persons carrying on business in common with a view to profit. Accordingly, partnerships themselves are generally not taxable entities. 12 Pursuant to a series of rules in section 96, income, gains, and losses of a partnership are first calculated as if the partnership were a separate person, but are then allocated to the partners and taxed accordingly. Income or loss from a particular source retains its character as income or loss from that source in the hands of the partner. 13 Most U.S. partnerships used to form MLPs (e.g., Delaware limited partnerships) are respected as partnerships for Canadian tax purposes. Occasionally, MLPs are formed with Marshall Islands limited partnerships. 14 Marshall Islands limited partnership law generally follows Delaware partnership law and, accordingly, Marshall Islands MLPs should generally be respected as partnerships for Canadian tax purposes. As discussed above, a number of MLPs have been formed as LLCs. LLCs are considered corporations for Canadian tax purposes, but may be treated as partnerships or branches for U.S. tax purposes. 15 MLPs that are formed as LLCs have the same U.S. tax consequences as limited partnerships; however, LLCs can have dramatically different Canadian tax consequences. As discussed further below, LLCs are generally better suited: (i) to avoid SIFT taxes applicable to public partnerships, and (ii) to avoid Canadian tax on dispositions of MLP equity. Where little Canadian real or resource property is expected in the MLP structure (i.e., less than half), entity selection is likely not a significant planning concern. B. Specified Investment Flow-Through Tax 6

Where an MLP is formed using a partnership, Canada's SIFT tax must be carefully considered. On October 31, 2006, Canada's Department of Finance fundamentally altered the taxation of flowthrough entities by announcing a new taxation regime for SIFT entities, including certain publiclylisted income trusts ("SIFT trusts") and partnerships ("SIFT partnerships"). The SIFT rules effectively tax partnerships as Canadian corporations and after-tax allocations of income from "nonportfolio properties" ("NPP") as taxable dividends. 16 A SIFT partnership is defined in section 197 as a partnership: (i) other than an "excluded subsidiary entity", (ii) that holds NPP, (iii) that is a "Canadian resident partnership", and (iv) whose securities are listed or traded on a stock exchange or other public market. An MLP that is formed as a U.S. partnership should avoid being characterized as a "Canadian resident partnership". The term "Canadian resident partnership", as defined in subsection 248(1), embraces: (i) a "Canadian partnership"; 17 (ii) a partnership that "would, if it were a corporation, be resident in Canada (including, for greater certainty, a partnership that has its central management and control in Canada)"; and (iii) a partnership formed under the laws of a Canadian province. While it remains unclear precisely how the "mind and management" test will be applied to partnerships, 18 MLPs should seek to ensure that the "mind and management" of the entities who exercise control over the MLP are outside of Canada so as to avoid potentially being subject to the SIFT regime. Since all MLPs will have issued a publicly-traded class of partnership interests or units on a national securities exchange, the remaining issue in determining SIFT status is whether the MLP holds NPP. An MLP's property will be NPP if at any time in the taxation year it falls within one of three categories. 19 The first category is property held by a "particular entity" that is used by the particular entity (or a non-arm's length person or partnership) in the course of carrying on a business in Canada. The second category is property held by a particular entity that is "Canadian real, immovable or resource property" 20 if at any time in the taxation year the total fair market value of such property is greater than 50% of the equity value of the entity. The final category is property of a particular entity where the property is a "security" 21 in a "subject entity" 22 if, at any time in the taxation year, the particular entity holds (i) securities of the subject entity that have a total fair market value greater than 10% of the "equity value" of the subject entity, or (ii) securities of the subject entity (or entities affiliated with the subject entity) that have a total fair market value that is greater than 50% of the equity value of the particular entity. A "subject entity" includes a non-resident person or partnership, but only if the principal source of the non-resident's income is from Canadian sources. Where an MLP has its management and control in Canada, the SIFT tax can only be avoided if the MLP avoids holding NPP. A structure to mitigate against classification as a SIFT partnership in these circumstances is to interpose an LLC below the MLP, as illustrated in the figure below. 7

Avoid MLP Holding NPP In this structure, Canadian assets are held by a Canadian ULC that is wholly-owned by a Luxembourg or Dutch intermediary. The rationale for this holding structure is discussed below, under the heading "Managing Tax Leakage". For the time being, however, we will focus our discussion on managing NPP holdings. In order to mitigate the risk of the MLP holding NPP, the LLC must not be a Canadian resident and its principal source of income (i.e., more than 50%) cannot be from Canada. In the absence of the LLC, the MLP would hold the Lux/Dutch intermediary directly. The intermediary could be a subject entity since greater than 50% of its income is from Canadian sources and, accordingly, its equity would be NPP for the MLP. When structuring an MLP, it is also important to ensure that any lower tier partnerships of the MLP are not SIFTs. In this regard, the definition of "excluded subsidiary entity" in subsection 122.1(1) is paramount. As noted above, the definition of a SIFT partnership in section 197 excludes "excluded subsidiary entities". The definition of "excluded subsidiary entity" includes an entity without publicly traded equity, all of the equity of which is owned by real estate investment trusts, taxable Canadian corporations, SIFT trusts, SIFT partnerships, or other excluded subsidiary entities. Accordingly, the equity of lower tier partnerships cannot be listed and should not be held by a person other than one of the permitted holders. By selecting an LLC upon the initial IPO of a Canadian based MLP structure, it is possible to avoid SIFT tax issues. As noted above, LLCs are viewed as corporations for Canadian tax purposes, but, are considered partnerships or flow-through entities for U.S. tax purposes. It continues to remain important, however, that any lower-tiered partnerships of the MLP are excluded subsidiaries. In addition, the LLC must still have its mind and management outside of Canada. C. Dispositions of Taxable Canadian Property 8

Pursuant to paragraph 2(3)(c), income and capital gains realized by non-residents of Canada on the disposition of "taxable Canadian property" are generally taxed in Canada in the same manner as gains realized by Canadian residents. If an MLP's equity constitutes taxable Canadian property, non- Canadian investors would be subject to Canadian tax when they dispose of their interests, subject to any treaty relief. "Taxable Canadian property" is defined in subsection 248(1). The definition includes interests in a partnership that have derived, directly or indirectly, more than 50% of their value from Canadian real or resource properties at any time in the past 60 months. 23 In contrast to shares of a listed corporation, a listed interest in a partnership does not have a relieving 25% ownership test. 24 This relieving provision will apply, however, where an MLP is formed as an LLC. In this context, "shares" of the MLP are taxable Canadian property only if, in the past 60 months, greater than 50% of the fair market value of the shares is derived from Canadian real or resource property and the shareholder (together with non-arm's length persons) held greater than 25% of any class of the LLC's shares. If an MLP's equity is considered taxable Canadian property, dispositions by non-residents of Canada could also give rise to a 25% withholding tax under section 116. Subsection 116(5) generally requires the person acquiring taxable Canadian property from a non-resident to withhold and remit to the Receiver General, 25% of the gross purchase price of the property within 30 days after the end of the month in which such property was acquired. The withholding obligation does not apply where the vendor reported the transactions and obtained a clearance certificate from the Canada Revenue Agency (the "CRA"), or where the property was "excluded property". Assuming the property at issue is taxable Canadian property and given the compliance burden of applying to the CRA for a clearance certificate, the key issue will generally be whether the MLP units are "excluded property" as defined in subsection 116(6). In regards to MLPs formed as partnerships, partnership units are not excluded property even if they are listed. As such, section 116 withholding tax will apply on dispositions of MLP units where the units constitute taxable Canadian property. In contrast, pursuant to subparagraph 116(6)(b)(i) and clause 116(6)(b)(ii)(A), listed shares of a corporation are excluded property. Thus, in regards to an MLP formed as an LLC, its units will constitute "excluded property". Section 116 withholding tax will not apply, even if the units constitute taxable Canadian property. 5. Transferring Assets to a Master Limited Partnership Companies considering organizing or converting to an MLP structure must be mindful of potential tax pitfalls when transferring assets into the MLP. A. U.S. Assets The contribution of a U.S. subsidiary's assets to an MLP is generally eligible for tax-deferred or rollover treatment. 9

Transferring U.S. Assets to MLP Under special rules, it may be possible for some of the cash proceeds invested by Public Investors to be distributed to the contributing U.S. subsidiary on a tax-deferred basis (to the extent of tax-basis and there are strategies for increasing tax basis through new borrowings by the MLP to permit greater tax-deferred distributions). The U.S. subsidiary will pay tax on "built-in gain" in assets over time in order to provide Public Investors with the benefit of an effective "step-up" in tax basis in the contributed asset. B. Transferring Canadian Assets to an MLP (i) Subsection 97(2) Rollover Canadian taxes must be managed when Canadian assets are contributed into an MLP structure. The general rule under subsection 97(1) is that when a taxpayer transfers property to a partnership, and is a member of the partnership immediately after the transfer, the taxpayer is deemed to have disposed of the transferred property at its fair market value and the partnership is deemed to have acquired it at the same amount. Through this deemed disposition, the transferor will generally realize any previously unrealized gains or losses on the property at the time of the transfer or otherwise have an erosion of underlying tax pools. In limited circumstances, however, subsection 97(2) permits certain eligible property to be transferred on a tax-deferred rollover basis to a partnership. If subsection 97(2) applies to a transfer of property to a partnership, the rules in subsection 85(1) apply, with appropriate modifications. 25 Pursuant to these rules, the transferor and partnership can elect to transfer property into the partnership on a tax-deferred basis. The transferor and partnership must agree on an "elected amount" which is deemed to be the transferor's proceeds of disposition and the partnership's tax cost of the property. 26 The rules in subsection 85(1) operate to limit the range of the elected amount as well as how much consideration, other than transferee partnership interests, that may be received if the transfer is to remain fully tax-deferred. These alternative forms of consideration are frequently referred to as "boot" and may include cash, promissory notes, and assumptions of the transferors' liabilities. In order for subsection 97(2) to apply, the following conditions must be satisfied: 10

The transferred property must be property described in subsection 97(2), including capital property, Canadian resource property, foreign resource property, eligible capital property, and inventory of the taxpayer; The partnership must be a "Canadian partnership" immediately after the transfer; The transferor must be a member of the Canadian partnership immediately after the transfer; and The transferor and all members of the Canadian partnership must jointly elect to have the provisions of subsection 97(2) apply. A "Canadian partnership" is defined in subsection 102(1) as a partnership all of the members of which are resident in Canada at the relevant time. There is no express requirement for all the partners to be Canadian residents throughout the partnership's applicable fiscal period. In addition, Canadian partnerships are not required to be organized under Canadian law nor are they required to carry on any business in Canada. Accordingly, an MLP organized under U.S. law that is treated as a partnership for Canadian tax purposes, should qualify as a Canadian partnership for purposes of the Act so long as it is comprised exclusively of Canadian residents at the relevant time. In a tiered partnership (i.e., where at least one partner of a partnership is another partnerships), the CRA will look through the upper partnership to determine Canadian partnership status. 27 Thus, so long as all the partners of the top partnership are Canadian residents, the bottom partnership can qualify as a Canadian partnership. Given the difficulty for an MLP to qualify as a Canadian partnership but subject to the comments below, tax-deferred rollover treatment will generally not be available. In addition, should the MLP qualify as a Canadian partnership, SIFT tax issues will arise. (ii) Staggered Sale As there will eventually be non-residents in the MLP, the forgoing challenges may be overcome, subject to any anti-avoidance issues under section 245, by implementing a staggered sale. This would require a subsection 97(2) rollover for Canadians, followed by non-canadians becoming partners at a later time. In these circumstances, the SIFT tax would generally apply in the first tax year given that the partnership would be a Canadian resident partnership. However, this may not be a significant issue if there is immaterial income from NPP while the partnership is a SIFT partnership. The issue of how much time must elapse between the Canadian transferors and the non-resident transferors becoming partners in the partnership is unclear. However, we are aware of a public transaction where seven hours and twenty-one minutes elapsed between the transfers. (iii) Transfer to Canadian Limited Partnership In certain circumstances, it may be possible to obtain a Canadian tax deferral by transferring Canadian assets to a Canadian limited partnership owned in part (indirectly, through a ULC) by an MLP. Under this approach, a Canadian corporation ("Canco") sells assets to a Canadian limited partnership on a tax-deferred basis under subsection 97(2). Canco is controlled by the Sponsor, who also controls the MLP. In exchange for its assets, Canco receives an interest in the Canadian partnership and may take back "boot" including (i) cash, or (ii) MLP equity. Canco may take back enough cash to create leverage between ULC and Holdco. The more tax pools available to Canco, the more Canadian assets can be transferred and the more boot that can be received on a taxdeferred basis. In addition, the MLP will typically be given a right of first refusal ("ROFR") on the 11

partnership equity to protect against unauthorized transfers of partnership equity by Canco to a third party. Partial Sale to Canadian Limited Partnership (iv) Transfers to LLC Where Canadian assets are transferred to an MLP that has been formed as an LLC, no rollover will be available. In order for subsection 85(1) to apply, the transferee corporation must be a "taxable Canadian corporation". Pursuant to subsection 89(1), a "taxable Canadian corporation" must be a "Canadian corporation". A "Canadian corporation", 28 in turn, is a corporation that is currently resident in Canada and was (a) incorporated in Canada, or (b) resident in Canada since June 18, 1971. These definitions would generally exclude an LLC incorporated in the United States. (v) Sale at Shareholder Level As an additional alternative to Canco transferring its assets directly to the MLP (or a subsidiary thereof), Canco's public shareholders could transfer their shares to the MLP in exchange for cash, MLP units or a combination thereof. 12

Sale at Shareholder Level As before, this transfer can be undertaken on a tax-deferred basis for U.S. tax purposes but cannot be undertaken on a tax-deferred basis to an LLC or partnership for Canadian tax purposes unless the MLP is a "Canadian partnership". Accordingly, Canco's shareholders may be forced to realize and pay tax on any accrued gains. This will typically not be an issue for shareholders of Canco who are either non-residents of Canada or Canadian tax exempts. 29 For taxable investors, however, one means of accomplishing a tax-deferred transfer would be through an exchangeable share arrangement. Pursuant to this arrangement, investors of Canco would exchange their common shares for a class of non-voting, redeemable, retractable preference shares with a discretionary dividend in a Canadian subsidiary of the MLP. When and if a Canadian investor retracts its shares (and subject to customary overriding call rights by entities in the MLP structure), the Canadian subsidiary would satisfy any amounts payable on the exchange with MLP units. The exchange triggers a gain in Canada; however, the investor acquires liquid MLP units which are traded on a recognized stock exchange and can be sold to satisfy the tax burden. However, subsequent to the 2013 federal Budget this structure has to be carefully reviewed because of the introduction of the "character conversion" and the "synthetic disposition" rules. 30 The rules set out in the Budget aim to prevent the use of derivative forward agreements that convert ordinary income into capital gains. While the rules are potentially broad enough to capture exchangeable shares, the approach is subject to uncertainty. However, the Department of Finance has acknowledged that exchangeable shares were not an intended target of the Budget. In addition, the MLP could later convert Canco to a ULC, however, this could potentially trigger U.S. tax, as the conversion would generally be treated as a taxable disposition of the shares of Canco. In regards to shareholders of Canco who are non-residents of Canada, there will be no Canadian tax liability unless the shares are taxable Canadian property and no treaty relief is available. As discussed above, publicly-listed shares will be taxable Canadian property for a non-resident shareholder if the shareholder owns 25% or more of the issued shares of any class of the corporation during a five-year period, and the shares derive, or have derived in the past five years, more than 13

50% of their value from Canadian real and resource properties. If the shares are taxable Canadian property, the Canada-U.S. Tax Treaty 31 may offer tax relief to U.S. shareholders in certain circumstances as it effectively eliminates the five-year look-back period. 32 If the Canco shares do no derive more than 50% of their value from Canadian immovable property at the time of disposition, residents of the United States will not be subject to Canadian capital gains tax. By virtue of section 212.1, non-residents are effectively prevented from avoiding Part XIII withholding tax on dividends through non-arm's length sales of shares from one corporation resident in Canada to another. In particular, where a non-resident extracts boot in excess of the paid-up capital of the transferred shares, section 212.1 will trigger a deemed dividend on the excess, creating an immediate Part XIII withholding tax obligation. 33 Where the non-resident takes back shares of the purchaser corporation, the paid-up capital of the shares of the purchaser corporation will be reduced accordingly. 34 The non-resident is therefore unable to repatriate funds from Canada in excess of the original paid-up capital of the Canco shares on a non-arm's length share transfer without being subject to Part XIII dividend withholding tax. There may be potential section 212.1 workarounds (including a sale of partnership and/or sale to partnership), however, the general-anti avoidance rule in section 245 could be a concern. Where Canco shares are taxable Canadian property, non-residents must also consider what form of compliance is required under section 116: (i) notification, (ii) clearance certificate, or (iii) the excluded property exemption. 6. Operating Master Limited Partnerships with Canadian Assets A. Overview of the Canada-U.S. Tax Treaty and the Fifth Protocol The tax efficient operation of Canadian assets requires not only careful consideration of Canadian and U.S. domestic tax laws, but also how domestic rules interact and are modified by the Canada- U.S. Tax Treaty. The Canada-U.S. Tax Treaty often reduces or eliminates the rate of withholding tax applicable to certain passive types of income and relieves residents from one state from tax on active business income in the other state unless they carry on business through a permanent establishment in the other state. Like all of Canada's bilateral tax treaties, at the core of the Canada-U.S. Tax Treaty is the concept of residency: the treaty is only for the benefit of those persons who are residents of Canada, the U.S., or both countries. Article IV of the Canada-U.S. Tax Treaty defines the term "resident of a Contracting State" as "any person that, under the laws of the state, is liable to tax therein by reason of that person's domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature ". The Fifth Protocol to the Canada-U.S. Tax Treaty added special rules to Article IV of the Canada-U.S. Tax Treaty relating to flow-through and hybrid entities, and also introduced a Limitation on Benefits Article pursuant to which persons resident in Canada or the U.S. must also be a "qualifying person", or satisfy other tests, in order to be eligible for treaty benefits. 35 Article IV(6) of the Canada-U.S. Tax Treaty, the first of the hybrid rules, provides that a particular amount is considered to be derived by a resident of the U.S. where the person is considered under U.S. law to have derived the amount through an entity (other than an entity that is resident in Canada), and by reason of the entity being fiscally transparent under the laws of the U.S., the treatment of the amount under U.S. tax law is the same as it would be if the amount had been derived directly by that person. 36 "Same treatment" generally involves an analysis of the quantum, character, 14

and timing of the item of income, profit or gain under U.S. tax laws. 37 In essence, the provision allows a flow-through entity, such as an LLC, to benefit from the treaty on a derivative basis if its members would have been entitled to treaty benefits had they earned the amount in question directly. 38 The Fifth Protocol also introduced two anti-abuse provisions in Article IV(7) of the Canada-U.S. Tax Treaty that are unfavourable to several hybrid structures. Of particular concern for MLPs, Article IV(7)(b) of the Canada-U.S. Tax Treaty potentially denies favourable treaty-reduced withholding rates on payments from Canadian unlimited liability companies ("ULCs") to U.S. recipients. Pursuant to Article IV(7)(b) of the Canada-U.S. Tax Treaty, a U.S. resident will not be considered to have received an amount of income, profit, or gain if the U.S. resident is considered under the Act to have received the amount from a Canadian-resident entity that is fiscally transparent for U.S. tax purposes and the treatment of that amount for U.S. tax purposes is not the same as it would be if the Canadian resident entity were not fiscally transparent. B. Structures to Avoid Without careful planning, common holding structures can result in unintended and adverse tax consequences. Below are four examples of common structures that an MLP might consider when holding Canadian assets. Each structure has inherent deficiencies. Possible MLP Structures Structure 1 Structure 2 Structure 3 Structure 4 MLP (Del) Loan ULC CDN Assets (i) Canadian Operations carried on by a Canadian Limited Partnership held by U.S. Limited Partnership (MLP) In Structure 1, a Canadian limited partnership, held by a U.S. limited partnership, carries on business in Canada through a permanent establishment. Under this structure, all U.S. partners of the partnership would be required to include their share of the profit earned through the Canadian permanent establishment of the limited partnership in their "taxable income earned in Canada" under Part I of the Act. 15

The CRA's long-standing position is that the partners of a foreign partnership can qualify for treaty benefits on the basis that its income is treated as earned by the partners. 39 Accordingly, Article IV(6) of the Canada-U.S. Tax Treaty is not required in order to look through the partnership and attribute an item of Canadian-source income to the members of the partnership. All U.S. investors would be required to file Canadian tax returns and would also potentially be subject to section 116 withholding obligations. In addition, given that this structure does not utilize Canadian leverage, no deductions would be available to reduce Canadian Part I income tax. (ii) Canadian Operations carried on by a Canadian Limited Partnership held by a U.S. Limited Liability Company In Structure 2, a Canadian limited partnership held by a U.S. LLC carries on business in Canada through a permanent establishment. The LLC is treated as a corporation for Canadian tax purposes but is fiscally transparent for U.S. tax purposes. Given that the 99% member of the Canadian limited partnership is a U.S. LLC, the LLC effectively acts as a "blocker" for U.S. investors. Accordingly, U.S. investors are not required to file Canadian tax returns and any section 116 withholding issues will be dealt with at the LLC level. The drawback of this structure is that significant Canadian branch tax may be payable by the LLC under Part XIV of the Act in respect of the Canadian profits. Generally, the rate of branch tax under subsection 219(1) is 25%. Article X(6) of the Canada-U.S. Tax Treaty limits the amount of branch tax that Canada may impose to 5% 40 of "earnings of a company" attributable to a permanent establishment in Canada. In addition, Article X(6) of the Canada-U.S. Tax Treaty provides the company with a $500,000 exemption. In a number of technical interpretations, the CRA has stated that treaty benefits under Article X(6) of the Canada-U.S. Tax Treaty apply only if the income attributable to the LLC's permanent establishment was derived in accordance with Article X(6) of the Canada-U.S. Tax Treaty by a corporation that is a "qualifying person" under Article XXIX-A(2) of the Canada-U.S. Tax Treaty or a U.S. resident entitled to benefits under Article XXIX-A(3) of the Canada- U.S. Tax Treaty. 41 In the CRA's view, the treaty does not limit branch tax in respect of individual members of an LLC. 42 Thus, it may be difficult to establish a rate of branch tax other than the 25% default rate. In addition, as was the case in Structure 1, given that this potential structure does not utilize Canadian leverage, no interest deductions will available to reduce Canadian Part I income tax. (iii) Canadian Unlimited Liability Company held by U.S. LP In Structure 3, a Canadian ULC held by a U.S. limited partnership, carries on business in Canada through a permanent establishment. MLPs holding Canadian assets will frequently use a Canadian ULC as an operating entity to hold Canadian assets. The ULC provides a flow-through for U.S. tax purposes but is taxable as a corporation for Canadian purposes. In order to minimize tax at the ULC level, the ULC is capitalized with debt and equity with the aim that interest on the debt will be sufficient to minimize ULC's income. In this regard, Canada's "thincapitalization rules" must be considered. 43 The rules effectively limit the amount of interest expense that can be deducted by a Canadian corporation in respect of debts owed to certain non-residents based on a ratio of debt-to-equity of 1.5 to 1.0 (i.e., 60% debt, 40% equity). Interest on debt in excess 16

of this ratio would generally not be deductible and would be deemed to be a dividend rather than interest. Provided the 1.5:1 debt-to equity ratio is maintained, and the terms of the loan otherwise comply with the requirements for interest deductibility in paragraph 20(1)(c) and section 67, interest payable by the ULC should generally be deductible. Given the disregarded nature of the structure for U.S. tax purposes, there should be no recognition of interest income in the U.S. If the ULC has residual tax, the U.S. partners of the MLP may be able to claim a foreign tax credit ("FTC") in respect of the Canadian ULC, depending on the circumstances. Payments from the ULC to the U.S. partnership will be subject to Canadian withholding tax. Section 212 subjects non-residents to a tax of 25% on certain passive amounts that a person resident in Canada pays or credits to the non-resident. In most cases, Canada's tax treaties reduce the amount below the domestic rate. Subsection 212(2) imposes the withholding tax on dividends paid from Canadian corporations to nonresidents. Article X of the Canada-U.S. Tax Treaty generally limits the rate to 5% for dividends paid to shareholders owning at least 10% of the voting stock of the Canadian corporation, and to 15% for "portfolio" dividends. The Fifth Protocol amended Article X(2)(a) of the Canada-U.S. Tax Treaty to treat a company which beneficially owns dividends paid by a corporation resident in Canada (i.e., the ULC) and derived through an entity considered fiscally transparent under U.S. tax laws (i.e., the MLP), as owning its allocable share of the stock of the dividend payor (i.e., the ULC) that are held by the partnership. In regards to interest payments made by the ULC, paragraph 212(1)(b) applies withholding tax for any interest paid or credited by a Canadian resident to a non-resident. 44 This withholding is, however, generally eliminated under Article XI of the Canada-U.S. Tax Treaty. Notwithstanding the foregoing, where the parent of the ULC is a U.S. limited partnership, Article IV(7)(b) of the Canada-U.S. Tax Treaty will generally operate to deny treaty benefits. As noted above, Article IV(7)(b) of the Canada-U.S. Tax Treaty applies where the receipt of an amount by the MLP from a ULC that is disregarded would not have the same treatment as an amount received from a ULC if it were regarded. Since the ULC is fiscally transparent for U.S. tax purposes, the MLP would be viewed as carrying on business directly in Canada and the actual payments from the ULC to the MLP would be ignored. However, if the ULC were not fiscally transparent for U.S. tax purposes, the partners would be regarded as receiving interest payments from the ULC through the MLP. Given the potentially different tax treatments, no treaty benefits will be available to U.S. limited partners of the MLP. 45 (iv) Canadian Unlimited Liability Company held by U.S. LLC In Structure 4, a Canadian ULC held by a U.S. LLC carries on business in Canada through a permanent establishment. In these circumstances, the MLP will not receive treaty relief and, accordingly, will be subject to a 25% withholding tax on all dividends and interest received from the Canadian ULC. The CRA's administrative position is that a fiscally transparent LLC is not itself liable to tax in the U.S. and, accordingly, is not a resident of the U.S. for the purpose of the Canada-U.S. Tax Treaty. 46 The CRA has acknowledged, however, that pursuant to Article IV(6) of the Canada-U.S. Tax Treaty, treaty benefits may be available to an LLC in respect of its income if the members of the LLC are residents of the U.S. who are entitled to the benefits of the Canada-U.S. Tax Treaty 47 and under U.S. tax laws the members of the LLC are considered to have derived such amounts through the LLC. As noted above, an amount is considered to be derived by a U.S. resident if (i) the person is considered to 17

have derived the amount through an entity, other than an entity resident in Canada, and (ii) by reason of the entity being fiscally transparent under U.S. tax laws, the treatment of the amount under U.S. tax laws is the same as it would be had the amount been derived directly by that person. It should be noted, however, where amounts are received or earned by an LLC through a source that is disregarded for U.S. tax purposes, such as a ULC, the CRA has taken the position that treaty relief will not be available. The CRA has stated that Article IV(6) of the Canada-U.S. Tax Treaty will not apply to treat a particular amount of Canadian-source income as "derived" by the U.S. members of the LLC, given that the amount is disregarded for U.S. tax purposes (for example, dividends and interest paid by a single-member ULC to its shareholder). 48 Thus, the so-called two-step distribution (i.e., a deemed dividend followed by a return of paid-up capital) is generally not available where the deemed dividend created under step one is disregarded for U.S. tax purposes and thus cannot be derived through the fiscally transparent entity. Similarly, Article IV(7)(b) of the Canada-U.S. Tax Treaty would apply to deny treaty benefits. Under the same reasoning that applied to the ULC held by a U.S. limited partnership (i.e., structure 3), the receipt of income by the LLC from a ULC that is regarded (i.e., dividend payments) would not have the same treatment as an amount received from a ULC if it were disregarded (i.e., profits from carrying on business). Accordingly, a full 25% Canadian withholding would apply on payments from the ULC to the LLC. C. Tax-Efficient Structuring With proper planning and structuring, an MLP can be structured to reduce Canadian taxes within the existing Canadian tax regime. To illustrate, assume U.S. investors invest directly in a Canadian public corporation that holds Canadian assets and has the following attributes: Attributes Market capitalization $3.0 billion EBITDA $300 million Bank debt $500 million External interest rate 5% Annual tax pool deductions $80 million Canadian withholding rate 10% / 0% (U.S.) With these attributes, Canadian tax payable would be as follows: Tax Payable (in millions) EBITDA $300 External Interest ($500 million @ 5%) ($25) Annual tax pool deductions ($80) Internal interest $0 Taxable Income $195 Canadian Part I Tax @ 25% $48.75 Canadian Part XIII Withholding Tax @ $0 10% Cash Tax $48.75 18

The Canadian corporation's income would be fully taxed at Canada's corporate rate of approximately 25% and the corporation would not benefit from any internal interest deductions. Another downside of this structure is that U.S. public shareholders would not be entitled to claim a U.S. foreign tax credit for any Canadian corporate tax paid by the Canadian corporation. Below are two potential structures which demonstrate how an MLP can invest in Canadian assets on a more tax efficient basis. (i) MLP with Luxembourg Intermediary As discussed above, the use of a Canadian ULC is generally advantageous as it can be treated as a disregarded entity for U.S. tax purposes. Under one potential structure, a Luxembourg Société à responsabilité limitée ("Lux SARL") 49 could be interposed as an intermediary between the Canadian ULC and the MLP. A Lux SARL may be a disregarded entity for U.S. tax purposes, but is treated as a corporation and treaty resident for Canadian tax purposes and is therefore generally eligible for treaty relief under the Canada-Luxembourg Tax Treaty. 50 Luxembourg Intermediary To implement this structure, Lux SARL could make a loan to a Canadian ULC ("AcquisitionCo"). AcquisitionCo could then use the loaned funds to acquire the target entity and, in turn, the target could be turned into a ULC through an amalgamation. As discussed above, in order to minimize tax at the ULC level, the ULC could be capitalized with debt and equity with the aim of reducing Canadian Part I tax. The debt/equity ratio must comply with a 60:40 ratio required under Canadian thin capitalization rules. By utilizing this structure, the anti-hybrid treaty denial rule in Article IV(7)(b) of the Canada-U.S. Tax Treaty is no longer an issue. From a Canadian tax perspective, the ULC would be paying dividends or interest to a treaty resident of Luxembourg. Canadian Part XIII withholding tax on dividends would be reduced to 5% under the Article X(2) of the Canada-Luxembourg Tax Treaty, provided Lux SARL is considered the "beneficial owner" of the dividends. Similarly, withholding tax on interest payments from the ULC to Lux SARL would be reduced to 10% of the gross amount of the interest pursuant to 19

Article XI(2) of the Canada-Luxembourg Tax Treaty, provided Lux SARL is considered the "beneficial owner" of the interest. There have been two favourable Canadian court decisions on the concept of "beneficial ownership" in Prévost Car Inc. v. The Queen ("Prévost Car"), 51 and Velcro Canada Inc. v. The Queen ("Velcro"). 52 In Prévost Car, a Canadian corporation paid dividends to a corporate shareholder resident in the Netherlands, which in turn paid dividends of substantially the same amount to corporate shareholders in Sweden and the United Kingdom. If the dividends were paid directly to the corporate shareholders, Canadian withholding tax would have been limited to 15% under the Canada-Sweden Tax Treaty 53 and to 10% under the Canada-U.K. Tax Treaty. 54 However, pursuant to Article X of the Canada- Netherlands Tax Treaty, 55 the rate of withholding was reduced to 5%. The issue was whether the Dutch company was the "beneficial owner" of the dividends. Despite several bad facts, including a provision in the shareholders' agreement that no less than 80% of the Canadian corporation's profits must be distributed, the Tax Court held in favour of the taxpayer. Rip ACJ described a beneficial owner as: the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. The person who is beneficial owner of the dividend is the person who enjoys and assumes all the attributes of ownership. In short the dividend is for the owner s own benefit and this person is not accountable to anyone for how he or she deals with the dividend income. 56 Rip ACJ found that there was no pre-determined or automatic flow of funds to the ultimate shareholders because the Dutch corporation was not party to the shareholders' agreement and, as such, was under no legal obligation to pay dividends pursuant to the agreement. 57 Accordingly, the reduced 5% Canadian withholding rate applied. In a short decision, the Federal Court of Appeal dismissed the Crown's appeal. In Velcro, a Canadian corporation paid royalties to a related Dutch cooperative. The cooperative, in turn, had a contractual obligation to pay 90% of the royalties to a Netherlands Antilles company within 30 days. Canada does not have a tax treaty with Netherlands Antilles. Accordingly, if the royalties were paid directly to the entity resident in the Netherlands Antilles, the royalties would have been subject to a 25% Canadian withholding tax. 58 However, under the Canada-Netherlands Tax Treaty, the royalty withholding rate was reduced to 10% and, following an amendment, to 0%. The issue was which company was the "beneficial owner" of the royalties. Despite the contractual obligation to pay 90% of the royalties, the Court held that the Dutch cooperative was the beneficial owner. The Court found that it retained the attributes of beneficial ownership, namely possession, use, risk, and control. 59 As such, the reduced withhold rates applied. In the past, the CRA has taken the position that the general anti-avoidance rule ( GAAR ) may apply under certain facts and circumstances, but that it would likely not apply if a Canadian ULC carried on active business in Canada and a Lux SARL was interposed merely to obtain reduced treaty withholding rates on dividends. 60 More recently, however, the CRA has stated that it will consider the application of the GAAR to deny treaty benefits "where a transaction or a series of transactions is carried out so that income is paid to a treaty resident in order to obtain the benefits of the particular treaty, and those benefits would not have applied in the absence of the transaction or series of transactions." 61 In addition, in the 2013 Budget released on March 21, 2013 and accompanying consultation paper release on August 12, 2013, 62 the Federal Government expressed concerns about the growing 20