PLR 1222029: IRS rules that petroleum-water services produce qualifying income

Plain-English summary

The IRS ruled that a limited partnership's income from removing, transporting, storing, and disposing of petroleum-water mix from oil and natural gas operations is qualifying income under the publicly traded partnership rules. The ruling also covers income from separating the mix into wastewater and condensate, selling recovered condensates, and treating some of the mix for later drilling use. The partnership represented that it would not market hydrocarbons to retail end users. The ruling matters because a publicly traded partnership generally must receive at least 90 percent qualifying income to avoid being treated as a corporation under section 7704.

Ruling snapshot

• Question: Does income from petroleum-water handling, related treatment, transportation, disposal, and condensate sales qualify under section 7704?
• Outcome: Approved
• Key authorities: IRC § 7704(b), (c), and (d)(1)(E)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201222029 Third Party Communication: None
Release Date: 6/1/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 7704.03-00 ----------------------------, ID No. ---------------
-----------------
Telephone Number:

                                                            Refer Reply To:

------ CC:PSI:02
------------------------------------------ PLR-145204-11
--------------------------------------------- Date:
-------------------------- February 09, 2012

Legend
X = ------------------------------------------------------------------------------------------------------
------------------------
State = -------------

Dear ------------:

This letter responds to a letter from your authorized representative dated October 21,
2011, submitted on behalf of X requesting a ruling concerning the qualifying income
exception to the publicly traded partnership rules of § 7704 of the Internal Revenue
Code.

X is a limited partnership organized under the laws of State. X, through a wholly owned
subsidiary that is disregarded for U.S. federal income tax purposes, will earn income by
providing services to customers engaged in the exploration for, and the development
and production of, oil and natural gas. Specifically, X will earn income from the
removal, transportation, and disposal of the petroleum-water mix produced in
connection with natural gas processing activities. X also intends to earn income in
connection with a fluid treating/recycling business, whereby X will conduct additional
treatment activities to render a portion of the petroleum-water mix, not otherwise
marketable as a hydrocarbon, suitable for use in later drilling operations. X also plans
to generate income from the sale of recovered condensates, although it represents that
it will not market hydrocarbons to end users at the retail level.

Raw natural gas extracted from natural gas reservoirs is a mixture of many compounds
that in combination are not ready to be transported from the wellhead for further
processing or used as a fuel source. To meet pipeline standards, the compounds found
in raw natural gas (water, sulfur and natural gas liquids, including ethane, propone, and
butane) must be removed at the wellhead. One of the unavoidable byproducts of
natural gas processing is water saturated with petroleum molecules, which X refers to
as “petroleum-water” mix. Most plant and field locations have very little petroleum-water
mix storage capacity, making reliable removal services essential. Natural gas
producers rely on third parties, such as X, to remove, transport, and dispose of the
petroleum-water mix generated by their facilities to enable continuing development and
production operations. Due to the high hydrocarbon levels in the mix, the material is
hazardous and must be properly handled to comply with applicable state and Federal
environmental regulations. Once removed from the site, the petroleum-water mix is
further processed to segregate it into waste water and marketable condensate. The
waste water is usually pumped into a disposal well, in compliance with state and
Federal regulations, and the condensate is sold.

X will charge its customers fees for its petroleum-water mix storage and disposal
services. A petroleum-water mix disposal company typically charges an hourly fee for
its transportation services and a separate fee at either hourly or per-barrel rates for its
removal/disposal services. X also plans to generate income from the sale of petroleum
condensates. Sales proceeds from petroleum condensates often account for a
substantial portion of a petroleum-water mix disposal company’s income and often
exceed the revenue earned from the removal services. X will also conduct additional
treatment activities to render a portion of the petroleum-water mix, not otherwise
marketable, suitable for use in later drilling operations and either re-convey the
treatment mix to its customers or third parties.

Section 7704(g) provides generally that a publicly traded partnership shall be treated as a corporation.

Section 7704(b) provides that the term “publicly traded partnership” means any
partnership if (1) interests in the partnership are traded on an established securities
market, or (2) interests in the partnership are readily tradable on a secondary market
(or substantial equivalent thereof).

Section 7704(c)(1) exempts from treatment as a corporation any publicly traded
partnership for any tax year if the partnership meets the gross income requirements of
§ 7704(c)(2) for that year and each preceding tax year beginning after December 31,
1987, during which the partnership (or any predecessor) was in existence. Section
7704(c)(2) provides that a partnership meets the gross income requirements of § 7704
for any tax year if 90% or more of the partnership’s gross income for that year consists
of qualifying income.

Section 7704(d)(1)(E) defines ”qualifying income” to include income and gains derived
from the exploration, development, mining or production, processing, refining,
transportation, or marketing of any material or natural resource.

Based solely on the facts submitted and representations made, we conclude that X’s
gross income from the transportation, storage, and disposal of petroleum-water mix
derived from oil and natural gas wells, including any associated condensate sales, is
qualifying income within the meaning of § 7704(d)(1)(E).

Except for the specific ruling above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion as to whether X is taxable as a
partnership for federal tax purposes.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that this ruling may not be used or cited as precedent. Under a power of
attorney on file with this office, we are sending a copy of this letter to your authorized
representative.

                                  Sincerely,



                                  Bradford R. Poston
                                  Senior Counsel, Branch 2
                                  (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc: