PLR 1227002: IRS treats oilfield waste treatment and recovered products as qualifying income

Plain-English summary

The IRS ruled that income from removing, treating, recycling, and disposing of waste generated by oil and gas wells during hydraulic fracturing qualified as qualifying income under § 7704(d)(1)(E). The ruling also treated income from marketing salvaged crude oil and an asphalt alternative made from drilling and production waste as qualifying income, except for retail marketing to end users. The ruling did not determine whether the partnership satisfied the separate 90 percent gross-income requirement.

Ruling snapshot

• Question: Did income from oilfield waste services and marketing recovered products qualify under the publicly traded partnership rules?
• Outcome: Approved
• Key authorities: IRC §§ 7704(c), 7704(d)(1)(E); H.R. Rep. No. 495, 100th Cong., 1st Sess. 943 (1987); S. Rep. No. 445, 100th Cong., 2d Sess. 424 (1988)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201227002 Third Party Communication: None
Release Date: 7/6/2012 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
----------------------------- ----------------------, ID No. -----------------
----------------------------------------------- Telephone Number:
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-------------------------------- Refer Reply To:
-------------- CC:PSI:02
-------------------------------------- PLR-138008-11
Date:
March 01, 2012

                                               LEGEND

                 -----------------------------------------------

X =
----------------------------

Y = ------------------------------------------------

State = -------------

a = ----

b = ----

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

   This letter responds to a letter from X’s authorized representatives dated

September 8, 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 (the Code).

   X is a corporation organized under the laws of State. X intends to form Y under

the laws of State and cause Y to become a publicly traded partnership within the
meaning of § 7704(b). Y will earn income for providing services to customers engaged
in the exploration for, and the development and production of, oil and natural gas.

Specifically, Y will earn income from the removal, treatment, recycling, and disposal of
waste products generated by the fracturing process and residual wastes that
accumulate in crude oil tank bottoms.

    Fracturing is a technique by which fluids are pumped into an oil or gas well at

high pressure to fracture geologic formations and open up pathways for the oil or gas to
flow up for extraction. Y will earn fees from the removal, treatment, recycling, and
disposal of flowback generated in the fracturing process, naturally occurring produced
water, drilling muds, contaminated soils, and other residual waste products. Y will treat
the flowback and produced water at offsite treatment facilities and onsite through the
use of a closed-loop system. The closed-loop system removes solid wastes and heavy
brine from the fluids allowing oil and gas producers to reuse the fluids in the fracturing
process. Employees of Y will remain onsite to oversee the treatment process and
periodically transport solid wastes to offsite treatment facilities. Y will not provide
closed-loop systems to oil and gas producers to operate independently or for third party
waste disposal providers to operate. Y will also remove and treat fluids used to wash
and remove debris from containers, trucks, and equipment used by the oil and gas
producers.

    In addition to its waste removal, treatment, recycling, and disposal services, Y

will earn income from the production and marketing of hydrocarbon products recovered
from oil field wastes handled by Y. Y will collect crude oil skimmed from oil field wastes
during the waste treatment process and sell the salvaged crude oil to oil refiners who
do not themselves consume the crude oil in their own operations. X represents that Y
will treat any income derived from the sale of crude oil to third party end users as
nonqualifying income. Y will also produce an asphalt alternative consisting of a percent
drilling and production wastes and b percent binder. Y will sell the asphalt alternative to
government entities and commercial users for road construction and paving.

  Section 7704(a) provides 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 that partnership are traded on an established securities
market, or (2) interest in that partnership are readily tradable on a secondary market (or
substantial equivalent thereof).

   Section 7704(c)(1) provides that § 7701(a) shall not apply to any publicly traded

partnership for any taxable year if such partnership met the gross income requirements
of § 7704(c)(2) for such taxable year and each preceding taxable year beginning after
December 31, 1987, during which the partnership (or any predecessor) was in
existence.

   Section 7704(c)(2) explains that a partnership meets the gross income

requirements of § 7704(c)(2) for any taxable year if 90 percent or more of the gross
income of such partnership for such taxable year is qualifying income.

   Section 7704(d)(1)(E) provides that the term “qualifying income” means income

or gains derived from the exploration, development, mining or production, processing,
refining, transportation (including pipelines transporting gas, oil, or products thereof), or
the marketing of any mineral or natural resource (including fertilizer, geothermal energy,
or timber).

  The Conference Report accompanying the Omnibus Budget Reconciliation Act

of1987, in discussing the type of qualifying income described in § 7704(d)(1)(E),
provides the following:

  Income and gains from certain activities with respect to minerals or natural
  resources are treated as passive-type income. Specifically, natural resources
  include fertilizer, geothermal energy, and timber, as well as oil, gas or products
  thereof . . . For this purpose, oil, gas, or products thereof means gasoline,
  kerosene, number 2 fuel oil, refined lubricating oils, diesel fuel, methane, butane,
  propane, and similar products which are recovered from petroleum refineries or
  oil field facilities. Oil, gas, or products thereof are not intended to encompass oil
  or gas products that are produced by additional processing beyond that of
  petroleum refineries or field facilities, such as plastics or similar petroleum
  derivatives. Income of certain partnerships whose exclusive activities are
  transportation and marketing activities is not treated as passive-type income. For
  example, the income of a partnership whose exclusive activity is transporting
  refined petroleum products by pipeline is intended to be treated as passive-type
  income, but the income of a partnership whose exclusive activities are
  transporting refined petroleum products by truck, or retail marketing with respect
  to refined petroleum products (e.g., gas station operations) is not intended to be
  treated as passive type income.

H.R. REP. NO. 495, 100th Cong., 1st Sess. 943 (1987), 1987-3 C.B. 226-227.

  The Senate Report accompanying the Technical and Miscellaneous Revenue Act

of 1988 provides the following:

  With respect to marketing of minerals and natural resources (e.g. oil and gas and
  products thereof), the Committee intends that qualifying income be income from
  marketing at the level of exploration, development, processing or refining oil and
  gas. By contrast, income from marketing minerals and natural resources to end
  users at the retail level is not intended to be qualifying income. For example,
  income from retail marketing with respect to refined petroleum products (e.g., gas
  station operations) is not intended to be treated as qualifying income.

S. REP. NO. 445, 100th Cong., 2d Sess. 424 (1988).

    Based solely on the facts presented and representations made, we conclude that

Y’s gross income from the removal, treatment, recycling, and disposal of fracturing
flowback, produced water, and other residual waste products generated by oil and gas
wells during the fracturing process is qualifying income within the meaning of
§ 7704(d)(1)(E). We further conclude that the income derived from the marketing and
distribution of salvaged crude oil and asphalt alternative produced by Y, excluding
income earned from marketing minerals and natural resources to end users at the retail
level, will also constitute qualifying income within the meaning of § 7704(d)(1)(E).

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. In particular, no opinion is expressed as to whether Y meets
the 90 percent gross income requirement in § 7704(c)(1).

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

                                    Sincerely,

                                    Melissa C. Liquerman
                                    Branch Chief, Branch 2
                                    (Passthroughs & Special Industries)

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