PLR 1338035: IRS treats oilfield waste and related services as qualifying partnership income

Plain-English summary

A planned publicly traded partnership intended to provide fluid handling, treatment, transportation, and disposal services for oil and natural gas producers. The IRS concluded that income from removing, treating, recycling, and disposing of fracturing flowback, produced water, and other well waste would be qualifying income under IRC § 7704(d)(1)(E). It also treated income from selling salvaged hydrocarbons as qualifying, except income from retail sales to end users. Related services such as refined-fuel supply, rail assets, communications technology, and infrastructure inspections also qualified when provided for customers' drilling, exploration, production, transportation, or mining activities, subject to the stated retail exclusion. The ruling did not decide whether the partnership would satisfy the separate 90 percent gross-income test.

Ruling snapshot

• Question: Which planned oilfield services would generate qualifying income under IRC § 7704(d)(1)(E)?
• Outcome: Approved, the described income was treated as qualifying income subject to the ruling's conditions.
• Key authorities: IRC §§ 7704(a), 7704(b), 7704(c), and 7704(d)(1)(E); IRC § 7701(a).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201338035 Third Party Communication: None
Release Date: 9/20/2013 Date of Communication: Not Applicable
Index Number: 7704.00-00, 7704.03-00
Person To Contact:
---------------------------------------------------- ---------------------, ID No. -----------------
----------------------------------------- Telephone Number:
--------------------------------------------- ---------------------
---------------------------------------- Refer Reply To:
CC:PSI:B03
PLR-152307-12
Date:
May 09, 2013

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

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

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

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

   This letter responds to a letter dated December 7, 2012, and subsequent

correspondence, submitted on behalf of X by X’s authorized representatives, requesting
a ruling concerning the qualifying income exception to the publicly traded partnership
rules of § 7704 of the Internal Revenue Code.

                                                   FACTS

    X is a limited liability company 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). X represents that Y will earn income by providing
services to oil and natural gas producers critical to the producers’ ability to retrieve
otherwise inaccessible oil and gas reserves. Specifically, Y will earn income by
providing essential fluid, solids, and other oilfield waste handling, treatment, and
disposal services necessary for its customers’ use of the fracturing technique of oil and
natural gas extraction. X intends that Y provide such services through affiliated
operating limited partnerships, limited liability companies, or disregarded entities.

   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 supply of water, chemicals, and other
solutions used in the fracturing process. Y will provide transportation services for those

PLR-152307-12 2

fluids via trucks, tanks, and, in some cases, pipelines. Y also will provide heating
services with respect to such fluids using superheaters and hot oilers. In addition, Y will
treat and dispose of completion fluids, drilling muds, drill cuttings, contaminated soil,
tank bottoms, produced water, pit water, fracturing fluid and flowback which result from
the use of the fracturing process in compliance with environmental regulations. 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 provision of fluids and waste removal, treatment, recycling, and

disposal services, Y will earn income from hydrocarbon remediation services. Y will
remove such hydrocarbons from drilling waste at its treatment facilities during the waste
treatment and disposal process. Y will then sell such reclaimed hydrocarbons on
relevant markets. X represents that Y does not intend to market reclaimed
hydrocarbons to end users at the retail level and, to the extent that Y earns income from
the marketing of reclaimed hydrocarbons to end-users at the retail level, Y will treat
such income as non-qualifying income under § 7704(d)(1)(E).

     X also represents that Y will provide what it refers to as further “miscellaneous

services” related to and in support of its primary fluid handling business. Y will earn
income from the provision of refined fuels, such as diesel, to oil and natural gas
producers for use in their exploration and production activities. X represents that Y
does not intend to provide refined fuels to end-users at the retail level, and, to the extent
that Y earns income from the provision of refined fuels to end users at the retail level, Y
will treat such income as non-qualifying income under § 7704(d)(1)(E). Furthermore, to
support this business, Y will design, own, manage, and operate rail and rail
transportation assets. Y also will design, develop, own, operate, license and manage
communications technology which will provide remote monitoring capabilities to oil and
natural gas producers and early detection of problems with the pumps and recovery
facilities used in the production activities. Finally, because oil and natural gas
companies as well as oil and gas pipeline operators are required by law at both the
federal and the state level to inspect their oil and gas pipelines and gathering systems
on a regular basis to protect the environment and ensure public safety, Y will provide
infrastructure inspection services.

                                       LAW

  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).

PLR-152307-12 3

   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” includes 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 of

1987, 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:

PLR-152307-12 4

   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).

                                   CONCLUSION

   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 hydrocarbons, 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).

     Finally, we conclude that, to the extent the “miscellaneous services” described

above are provided to customers engaged in drilling, exploration and production,
transportation, or mining of a mineral or natural resource for use in those activities,
excluding income earned from providing such services with respect to end users at the
retail level, Y’s gross income from the provision of those services is 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). To the extent that Y’s gross
income from its activities described above are not attributable to its customer’s
§ 7704(d)(1)(E) activities (i.e., to activities of the customer, such as drilling, exploration
and production, transportation, or mining of a mineral or natural resources, that would
generally be expected to produce gross income that is qualifying under § 7704(d)(1)(E)
regardless of the customer’s Federal tax classification), this letter will not apply in
determining whether the income that may be derived by X from such other uses
constitutes qualifying income under § 7704(d)(1)(E).

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

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

PLR-152307-12 5

  In accordance with the Power of Attorney on file with this office, we are sending

copies of this letter to your authorized representatives.

  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,

                                  /s/

                                  Richard T. Probst
                                  Senior Technician Reviewer, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: