IRS treats oilfield water and waste services as qualifying partnership income

Plain-English summary

The IRS ruled that specified income of a publicly traded limited partnership would be qualifying income under IRC § 7704(d)(1)(E). The services include supplying and transporting water used in hydraulic fracturing, disposing of flowback and other drilling wastes, and hydrocarbon remediation. The ruling covers the income described in the request, but does not decide whether the partnership meets the separate 90 percent gross-income requirement under § 7704(c)(1). The ruling may continue to be relied on by a resulting partnership after a qualifying technical termination under § 708(b)(1)(B).

Ruling snapshot

• Question: Does income from the company's described water supply, waste disposal, and hydrocarbon remediation services qualify under § 7704(d)(1)(E)?
• Outcome: Approved, the described income was ruled to be qualifying income
• Key authorities: IRC § 6426; IRC § 708; IRC § 7701; IRC § 7704; IRC § 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201410017 Third Party Communication: None
Release Date: 3/7/2014 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
------------------------------------------------------------ ----------------------, ID No. -----------------
------------------- Telephone Number:
-------------------------------------------- ---------------------
------------------------------- Refer Reply To:
------------------------------------------ CC:PSI:B03
PLR-124570-13
Date:
October 28, 2013

                                                LEGEND

Company = --------------------------------------------------------------------------------------------------------------------

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

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

  This responds to a letter dated May 28, 2013, and subsequent correspondence,

submitted on behalf of Company, requesting a ruling concerning the qualifying income
exception to the publicly traded partnership rules of § 7704 of the Internal Revenue
Code (“Code”).
FACTS

    Company is a limited partnership organized under the laws of State. Company is

a “publicly traded partnership” within the meaning of § 7704(b) of the Code. Company,
through affiliated limited partnerships or disregarded entities, represents that it will
provide essential fluid handing and disposal services to oil and natural gas producers
engaged in the exploration, development and production of oil and natural gas. This
ruling request involves income Company derives from the supply of water in the
fracturing process; the disposal of flowback, produced water, pit water, drilling mud and
other drilling and production wastes; and hydrocarbon remediation.

    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. Company will earn income from the supply of water used in the
fracturing process. Company will provide transportation services for the water via
trucks, tanks and pipelines. As the business grows, Company expects to source a
PLR-124570-13 2

portion of its water from third parties. With respect to the water sourced from third
parties, Company will repurpose an existing gas gathering system that it owns and
convert that system into a water transportation system. Company will also provide inter-
well site transportation services for which Company will charge on a per barrel, daily or
hourly rate, or on a per-volume transported basis.

   In addition, Company represents it will earn income from the disposal of

flowback, produced water, pit water, drilling mud and other drilling and production
wastes which result during the fracturing process in compliance with environmental
regulations.

    Company also represents that will earn income from hydrocarbon remediation

services in connection with its fluid and other oilfield waste handling and disposal
services. Company will remove skim oil and other similar hydrocarbons from the drilling
waste at its facilities during the disposal process and to sell the reclaimed hydrocarbons
in the relevant markets.

                              LAW AND ANALYSIS

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) interests 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) for any taxable year if 90 percent or more of the gross income of such
partnership 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), industrial source carbon dioxide, or the transportation or storage of any fuel
described in §§ 6426(b), (c), (d), or (e) or any alcohol fuel defined in § 6426(b)(4)(A) or
any biodiesel fuel defined in § 40A(d)(1).
PLR-124570-13 3

    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:

  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 submitted and representations made, we conclude that the
income derived by Company from the supply of water in the fracturing process; the
disposal of flowback, produced water, pit water, drilling mud and other drilling and
production wastes; and hydrocarbon remediation is qualifying income within the
meaning of § 7704(d)(1)(E).
PLR-124570-13 4

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal tax consequences of any transaction or item discussed or referenced in this
letter. In particular, no opinion is expressed as to whether Company meets the 90
percent gross income requirement of § 7704(c)(1) in any taxable year for which this
ruling may apply.

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.

This ruling is directly only to the taxpayer requesting it. Section 6110(k)(3) provides that
it may not be used or cited as precedent. However, in the event of a technical
termination of Company under § 708(b)(1)(B), the resulting partnership may continue to
rely on this ruling in determining its qualifying income under § 7704(d)(1)(E).

Pursuant to the power of attorney on file with the office, a copy of this ruling will be sent
to taxpayer’s authorized representatives.

                                   Sincerely,



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

Enclosures (2)

   A copy of this letter
   A copy for § 6110 purposes