LNG terminal contract income qualifies under section 7704

Plain-English summary

A limited partnership planned a public offering and would indirectly own interests in a liquefied natural gas terminal. The terminal regasified imported LNG and was adding facilities to liquefy domestic natural gas for export. Customers would pay under contracts covering processing, regasification, liquefaction, storage, and related movement of natural gas and LNG through the terminal. The IRS ruled that the partnership's direct or indirect income from those contracts was qualifying income under section 7704(d)(1)(E), but did not decide whether it met the overall 90 percent gross-income requirement.

Ruling snapshot

• Question: Does income from contracts for processing, regasifying, liquefying, and storing natural gas qualify under the publicly traded partnership rules?
• Outcome: Approved
• Key authorities: IRC § 7704(a), (b), (c), and (d)(1)(E)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201537007 Third Party Communication: None
Release Date: 9/11/2015 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
--------------------------------- -----------------------, ID No. -------------------
----------------------------------------------------- ---------------------------------------------------
----------------- Telephone Number:
---------------------------------- ----------------------
----------------------------- Refer Reply To:
CC:PSI:01
PLR-103868-15
Date:
May 26, 2015

Legend

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

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

Z= -----------------------------------------------

A= -----------------------------------------------

B= --------------------------------------------------------

C= --------------------------------

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

Date = ------------------

n1 = ----

n2 = --

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

This responds to your letter dated January 16, 2015, submitted on behalf of X,
requesting a ruling under § 7704(d)(1)(E) of the Internal Revenue Code (Code).
PLR-103868-15 2

                                     FACTS

X is a limited partnership organized on Date under the laws of State. Upon
consummation of an initial public offering (IPO), X will become a publicly traded
partnership within the meaning of § 7704(b).

X will own n1% of the outstanding equity interests of Y, an LLC treated as a partnership
for Federal tax purposes. Z will own the remaining n2% interest in Y. Y owns all of the
outstanding equity interests of A, a disregarded entity for Federal tax purposes. A owns
and operates a liquefied natural gas (LNG) receiving and regasification terminal
(Terminal). Y also owns all of the outstanding equity interests of B, a disregarded entity
for Federal tax purposes. B will construct and own additional liquefaction capabilities at
Terminal that will enable B to process and convert natural gas into LNG (Liquefaction
Project).

LNG is natural gas that has been cooled until it condenses into a liquid in a process
referred to as liquefaction. The liquefaction process includes the removal of certain
components from the natural gas stream, such as water, carbon dioxide, sulfur,
mercury, and heavy hydrocarbons. The purified natural gas is condensed into a liquid
at close to atmospheric pressure by cooling it to a cryogenic temperature of
approximately minus 260 degrees Fahrenheit. The liquefaction process reduces the
volume of the molecules to 1/600th of their original size. The reduction in volume makes
natural gas considerably more cost effective to transport over long distances where
pipelines do not exist. LNG transportation to a LNG receiving terminal typically occurs
by ocean-going LNG tankers that are designed with a special containment system to
keep the appropriate atmospheric pressure and cryogenic temperature.

Regasification is the inverse process of liquefaction. It involves warming the LNG
through a series of vaporizers until the LNG is converted into pipeline quality natural
gas. Unloaded LNG is pumped through various components, including vaporizers, to
convert or warm the LNG into natural gas. The vaporizers use either air or seawater to
warm the LNG (ambient temperature systems) or burn fuel to generate heat to indirectly
warm the LNG (above-ambient temperature systems).

Terminal is currently comprised of all the facilities necessary for regasification: marine
docks for LNG tankers to offload or upload LNG, LNG storage tanks, LNG vaporizers,
and other required facilities and equipment. A has a series of agreements for
regasification (Regasification Agreements) with C, pursuant to which C has
contractually committed to pay A fixed fees for A’s agreement to accept a specified
amount of C’s LNG via LNG tankers, to store the LNG in tanks at Terminal, to process
the LNG into natural gas, and to deliver the natural gas to C for further transport via
pipeline. Under the Regasification Agreements, A assumes the risk of loss for the LNG
PLR-103868-15 3

as it is received at Terminal and has the risk of loss during the processing of the LNG
into gas and during the transportation of the gas to C’s delivery point. The risk of loss
reverts from A to C at the time the gas is delivered to C (at the point a pipeline connects
to Terminal).

Terminal cannot currently liquefy domestically-produced natural gas for export. As part
of the Liquefaction Project, B will construct and install gas treatment facilities, refrigerant
compressors, cold boxes and heat exchangers, waste heat recovery systems,
associated fire and gas detection systems, interconnections to Terminal, and new
control buildings to enable it to liquefy natural gas. The Liquefaction Project, in
combination with the existing services provided at Terminal, will allow Terminal to both
liquefy natural gas into LNG for export and regasify LNG into natural gas for import.

B intends to execute a long-term Liquefaction Services Agreement (Liquefaction
Agreement) with C. B will contract to process a calculated amount of C’s domestic
natural gas into LNG and transport the LNG to its marine docks for uploading onto an
LNG tanker. Pursuant to the Liquefaction Agreement, B will assume the risk of loss for
the gas as it is received at Terminal and will have risk of loss during the processing of
the natural gas into LNG and during the transport of the LNG to the LNG tanker. The
risk of loss reverts from B to C at the point the LNG is delivered onto the LNG tanker. In
connection with entering into the Liquefaction Agreement, C will continue to pay the
fixed fees under the Regasification Agreements.

Pursuant to the Liquefaction Agreement, C may assign a portion of its right to
processing capacity at Terminal to other third parties. Such other third parties would
become customers of Terminal and would execute similar agreements. Y expects that
Terminal ultimately will have multiple customers.

X requests a ruling that its distributive share of income derived from contracts for the
processing, regasification, liquefaction, and storage of natural gas constitutes qualifying
income under § 7704(d)(1)(E).

                                 LAW & ANALYSIS

Section 7704(a) provides that, except as provided in § 7704(c), a publicly traded
partnership will 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 the substantial equivalent thereof).

Section 7704(c)(1) provides that § 7704(a) does not apply to a publicly traded
partnership for any taxable year if such partnership meets the gross income
PLR-103868-15 4

requirements of § 7704(c)(2) for the 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) provides, in relevant part, 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 the partnership for the taxable year consists of qualifying income.

Section 7704(d)(1)(E) provides that the term “qualifying income” includes income and
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,
and 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 as defined in § 40A(d)(1).

                                  CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
income derived by X, directly or indirectly, from contracts for the processing,
regasification, liquefaction, and storage of natural gas constitutes qualifying income
under § 7704(d)(1)(E).

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal 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 X meets
the 90 percent gross income requirement of § 7704(c)(1) in any taxable year for which
this ruling may apply.

This ruling is directed only to the taxpayer requesting it. However, in the event of a
technical termination of X 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). Section
6110(k)(3) of the Code provides that this letter may not be used or cited as precedent.
PLR-103868-15 5

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

                                   Sincerely,


                                   Laura C. Fields
                                   Laura C. Fields
                                   Senior Technician Reviewer, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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