Oil-and-gas service income qualifies as partnership income

Plain-English summary

A publicly traded partnership planned to acquire a business that supplied handling, treatment, processing, and related services for oil-and-gas exploration and production, including hydraulic fracturing operations. The business represented that its services required substantial specialized assets and trained personnel and were necessary to make the production process commercially viable. The IRS ruled that gross income from the specified activities, including the collection, treatment, and transport activities described in the redacted letter, would be qualifying income under IRC § 7704(d)(1)(E). The ruling did not apply to certain income from a redacted activity when the partnership did not also perform the related post-use activities identified in the letter. The ruling addressed qualifying-income status, not whether the partnership met the separate 90 percent gross-income test for a taxable year.

Ruling snapshot

• Question: Would income from the described oil-and-gas support activities count as qualifying income for a publicly traded partnership?
• Outcome: Approved, subject to the stated limitation
• Key authorities: IRC §§ 7704(c), 7704(d)(1)(E)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201549004 Third Party Communication: None
Release Date: 12/4/2015 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
---------------------------------------------------- -----------------------, ID No. -------------------
------------------------------------------------- ---------------------------------------------------
------------------------------------------- Telephone Number:
----------------------- ----------------------
------------------------------ Refer Reply To:
CC:PSI:01
PLR-102779-14
Date:
May 26, 2015

Legend

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

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

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

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

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

n1 = ----------

n2 = ----------

n3 = --------------

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

This responds to your letter dated January 10, 2014, and subsequent correspondence,
submitted on behalf of X, requesting a ruling under section 7704(d)(1)(E) of the Internal
Revenue Code.
PLR-102779-14 2

                                                 FACTS

According to the information submitted, X is a limited partnership organized under the
laws of State. Y is a publicly traded corporation formed in State. Y is engaged in the
exploration, development, and acquisition of natural gas, natural gas liquids, and oil
properties. Y entered into an agreement with X pursuant to which it would contribute its
--------------- businesses to X. On Date, Y executed an initial public offering (IPO) of X.
Prior to the IPO, Y’s exploration and development activities were supported by its -------
-------------- businesses, which included -----------------------------------------------------------------
------------------------------------------------------------------------------- services including the -------
---------------------------------------------------------- of ------------------------------ necessary for Y’s
exploration and production activities (--------- Services Business). As part of the IPO, Y
contributed the ------- Business to X and transferred the --------- Services Business to Z,
a wholly-owned, disregarded subsidiary of Y. Y also granted X an option to acquire the
--------- Services Business. X intends to exercise this option.

Z provides a full suite of ------ handling, treatment, processing, and ------------ services to
Y pursuant to a long-term services contract. To the extent Y does not require the use of
Z’s entire capacity, Z has the right to use excess -------------------- system capacity to
provide -------- to other oil and gas producers. These services are rendered in all three
phases of the exploration and production of oil and gas: upstream of the well site, at the
well site, and downstream of the well site.

As part of its upstream services, Z delivers --------------- through its system of ---------------

------------------------------------------------------------------------------------, for use in hydraulic
fracturing (“fracking”). Z also treats --------------------- with -----------------------------------------
that can damage oil and gas wells and have an adverse impact on ----------------------------
-------------------------------------------------------------------------------------------------------------------.

Fracking stimulates production of natural gas and oil from dense subsurface rock
formations. Fracking involves the injection of fluids, primarily water, sand, and
chemicals under pressure through a cased and cemented wellbore into targeted
subsurface formations to fracture the surrounding rock and stimulate production, ---------
--------------------------------------------------.

At the well site, Z typically installs --------------------------------------------- to connect the
applicable --------------------------------------. After the infrastructure is in place, Z supplies --
-------- to the well site and stores it in --------------------------------------- with a capacity of n1
to n2 ---------------------. Employees and subcontractors of Z must be present at the well
site during all active fracking operations to ensure equipment is functioning properly and
maintain proper --------------. Maintaining proper ------------ is essential to the success of
the drilling operation because -------- being removed from ----------------------------------------

PLR-102779-14 3

may exceed the rate at which -------- is entering the --------. Personnel must monitor -----
------------------------- and make adjustments as necessary to ensure that ------------- do not
------------ while transferring -------- at a rate that most efficiently compensates for ----------
-------------------------------- at which the --------------------------------------. The provision of ----
------------------------------------ is a specialized and requires skilled employees or
contractors to coordinate closely with the fracking contractor and other onsite personnel.

Z also -------------------------------------------------------------------- of ----------------- associated
with the exploration and production of oil and gas through hydraulic fracturing. ------------
------------- and ---------------------- are picked up -------------------- and transported to a -------
------- --------------------------------------. ------------------ are then processed to allow the
resulting -------- to be discharged -------------------------------------------------------------------------

---------------------------------------------------------.

X and Y make the following representations:

1. The services provided by Z require substantial assets and equipment that are
   dedicated exclusively to use in the exploration and production of oil and gas.
2. The production of oil and gas using the hydraulic fracturing process would not be
   commercially viable without ------------------- services.
3. Z employs directly, and through independent contractors, n3 of persons with a
   specialized knowledge base, training, and experience, who design, permit,
   install, and operate every aspect of Z’s business and oversee day-to-day field
   operations.

                                         LAW & ANALYSIS

Section 7704(a) provides that, except as provided in section 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 section 7704(a) does not apply to a publicly traded
partnership for any taxable year if such partnership meets the gross income
requirements of section 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.
PLR-102779-14 4

Section 7704(c)(2) provides, in relevant part, that a partnership meets the gross income
requirements of section 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).

                                      CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
gross income derived by X from the ----------- of -------- and the collection, treatment, and
transport of ----------------------------------------------------, and residual ----- will constitute
qualifying income for purposes of section 7704(d)(1)(E). This ruling is not applicable to
any income derived by X from the ----------- of -------- to affiliates or third parties where X
does not also ----------------------------------, or otherwise ----------- of the ---------------------
after use.

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.

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 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-102779-14 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