Cancellation payments for condensate facility are qualifying partnership income

Plain-English summary

A publicly traded partnership agreed to construct and operate a crude-oil-condensate splitter, storage capacity, and connecting pipelines for one customer. If the customer cancelled before the assets entered service, it would reimburse construction and termination costs and pay accelerated tolling and tariff fees, while the partnership retained the unfinished assets. The planned operations involved refining condensate into petroleum products, storing products, and transporting them by pipeline, all activities described in the qualifying-income rules. The IRS ruled that the combined termination payments were qualifying income under IRC § 7704(d)(1)(E). It did not decide whether the partnership met the overall 90 percent income test or whether any other income qualified.

Ruling snapshot

• Question: Is income received when the customer terminates the splitter, storage, and pipeline agreements qualifying income for a publicly traded partnership?
• Outcome: Approved. The reimbursement and accelerated fee payments qualified under IRC § 7704(d)(1)(E).
• Key authorities: IRC § 7704(c), (d)(1)(E); Treas. Reg. § 1.7704-4(c)(5) through (7), (c)(10)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201721007 Third Party Communication: None
Release Date: 5/26/2017 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
---------------------------------------------- ---------------------, ID No. -----------------
--------------------------------------------- Telephone Number:
--------------------------- -------------------
---------------------------- Refer Reply To:
CC:PSI:B03
PLR-130478-14
Date:
February 23, 2017

                                              LEGEND

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

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

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

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

    This letter responds to a letter dated August 7, 2014, submitted on behalf of X by

its authorized representative, requesting a ruling under § 7704(d)(1)(E) of the Internal
Revenue Code (Code).

                                               FACTS

     X is a publicly traded limited partnership organized under State law on Date. X is

currently engaged in the transportation, storage, and distribution of refined petroleum
products and crude oil. X anticipates engaging in the processing and refining of crude
oil condensate through use of a distillation tower (a “splitter”) that will break the crude oil
condensate into more valuable refined products (e.g., jet fuel, diesel, gas oil, and light
distillates, such as liquefied petroleum gas and naphtha).

  X entered into a Tolling Agreement with a single customer to process crude oil

condensate in a splitter to be constructed at a bulk petroleum storage terminal that is
owned by X. Contemporaneously, X entered into a Connection Agreement and a
Revenue Commitment Agreement with the customer to provide bi-directional pipeline
transportation services between X’s petroleum terminal and the customer’s petroleum
PLR-130478-14 2

terminal (the Tolling Agreement, Connection Agreement, and Revenue Commitment
Agreement are collectively referred to herein as “the Agreements”).

   As part of these Agreements, X committed to construct (or cause to be

constructed) certain assets, including the splitter and storage capacity (the facility) and
pipelines. X will own, operate, and maintain the facility and pipelines after the assets
are placed in service. Under the Tolling Agreement, X will earn (a) a monthly tolling fee
based on the volume of condensate processed, and (b) miscellaneous terminalling
services fees based upon the volume of product handled and stored. Under the
Revenue Commitment Agreement, X will earn a monthly tariff fee based on the volume
of the customer’s product that is transported through the pipelines.

     The Agreements also provide the customer with the right to terminate the

Agreements for any reason and at any time before the date on which the facility and
pipelines are placed in service. If the customer exercises such right, the customer
would pay X reimbursement payments, an accelerated tolling fee, and an accelerated
tariff fee (collectively, the “Termination Income”). The reimbursement payments
represent a reimbursement of capital expenditures incurred by X in connection with the
partial construction of the facility and pipelines as well as costs that were incurred by X
in connection with the customer’s termination of the agreements. Also, X would retain
possession and ownership of the construction in process.

  X requests a ruling that the Termination Income is qualifying income under

§ 7704(d)(1)(E).

                                       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) interests in that partnership are readily tradable on a secondary market
(or the substantial equivalent thereof).

   Section 7704(c)(1) provides that § 7704(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 for such taxable year is 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,
PLR-130478-14 3

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).

   Section 1.7704-4(c)(5) of the Income Tax Regulations provides that an activity

constitutes processing if it is performed to convert raw mined or harvested products or
raw well effluent to substances that can be readily transported or stored, as described in
§1.7704-4(c)(5). Section 1.7704-4(c)(5)(ii) provides that an activity constitutes
processing of crude oil if it is performed to separate produced fluids by passing crude oil
through mechanical separators to remove gas, placing crude oil in settling tanks to
recover basic sediment and water, dehydrating crude oil, and operating heater-treaters
that separate raw oil well effluent into crude oil, natural gas, and salt water.

    Section 1.7704-4(c)(6) provides that an activity constitutes refining if the activity

is set forth in §1.7704-4(c)(6). Section 1.7704-4(c)(6)(i)(A) provides that the refining of
natural gas and crude oil includes the further physical or chemical conversion or
separation processes of products resulting from activities listed in § 1.7704-4(c)(5)(i)
and (ii), and the blending of petroleum hydrocarbons, to the extent they give rise to a
product listed in § 1.7704-4(c)(5)(i) or (ii) or to the products of a type produced in a
petroleum refinery or natural gas processing plant listed in § 1.7704-4(c)(6)(i)(A).
Refining of natural gas and crude oil also includes the further physical or chemical
conversion or separation processes and blending of the products listed in § 1.7704-
4(c)(6)(i)(A), to the extent that the resulting product is also listed in § 1.7704-
4(c)(6)(i)(A). Jet fuel, diesel, gas oils, and light distillates, such as liquefied petroleum
gas and naphtha, are products listed in § 1.7704-4(c)(6)(i)(A).

    Section 1.7704-4(c)(7)(i) provides that an activity constitutes transportation if it is

performed to move minerals or natural resources, and products under § 1.7704-4(c)(4),
(5), or (6), including by pipeline, marine vessel, rail, or truck. Except as provided in
§ 1.7704-4(c)(7)(ii), transportation does not include the movement of minerals or natural
resources, and products produced under § 1.7704-4(c)(4), (5), or (6), directly to retail
customers or to a place that sells or dispenses to retail customers. Retail customers do
not include a person who acquires oil or gas for refining or processing, or a utility.
Transportation also includes providing storage services.

   Section 1.7704-4(c)(10)(i) provides that, if the partnership is in the trade or

business of performing a section 7704(d)(1)(E) activity, qualifying income includes
income received to reimburse the partnership for its costs in performing that section
7704(d)(1)(E) activity, whether imbedded in the rate the partnership charges or
separately itemized. Reimbursable costs may include the cost of designing,
constructing, installing, inspecting, maintaining, metering, monitoring, or relocating an
asset used in that section 7704(d)(1)(E) activity, or providing office functions necessary
to the operation of that section 7704(d)(1)(E) activity (such as staffing, purchasing
supplies, billing, accounting, and financial reporting). For example, a pipeline operator
that charges a customer for its cost to build, repair, or schedule flow on the pipelines
PLR-130478-14 4

that it operates will have qualifying income from such activity whether or not it itemizes
those costs when it bills the customer.

                                  CONCLUSION

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

the Termination Income constitutes qualifying income within the meaning of
§ 7704(d)(1)(E).

    Except as specifically provided, we express or imply no opinion as to 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), whether X is a publicly traded partnership
within the meaning of § 7704(b), or whether any other type of income not addressed in
this ruling is qualifying income under § 7704(d).

   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. 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).

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

copies of this letter to your authorized representatives.

   The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.

                                  Sincerely,


                                  /s/

                                  Holly Porter
                                  Chief, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: