Pipeline construction and operating reimbursements are qualifying income

Plain-English summary

A limited partnership gathered, processed, transported, stored, and marketed natural gas, natural gas liquids, crude oil, and refined petroleum products. It received fees and reimbursements for building interconnections and expanding facilities, and for operating transportation and processing assets owned by third parties or joint ventures. The IRS ruled that this income qualified under IRC § 7704(d)(1)(E) because it arose from the partnership's transportation and processing activities, including reimbursable construction and operating costs described in Treasury Regulation § 1.7704-4(c)(10). The ruling did not determine whether the partnership was publicly traded or satisfied the separate 90-percent qualifying-income test.

Ruling snapshot

• Question: Are construction, expansion, management, and cost-reimbursement receipts tied to natural-resource transportation and processing qualifying income?
• Outcome: Approved. The IRS treated the described receipts as qualifying income under IRC § 7704(d)(1)(E).
• Key authorities: IRC §§ 7704(c), 7704(d)(1)(E); Treas. Reg. §§ 1.7704-4(c)(5), 1.7704-4(c)(7), 1.7704-4(c)(10)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201724024 Third Party Communication: None
Release Date: 6/16/2017 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
------------------------------------------- -------------------------, ID No. -----------------
-------------- -----------------------------------------------------
----------------------------------------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:B3
PLR-138280-13
Date:
March 09, 2017

                                                LEGEND

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

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

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

   This letter responds to a letter dated August 29, 2013, and subsequent

correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under § 7704(d)(1)(E) of the Internal Revenue Code (Code).

                                                 FACTS

   X is a limited partnership organized under the laws of State. X is engaged in the

gathering, processing, and transportation of natural gas, the gathering and
transportation of crude oil and refined petroleum products, and the gathering,
transportation, fractionation, storage, and marketing of natural gas liquids (NGLs).

   X owns and operates several pipelines regulated by the Federal Energy

Regulatory Commission as well as other lateral pipelines for the transportation of
natural gas, NGLs, and crude oil. X’s pipelines interconnect with other larger pipelines
as well as refineries and processing facilities. X also owns and operates extensive
gathering systems that have multiple delivery interconnects with producer wells.

     In addition, X owns and operates a number of processing and fractionation

facilities either entirely or partially through joint ventures with related and unrelated
parties that are also engaged in the exploration, production, processing, and/or
transportation of natural gas and/or crude oil. The processing facilities remove water
vapor, solids, and other contaminants from NGLs to form a stream of marketable natural

PLR-138280-13 2

gas consisting primarily of methane, and another stream of raw NGL mix (Mixed NGLs).
The fractionation facilities separate the Mixed NGLs into their component parts (ethane,
propane, iso-butane, normal butane, and natural gasoline). X’s processing and
fractionation services may be provided through a variety of commercial arrangements,
but are typically reimbursed under fee or percent-of-proceeds arrangements that are
based on the volume and NGL content.

     In an effort to facilitate and grow X’s transportation and processing activities, X

derives income from the construction of interconnect points with its transportation and
gathering systems, and the development of new or modification of existing
transportation and processing facilities. For example, if no transportation is available
between a customer’s wellhead or existing pipeline, or if X has insufficient processing
capabilities to provide the desired processing services, X and its customer may enter
into separate but related contracts for the modification of existing or construction of new
transportation and processing assets. The payments compensate X for the design,
materials, construction or assembly of property, as well as the inspection and oversight
of work performed by third parties. Although X is generally responsible for constructing
(or causing the construction of) these assets, X typically engages a third party to
perform the construction work. X may be compensated on a (i) fixed cost basis,
(ii) reimbursement basis, or (iii) cost plus basis, or X may be reimbursed for the actual
cost of construction. Alternatively, X may recoup the cost of construction through
transportation and processing revenue by requiring the customer to commit to
transporting or processing a minimum volume of product at a set fee per volume for a
fixed period under an arrangement where the customer pays for committed
transportation and/or processing volumes regardless of whether the volumes are
actually transported or processed.

       X also earns income from the receipt of management fees and reimbursement

income for operating transportation or processing assets owned by third parties or
through joint ventures to which X is a party. In each case, X (or one of its subsidiaries)
performs all of the activities necessary for the function of the asset including
(i) contracting with customers for the use of the transportation asset or facility, (ii) taking
delivery of the natural gas from various gathering systems or common carrier pipelines,
(iii) performing the tasks necessary to transport or process the natural gas, (iv) metering
the quantities of natural gas, (v) monitoring the specifications of natural gas, and
(vi) performing the tasks necessary to offload the natural gas for receipt by the
customer. X is responsible for all ownership functions such as employing, directly or
through an affiliate, all personnel who physically control the transportation asset or
processing facility, handling all commercial transactions and conducting routine
maintenance, as well as identifying and purchasing all supplies necessary to operate
each facility. X is also responsible for billing, accounting, financial reporting, and
treasury functions for each of the transportation assets and processing facilities. X is
generally reimbursed for all costs incurred to operate and maintain the transportation
and processing facilities and receives an additional fee (either fixed or calculated on a

PLR-138280-13 3

cost-plus basis), though intercompany agreements may be cost-reimbursement only or
cost plus a percentage of capital expenditures.

    X requests a ruling that gross income recognized by X in the form of fees, cost

reimbursements, and cost-sharing payments related to interconnect and expansion
activities and X’s operation of transportation or processing assets generate qualifying
income under § 7704(d)(1)(E).

                              LAW AND ANALYSIS

  Section 7704(a) provides that, except as provided in § 7704(c), a publicly traded

partnership will be treated as a corporation.

   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
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).

  Section 1.7704-4(c) of the Income Tax Regulations provides that section

7704(d)(1)(E) activities include the exploration, development, mining or production,
processing, refining, transportation, or marketing of any mineral or natural resource.

    Section 1.7704-4(c)(5) 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)(i) provides that an activity constitutes processing of natural gas if
it is performed to (A) purify natural gas, including by removal of oil or condensate, water,
or non-hydrocarbon gases (such as carbon dioxide, hydrogen sulfide, nitrogen, and
helium), and (B) separate natural gas into its constituents which are normally recovered
in a gaseous phase (methane and ethane) and those which are normally recovered in a
liquid phase (propane, butane, pentane, and heavier streams).

PLR-138280-13 4

    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 includes moving or carrying (whether by owner or operator) products via
pipelines, gathering systems, and custody transfer stations and 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
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 gross income derived by X from the construction of interconnect points with its
transportation systems and from expanding transportation assets and processing
facilities for natural gas, NGLs, and crude oil for use in X’s performance of
§ 7704(d)(1)(E) activities constitutes qualifying income under § 7704(d)(1)(E). We also
conclude that the income derived by X from the receipt of management fees and
reimbursement income for operating transportation or processing assets owned by third
parties, or through joint ventures to which X is a party constitutes qualifying income
under § 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).

PLR-138280-13 5

   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, a copy of this

letter is being sent to your authorized representative.

   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,



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

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