Oil and gas management fee is qualifying partnership income

Plain-English summary

A publicly traded partnership indirectly owned an operating partnership engaged in oil and gas exploration, development, and production. The operating partnership had no employees or contractors of its own, so the taxpayer and its subsidiaries supplied field workers and personnel for geological, purchasing, accounting, tax, finance, legal, technology, and other support functions. The operating partnership paid a management fee through its general partner for those services. The IRS ruled that the taxpayer's management-fee income was qualifying income under section 7704(d)(1)(E) because it came from directly performing oil and gas exploration, development, and production activities and necessary back-office support. The ruling did not decide whether the taxpayer met the overall 90-percent income test.

Ruling snapshot

• Question: Was a publicly traded partnership's management fee for providing oil and gas field services and necessary support functions qualifying income?
• Outcome: Approved; the management-fee income qualified under section 7704(d)(1)(E).
• Key authorities: IRC § 7704(c) and (d)(1)(E); Treas. Reg. § 1.7704-4(c)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201927007                                            Third Party Communication: None
Release Date: 7/5/2019                                       Date of Communication: Not Applicable
Index Numbers: 7704.00-00, 7704.03-00
                                                             Person To Contact:
---------------------------------------                      ---------------------, ID No. ------------------
-----------------------------------                          Telephone Number:
-----------------------------------------                    --------------------
-----------------------------------------                    Refer Reply To:
                                                             CC:PSI:B03
                                                             PLR-127713-18
                                                             Date:
                                                             April 9, 2019




                                                   LEGEND

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

GP                       =     -------------------------------------------------------------------------------------
                               --------------------------------

Operating                =     -------------------------------------------------------------------------------------
Partnership                    ---------------------------------

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

a                        =     ----

b                        =     ----

c                        =     2


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

       This letter responds to a letter dated September 13, 2018, 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, a State limited liability company and a publicly traded partnership, is in the
business of owning and managing businesses in the upstream oil and gas sector. X
PLR-127713-18                                2

does not directly own the property on which the oil and gas exploration, development,
and production services are performed. Of the members of X’s group, Operating
Partnership, a State limited liability company, is the main operating entity and is a
partnership for federal tax purposes. X indirectly owns a% interest in Operating
Partnership as a limited partner. X also owns b% of GP, the sole general partner of
Operating Partnership. GP, a State limited liability company and a partnership for
federal tax purposes, holds a c% interest in Operating Partnership.

       Operating Partnership owns properties and has its operations in two states
where it directly engages in upstream oil and gas exploration, development, and
production, as well as the acquisition and development of producing oil and gas
properties and developing non-producing oil and gas properties. Operating Partnership,
however, does not employ any employees or independent contractors to manage or
operate its upstream oil and gas exploration, development, and production business.
Operating Partnership looks to GP to perform all the services. GP contracts with X and
its subsidiaries to provide the workforce to actually conduct the exploration,
development, production, and related support activities.

        X, including through subsidiaries, provides all employees needed to the
Operating Partnership in order for Operating Partnership to conduct the oil and gas
exploration, development, and production activities. In addition, X provides employees
to the Operating Partnership for all support and back-office activities needed to operate
Operating Partnership’s overall oil and gas business. X’s employees perform the
following activities on behalf of Operating Partnership: (1) geological services, including
conducting geological surveys and interpreting data; (2) field services, including drilling
an exploratory well, conducting drill stem and production flow tests, and monitoring
drilling, production, and gathering; (3) purchasing supplies; (4) human resources,
including staffing and payroll management; (5) accounting, including joint interest billing
and managing division orders; (6) tax reporting; (7) investor relations; (8) financial
services, including evaluations of the use of the capital markets and the debt markets,
hedging strategy and execution; (9) legal services, including property acquisition
agreements and title confirmation; and (10) information technology services. A majority
of the employees are involved with field services.

       X is reimbursed for its services via a management fee paid by Operating
Partnership to GP, which is passed-through to X. The management fee paid by
Operating Partnership to GP is earned lump-sum annually and paid quarterly. The
management fee is in exchange for the work X does for Operating Partnership. In
addition, X is directly reimbursed for some indirect costs, such as rent and general and
administrative costs.

                                  LAW AND ANALYSIS
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      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 for purposes of
§ 7704(d)(1)(E), qualifying income is income and gains from qualifying activities with
respect to minerals or natural resources as defined in § 1.7704-4(b). Qualifying
activities include both § 7704(d)(1)(E) activities (as described in § 1.7704-4(c)) and
intrinsic activities (as described in § 1.7704-4(d)).

      Section 1.7704-4(c)(1) provides that §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)(2) defines exploration as an activity performed to ascertain
the existence, location, extent or quality of any deposit of mineral or natural resource
before the beginning of the development stage, including by drilling an exploratory or
stratigraphic type test well, conducting drill stem and production flow tests, conducting
geological or geophysical surveys, and interpreting data obtained from geological or
geophysical surveys.

      Section 1.7704-4(c)(3) defines development as an activity performed to make
accessible minerals or natural resources, including by drilling wells to access deposits
of minerals or natural resources.

       Section 1.7704-4(c)(4) defines production as an activity performed to extract
natural resources from the ground including by operating equipment to extract natural
resources from wells.
PLR-127713-18                                 4

Section 1.7704-4(c)(10)(i) provides that, if the partnership is in the trade or business of
performing a § 7704(d)(1)(E) activity, qualifying income includes income received to
reimburse the partnership for its costs in performing that § 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
§ 7704(d)(1)(E) activity, or providing office functions necessary to the operation of that
§ 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 income recognized by X from the receipt of the management fee constitutes
qualifying income under § 7704(d)(1)(E). X is receiving the management fee income for
directly engaging in § 7704(d)(1)(E) activities, including oil and gas exploration,
development, and production, in addition to the associated back-office support functions
necessary to the operation of the business.

       Except as expressly provided herein, no opinion is expressed or implied
concerning the 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.

       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.
PLR-127713-18                                  5


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


                                       Sincerely,

                                       Associate Chief Counsel
                                       (Passthroughs and Special Industries)



                                    By:_________________________
                                       Caroline E. Hay
                                       Assistant to the Branch Chief, Branch 3
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)



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



cc: