The Internal Revenue Service (the IRS) recently published Private Letter Ruling 201043024 (July 12, 2010) (the Ruling), addressing qualifying income of a publicly-traded partnership engaged, in part, in providing services to customers engaged in the exploration, development and production of oil and gas. This Client Alert summarizes the conclusion of the Ruling.
Under Section 7704(a) of the Internal Revenue Code of 1986, as amended (the Code), a partnership whose interests are traded on an established securities market or whose interests are readily tradable on a secondary market (or the substantial equivalent thereof) is generally taxed as a corporation for US federal income tax purposes. Under an exception to the general rule in Section 7704 of the Code, a publicly-traded partnership will be taxed as a partnership if 90 percent or more of its gross income is "qualifying income." The term "qualifying income" includes, among other things, 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, as well as certain passive-type income including interest, dividends and real property rents.
In the Ruling, a publicly-traded partnership (the MLP) subject to US federal income tax as a partnership (and not a corporation), by reason of meeting the 90 percent qualifying income test of Section 7704 of the Code, entered into a joint venture with a third party, for which the MLP would serve as the managing member. The joint venture was engaged in the business of providing services to customers engaged in the exploration for, and the development and production of, natural resources (including oil, natural gas and coal).
Specifically, with respect to its oil and gas customers, the joint venture earned income from the supply and transportation of fracturing fluid for oil and natural gas wells and the removal, treatment and disposal of spent fracturing flowback fluids. The joint venture was thus involved (and derived income) at two stages of the fracturing process: At the front end, the joint venture processed and supplied fluids for the fracturing process, and at the back end, the joint venture treated flowback fluids in such a manner as to be reused in the fracturing process or disposed of in a manner consistent with applicable environmental regulations. With respect to its coal customers, the joint venture received fee income for treating acid mine discharges so that these fluids could be used as fracturing fluid for oil and gas companies or disposed of in a manner consistent with applicable environmental regulations. The IRS concluded that the MLP’s share of the gross income derived by the joint venture from providing, removing, treating and disposing of fracturing fluid and from removing, treating and disposing of acid mine discharge is qualifying income within the meaning of section 7704 of the Code.
The Ruling could be viewed as another confirmation by the IRS that oilfield service income can constitute "qualifying income" for an MLP, as certain types of oilfield service income are integral to the exploration, development and production of oil and gas. The IRS has taken this position consistently in recent years. For example, a similar conclusion was reached in Private Letter Ruling 200827014 (July 4, 2008), in which a taxpayer earned income from providing fluid handling services with respect to fracturing and from removing, disposing of and recycling fluids generated by oil and gas wells. In addition, in Private Letter Ruling 200827022 (July 4, 2008), the IRS ruled that drilling and related services income from well servicing and maintenance services, workover services, completion services and other specialized services provided by a to-be-formed oilfield service MLP to customers engaged in oil and gas exploration and production was qualifying income. These rulings, taken together with other authority published in recent years, lead us to believe that further opportunities may exist in the MLP space for certain types of oilfield services income.