United States: IRS Delivers Significant Year-End MLP Qualifying Income PLRs

The Internal Revenue Service (IRS) has released four qualifying income private letter rulings (PLRs) for publicly traded partnerships (MLPs) regarding end-user sales, wholesale marketing, olefins activities, and real property rents since our third-quarter update. These four PLRs are summarized below. All told, the IRS released 18 MLP PLRs in 2012 more than double the record set in 2011. The most recent guidance is particularly helpful in the areas of olefins activities and end-user sales, both of which have been areas of uncertainty for MLPs in the past with respect to qualifying income.

The Internal Revenue Code generally treats an MLP as a corporation, rather than a partnership, for federal income tax purposes unless 90 percent or more of the MLP's gross income for every taxable year consists of "qualifying income." For this purpose, qualifying income includes certain real property rents and income derived from the exploration, development, mining, production, processing, refining, transportation, or marketing of minerals, natural resources or industrial source carbon dioxide and the transportation and storage of certain renewable fuels. Subject to limited exceptions, however, gross income from retail sales to end-users of natural resources and refined products generally are not treated as qualifying income.

Other types of qualifying income include dividends, interest (other than interest generated by a financial or insurance business), and certain income that would be qualifying for a real estate investment trust (a REIT) or a regulated investment company (a RIC).

Only the taxpayer who receives a PLR may rely upon its holding. However, PLRs do provide valuable guidance with respect to the IRS's interpretation of the boundaries of qualifying income. This update describes the IRS's conclusions in the guidance released in the final quarter of 2012 and initial days of 2013.

Bulk Refinery Sales of Refined Petroleum Products to Governmental, Industrial, and Commercial End Users

In PLR 2013-01-010 (January 4, 2013), the IRS determined that refining, blending, processing, packaging, marketing, and distributing crude oil and other natural resource-based products generates qualifying income. The taxpayer refines and processes crude oil and other petroleum-based feedstocks into refined products and produces lubricants comprised of hydrocarbon-based feedstocks and a small amount of additives. The taxpayer sells certain products in bulk to governmental, commercial, and industrial users in wholesale transactions. Refinery processing and packaging are not novel. However, this PLR is the first to clearly treat bulk sales of refined products to end users as qualifying income. Although the MLP involved in this PLR is a refiner, and the conclusions may be interpreted as being limited to refiners, the PLR represents a significant departure from a position taken in a prior ruling by the IRS that treated all end-user sales as "retail" and, therefore, not qualifying income (PLR 96-19-011, May 10, 1996).

Wholesale Marketing of Refined Petroleum Products and Natural Gas

The IRS determined in PLR 2012-50-014 (December 14, 2012) that wholesale sales of refined petroleum products and natural gas to dealers, distributors, and certain businesses generate qualifying income. The taxpayer purchases refined products, including gasoline, diesel fuel, and residual fuel oils, from refineries, trading organizations, and various producers for resale, and conducts terminal operations. The taxpayer also purchases natural gas from producers and trading companies for resale. Although customer details are redacted, this PLR concludes that the taxpayer's wholesale marketing activities generate qualifying income. Depending on the nature of the "wholesale" activities, this ruling may indicate additional flexibility concerning sales of refined products to end users who are not retail purchasers.

Lease of Offshore Platform

In PLR 2012-50-003 (December 14, 2012), the IRS concluded that income derived from the lease of an offshore platform generates qualifying income as rents from real property. The taxpayer's platform, which is permanently affixed to the seabed, is intended to remain in operation at the selected location indefinitely. Machinery and equipment installed on the platform will be used and operated solely by the lessee to extract crude oil and natural gas, separate the hydrocarbons, and condition the hydrocarbons for transport via pipeline. Following an initial exclusive use period, taxpayer will have the right to lease the platform to other producers. The lessee will operate and maintain the facility using its own personnel, even though the taxpayer will maintain two employees on the platform to ensure that lessee is fulfilling its obligations under the lease. This PLR indicates the IRS' continued willingness to treat rents from non-traditional real property assets, like electrical transmission assets (PLR 2007-25-015, March 13, 2007) and local natural gas distribution assets (PLR 2009-37-006, March 3, 2009), as qualifying income.

Olefins Activities and Processing of Natural Gas Liquids

In PLR 2012-41-004 (October 12, 2012), the IRS determined that income from processing NGLs into olefins and storing, transporting, and marketing the olefins is qualifying income. The taxpayer in the ruling intends to acquire a facility that processes ethane and propane into olefins through a process that uses a gas-fired cracking furnace to decrease the size of the NGL molecules by removing hydrogen atoms. Olefins are produced as a byproduct of the cracking process and sold to third parties for use as feedstocks in the production of chemical derivatives. The taxpayer also intends to acquire and operate olefins storage facilities and pipelines to transport olefins in order to provide olefin storage and transportation services to third parties. The taxpayer represents that olefins produced and sold by the facility will not be sold to users at the retail level. This ruling attracted more attention from MLP professionals, industry participants, financial sponsors, private equity, and the broader market than any other ruling of the year. This ruling may be an extension of a prior ruling (PLR 2012-36-005, September 7, 2012), but is significant because it is the first to treat olefins as a natural resource for an MLP, and is a step toward resolving gray areas with respect to what constitutes a natural resource for qualifying income purposes.

Conclusion

The MLP PLRs issued at the end of 2012 and in the first days of 2013 are significant because they provide guidance in areas that had previously caused confusion or remained unaddressed publicly. The IRS continues to be active in issuing guidance addressing MLP qualifying income, which is a positive sign for MLPs considering expanding into new or different business activities.

Additional Information

A list of, and links to, these and all other MLP qualifying income PLRs as well as prior PLR updates are available at www.velaw.com/MLPQualifyingIncome.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.