Oilfield fluid and waste services produce qualifying income

Plain-English summary

A planned publicly traded partnership would provide fluid delivery, water transfer, equipment washout, and waste processing and disposal services to oil and gas producers. It would also recover, recycle, and market brine, chemicals, drilling mud, and hydrocarbons from those activities. The IRS ruled that income from the described services and recovered products was qualifying income under section 7704(d)(1)(E), including hydrocarbon sales made other than at retail to end users. The ruling does not cover delivery income when the partnership does not also collect, clean, recycle, or dispose of the delivered material after use. The IRS did not decide whether the partnership would satisfy the overall 90 percent qualifying-income test in any year.

Ruling snapshot

• Question: Does income from the partnership's oilfield fluid, waste, recycling, and related marketing activities qualify under section 7704?
• Outcome: Yes, for the specified integrated services and recovered products, subject to the stated delivery limitation
• Key authorities: IRC §§ 611, 613, and 7704(d)(1)(E); Rev. Rul. 73-540

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201602004 Third Party Communication: None
Release Date: 1/8/2016 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
---------------------- ---------------------, ID No. ----------------
------------------------------ Telephone Number:
--------------------------- --------------------
---------------------------------------------- Refer Reply To:
-------------------------- CC:PSI:B01
PLR-130994-14
Date:
September 25, 2015

Legend

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

Y = --------------------------

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

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

This responds to your letter dated August 14, 2014, and subsequent correspondence,
submitted on behalf of X and Y, requesting a ruling under section 7704(d)(1)(E) of the
Internal Revenue Code (the “Code”).

                                                   Facts

According to the information submitted, X is a limited liability company organized under
the laws of State. X intends to form a publicly traded partnership within the meaning of
§ 7704(b) by effecting an initial public offering of units in Y. Y is a limited partnership
organized under the laws of State. Y will provide a full suite of fluid, solid, and oilfield
waste handling, treatment, and disposal services to oil and natural gas producers
engaged in the exploration, development, and production of oil and gas.

As part of its upstream services, Y will deliver fresh water and other solutions, including
brine, to well sites for use in fracturing. The fresh water provided by Y will initially
consist of rain water and other natural runoff and may also consist of recycled water.
The brine provided by Y will initially consist of brine produced during the drilling and
PLR-130994-14 2

formation of a salt cavern by injecting fresh water into a salt formation and retrieving the
fully saturated brine that is returned through the cavern wellbore. Y may also provide
recycled brine. Y will also deliver drilling mud and casing cement. The water and other
fluids will be delivered by truck, tanks and, in some cases, temporary and permanent
pipelines that will be owned, operated and maintained by Y. During the provision of
these services, Y’s employees will either remain present at both the fluid source and the
well site to oversee the functioning of the pipelines and equipment or will monitor the
fluid source and well site on an ongoing basis.

Y intends to provide inter-well site water transportation services including transporting
fluids between producers’ well sites on a single producing property, transporting fluids
between frac tanks for a producer at a single well site, and transporting fluids for a
producer between one or more well sites or a treatment plant. Y anticipates using
pipelines for its water transfer services which will significantly reduce costs and produce
less carbon emission. Where necessary to complete Y’s fluid and waste handling
services, Y will also lease specially designed frac tanks to oil and gas producers to
provide temporary storage capacity for water, flowback, produced water, pit water, and
other drilling and production wastes. Y’s employees will either remain present at well
sites to ensure water is pumped at a sufficient rate or will monitor the fluid source and
well site on an ongoing basis.

Y will also process, treat, and dispose of waste solids and waste fluids associated with
the exploration and production of oil and natural gas produced through drilling,
fracturing and production. Y will develop, construct and manage water lines, gathering
systems and special waste landfills in connection with the treatment and disposal of
waste solids and waste fluids. The processed fluids will be cleaned and purified for
reuse, or will be disposed of by injecting the fluids into secure underground formations
or discharged into surface water sites. Reclaimed materials such as brine that are
separated during the recycling process will be marketed for reuse in the oil and natural
gas production process. Y will also earn income from the marketing of hydrocarbons
recovered during the waste fluid treatment and disposal process. Y intends to sell these
reclaimed hydrocarbons in relevant markets other than to end users at the retail level.
The waste solids will be disposed of in special waste landfills. Y expects to conduct
extensive monitoring of its disposal sites to comply with environmental and federal
regulations. Y’s employees will operate, maintain, and monitor the disposal and
treatment facilities on a continuous basis.

As part of its downstream services, Y expects to earn income from washing out trucks,
containment bins, tanks and other equipment used in the oil and natural gas extraction
and production process (“washout activities”). This equipment must periodically be
washed out to remove debris and preserve the full capacity of the equipment. Y’s
employees will perform washout activities at the well sites using equipment specifically
designed for use with the heavy machinery used in the exploration and production of oil
PLR-130994-14 3

and natural gas. Y will be responsible for disposing waste fluids washed out of the
producer’s equipment.

In conjunction with its washout activities and recycling and disposal services, Y will earn
income from the recycling of drilling mud. Drilling mud will be collected by Y through the
use of equipment, such as a centrifuge, to isolate the reusable drilling mud from the
drilling equipment that is being cleaned. The collected mud will be recycled and
repurposed for sale to producers for use in drilling and fracturing operations.

X and Y make the following representations with respect to Y’s operations:

1. The services provided by Y will require substantial assets and equipment that are
  dedicated exclusively to use in the exploration and production of oil and gas and
  have limited utility outside of those areas.
2. The services provided by Y will require personnel with specialized knowledge,
  training, and experience.
3. The production of oil and gas using the hydraulic fracturing process would not be
  commercially viable without fluid handling services.

                                Law and Analysis

Section 7704(a) provides that, except as provided in section 7704(c), a publicly traded
partnership will 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 section 7704(a) does not apply to a publicly traded
partnership for any taxable year if such partnership meets the gross income
requirements of section 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 section 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) provides that, for purposes of § 7704(d)(1)(E), the term “mineral or
natural resource” means any product of a character with respect to which a deduction
for depletion is allowable under § 611; except that such term shall not include any
product described in § 613(b)(7)(A) or (B).
PLR-130994-14 4

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 611 provides, in part, that in the case of mines, oil and gas wells, other natural
deposits, and timber, there shall be allowed as a deduction in computing taxable income
a reasonable allowance for depletion. Section 613(b) lists certain of the mines, wells,
and other natural deposits subject to depletion. Section 613(b)(4) identifies sodium
chloride.

Section 613(c) provides that mining includes the extraction of ores or minerals from the
ground.

Revenue Ruling 73-540, 1973-2 C.B. 203, provides that extracting sodium chloride by
the use of water in the solution mining method from underground rock salt beds are
extraction processes and are considered allowable mining processes within the
meaning of § 613(c).

                                     Conclusion

Based solely on the facts submitted and the representations made, we conclude that
gross income derived by Y from the delivery of fluids, provision of inter-well water
transfer services, and the processing, treatment and disposal of waste solids and waste
fluids, including washout services, will constitute qualifying income for purposes of §
7704(d)(1)(E). Further, gross income derived by Y from the recovery, recycling, and
marketing of brine, chemicals, and drilling mud to oil and gas producers and of
hydrocarbons other than to end users at the retail level constitutes qualifying income
within the meaning of § 7704(d)(1)(E). This ruling is not applicable to any income
derived by Y from the delivery of water, brine, drilling mud, or other materials to affiliates
or third parties where Y does not also collect and clean, recycle, or otherwise dispose of
the delivered materials after use.

Except as expressly provided herein, no opinion is expressed or implied concerning 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 Y will meet
the 90 percent gross income requirement of § 7704(c)(1) in any taxable year for which
this ruling may apply.

The rulings contained in this letter are 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 request for rulings, it is subject to verification on examination.
PLR-130994-14 5

This ruling is directed only to the taxpayer requesting it. However, in the event of a
technical termination of Y 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). Section
6110(k)(3) of the Code provides that this letter may not be used or cited as precedent.

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

                                   Sincerely,


                                   Laura C. Fields
                                   Laura C. Fields
                                   Senior Technician Reviewer, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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

cc: