Oilfield fluid and waste services produce qualifying partnership income

Plain-English summary

A publicly traded partnership provided water and chemical fluids for drilling and hydraulic fracturing, transported fluids between well sites, and treated or disposed of drilling and production waste. It also cleaned tanks and trucks, supplied serviced frac tanks, recycled contaminated fluids, and recovered hydrocarbons during remediation. The IRS ruled that income from those integrated fluid-management, transportation, disposal, washout, and storage services was qualifying income under IRC § 7704(d)(1)(E). Hydrocarbon-remediation income also qualified if the recovered hydrocarbons were not sold to retail end users. The ruling did not cover stand-alone delivery of water, brine, or injectants when the partnership did not also collect and process the resulting wastewater and drilling waste.

Ruling snapshot

• Question: Did the partnership's oilfield fluid-management, waste, storage, and hydrocarbon-remediation services generate qualifying income?
• Outcome: Approved, subject to limits on retail hydrocarbon sales and stand-alone fluid delivery.
• Key authorities: IRC § 7704(c), (d)(1)(E).

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201637007                                            Third Party Communication: None
Release Date: 9/9/2016                                       Date of Communication: Not Applicable
Index Number: 7704.03-00
                                                             Person To Contact:
---------------------------------                            ----------------------, ID No. ------------------
------------------------------                               Telephone Number:
-----------------------------------------                    ----------------------
------------------------------------------                   Refer Reply To:
                                                             CC:PSI:03
                                                             PLR-140710-15
                                                             Date:
                                                             June 13, 2016

-------------------
                                                  LEGEND

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

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


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

This letter responds to your letter dated December 14, 2015, submitted on behalf of X
by its authorized representative, requesting a ruling under section 7704(d)(1)(E) of the
Internal Revenue Code (Code).

                                                   FACTS

According to the information submitted, X is a publicly traded limited partnership
organized under the laws of State. X is engaged in certain midstream operations, and,
as a part of that business, provides fluid, solids, and oilfield waste handling, treatment,
and disposal services to customers engaged in the exploration for, and development
and production of, oil and natural gas.

As a part of its fluid management services, X supplies and transports drilling and
fracturing fluids, including fresh water, brine, and other chemical injectants, for use in
drilling and hydraulic fracturing. The brine and other injectants are obtained by X
through fluid separation and chemical recovery activities as part of its recycling and
disposal services, and then marketed by X exclusively to producers for use in the
exploration and production of oil and natural gas through the fracturing process. X
transports the fluids to producers via trucks, tanks, and, in some cases related to fresh
water supply, pumps and pipelines. These pipelines include: (1) temporary pipelines
owned, operated, maintained, and controlled by X and dedicated specifically to the
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transportation of fluids to producers for use in fracturing; (2) water delivery pipeline
systems that will be developed, constructed, owned, operated, maintained and
controlled by X for the specific purpose of transporting fluids to producers for use in the
fracturing process; or (3) water delivery pipeline systems that are managed and
operated—but not owned—by X. During the provision of these services, employees of
X (or employees of an affiliate of X working under the supervision, direction and control
of X) remain present at both the fluid source and the well site to oversee the process
and ensure proper functioning of the pipelines and related equipment.

As a part of its transportation services, X also provides inter-well site transportation via
pipelines when requested by its oil and natural gas producer customers. These transfer
services include: (a) transporting fluids between producers’ well sites on a single
producing property, (b) transporting fluids between frac tanks for a producer at a single
well site, and (c) transporting fluids for a producer between one or more well sites
and/or a treatment plant.

X also treats, recycles, and disposes of flowback, produced water, pit water, and other
drilling and production wastes, so that such wastes can be recycled or disposed of
consistent with environmental regulations. Flowback and produced water may be
transported to X’s recycling facilities or disposal sites by truck or pipelines. X’s recycling
activities produce water and fluids that are cleaned and purified for reuse in the oil and
natural gas production process. Such activities also result in certain materials (e.g.,
brine and other chemical injectants) being separated from the contaminated water and
fluids during the recycling process, which are then marketed to oil and natural gas
producers for reuse. Drilling mud, fracturing fluid waste, drill cuttings, tank bottoms, and
NORM (naturally occurring radioactive material) constitute the majority of the waste
treated at X’s existing disposal facilities, which may include, in the future, special-waste
landfills that are authorized to accept certain hazardous waste materials, such as
NORM.

In addition, X also provides truck and tank washout services, and recycling or disposal
services related to the resulting fluids. Storage tanks, trucks, and other equipment that
store and transport flowback, produced water, and other drilling and production waste
must be properly cleaned and maintained to prevent rust and corrosion. Failing to
properly clean these items could result in damage to tanks and potential leakage of
hazardous fluids.

Also in connection with its fluid management and disposal services, X earns income
through the provision of frac tanks for temporary storage of water, flowback, produced
water, pit water, drill cuttings, and other drilling and production wastes. X represents
that X must provide a substantial level of ongoing service to each customer during the
term of such customer’s use of the frac tank and must maintain a regular presence at
the customer worksite.
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X also provides hydrocarbon remediation services. As a part of these services, X
removes hydrocarbons from the drilling waste at its facilities during the waste treatment
and disposal process and sells such reclaimed hydrocarbons.
X makes the following representations:

    1. X supervises, directs, and controls personnel for its fluid management,
      transportation, disposal, washout, and storage services. These activities require
      personnel with specialized knowledge, unique training, and experience such as
      training in drill site maintenance, fluid pressure monitoring and spill prevention,
      operating mechanical and pressure pumps, as well as safety training critical to
      the operation of X’s recycling and disposal facilities.
    2. The provision of fluids as well as water transfer services are essential to the
      completion of oil and natural gas drilling and fracturing operations.
    3. Processing and treatment of flowback fluids and produced water is required in
      order to comply with governmental regulations and industry standards.
    4. X’s fluid management services require daily involvement and are performed on
      an ongoing basis throughout the exploration and production life cycle of each
      producing property. X’s recycling and disposal facilities and related service
      equipment are staffed on a continuous, 24 hour per day basis and are equipped
      with remote monitoring capabilities.

                                    LAW & 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 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)(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
PLR-140710-15                                4

the marketing of any mineral or natural resource (including fertilizer, geothermal energy,
and timber).


                                     CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
gross income derived by X from its fluid management, transportation, disposal,
washout, and storage services constitutes qualifying income within the meaning of
§ 7704(d)(1)(E). In addition, income derived by X from its hydrocarbon remediation
services performed as part of the disposal process constitutes qualifying income within
the meaning of § 7704(d)(1)(E) so long as X does not sell the recovered hydrocarbons
to end users at the retail level. This ruling is not applicable to any income derived by X
from the delivery and transportation of water, brine, or other injectants where X does not
also collect and clean, recycle, or otherwise dispose of the resulting produced water and
drilling production waste 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 X meets
the 90 percent gross income requirement of § 7704(c)(1) in any taxable year for which
this ruling may apply.

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 request for ruling, it is subject to verification on examination.

This ruling is directed only to the taxpayer requesting it. 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). Section
6110(k)(3) of the Code provides that this letter may not be used or cited as precedent.
PLR-140710-15                                  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,

                                       /s/

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


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