Wood pellet and wood chip operations produce qualifying income

Plain-English summary

A corporation planned to contribute its wood-pellet and wood-chipping operations to a publicly traded partnership. The activities included debarking, chipping, screening, drying, pressure-forming pellets without foreign binders, storage, bulk sales, transportation, mill operation, and reimbursement for constructing and maintaining mills. The IRS ruled that income from processing, transporting, storing, and marketing the wood pellets and chips qualified under IRC § 7704(d)(1)(E). The ruling did not cover retail sales directly to end users or decide whether the partnership would satisfy the separate 90-percent qualifying-income test.

Ruling snapshot

• Question: Is income from the partnership's wood pellet and wood chip operations qualifying income?
• Outcome: Approved. The described processing, transportation, storage, and marketing income qualifies, excluding retail sales to end users.
• Key authorities: IRC §§ 7704(c), 7704(d)(1)(E); Treas. Reg. §§ 1.7704-4(c)(5), 1.7704-4(c)(7), 1.7704-4(c)(8), 1.7704-4(c)(10)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201722023 Third Party Communication: None
Release Date: 6/2/2017 Date of Communication: Not Applicable
Index Number: 7704.00-00, 7704.03-00
Person To Contact:
------------------- ----------------------, ID No. ------------------
------------------------------------------------------------ Telephone Number:
-------------------------------------------- --------------------
------------------------------------- Refer Reply To:
CC:PSI:B03
PLR-137922-14
Date:
February 28, 2017

                                                LEGEND

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

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

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

    This letter responds to a letter dated October 3, 2014, submitted on behalf of X

by its authorized representative, requesting a ruling under § 7704(d)(1)(E) of the
Internal Revenue Code (Code).

                                                 FACTS

    X is a corporation organized under the laws of State. X intends to form a publicly

traded partnership and effect an initial public offering (IPO). The partnership will provide
timber processing, transportation, storage, and marketing services. Specifically, after
the IPO, the partnership will directly or indirectly conduct some or all of X’s current wood
pellet and wood chipping business.

    Currently, X’s wood pellet business consists of the following activities: X

acquires timber feedstock including raw logs (that it will debark and chip), mill chips,
roundwood chips, bole chips, sawdust, and kiln dried residue from both softwood and
hardwood sources (hereinafter, feedstock). After arrival at the facility, the feedstock is
screened and size reduced, and then dried in a rotary style dryer to reduce moisture
content (except for the kiln dried residue). The dried particles are combined with the
kiln dried residue and then size reduced again to achieve uniform consistency before
being sent through a pellet mill. The pellet mill operates by forcing the feedstock

PLR-137922-14 2

through holes under pressure. The intense pressure raises the temperature of the
feedstock, which assists in binding the particles into wood pellets without the addition of
any binding agents. Blades cut the pellets to size. X stores the wood pellets in pellet
silos. These stored pellets are then directly loaded for bulk sales or bagged for sales to
third party retailers.

    X operates timber processing mills as a part of its current wood chipping

business, whereby: (1) logs are debarked; (2) debarked logs are chipped; (3) chips are
screened for oversized and undersized chips and re-chipped as needed; (4) chips are
stacked for storage, loaded onto trucks or train cars for immediate delivery, or directly
conveyed to a customer’s facility; (5) bark is separated and sent for separate
processing; and (6) bark is screened and distributed to the customer. X may provide
just the operating services or X may also finance, construct, and maintain the mill that X
operates with its own employees. X typically charges a per ton fee for its processing
services, but may also charge a per hour fee coupled with a per month supervisory fee.
X may additionally charge a fee that reimburses X’s construction costs plus a
reasonable rate of return for the facility.

                                        LAW

   Section 7704(a) provides that a publicly traded partnership shall 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 § 7704(a) shall not apply to any publicly traded

partnership for any taxable year if such partnership met the gross income requirements
of § 7704(c)(2) for such 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) explains that a partnership meets the gross income

requirements of § 7704(c) for any taxable year if 90 percent or more of the gross
income of such partnership for such taxable year is 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
or timber).

PLR-137922-14 3

   Section 1.7704-4(c)(5) of the Income Tax Regulations provides that an activity

constitutes processing if it is performed to convert raw mined or harvested products or
raw well effluent to substances that can be readily transported or stored, as described in
§ 1.7704-4(c)(5). Section 1.7704-4(c)(5)(iv) provides that an activity constitutes
processing of timber if it is performed to modify the physical form of timber, including by
the application of heat or pressure to timber, without adding any foreign
substances. Processing of timber does not include activities that add chemicals or
other foreign substances to timber to manipulate its physical or chemical properties,
such as using a digester to produce pulp. Products that result from timber processing
include wood chips, sawdust, rough lumber, kiln-dried lumber, veneers, wood pellets,
wood bark, and rough poles. Products that are not the result of timber processing
include pulp, paper, paper products, treated lumber, oriented strand board/plywood, and
treated poles.

    Section 1.7704-4(c)(7)(i) provides that an activity constitutes transportation if it is

performed to move minerals or natural resources, and products under § 1.7704-4(c)(4),
(5), or (6), including by pipeline, marine vessel, rail, or truck. Except as provided in
§ 1.7704-4(c)(7)(ii), transportation does not include the movement of minerals or natural
resources, and products produced under § 1.7704-4(c)(4), (5), or (6), directly to retail
customers or to a place that sells or dispenses to retail customers. Retail customers do
not include a person who acquires oil or gas for refining or processing, or a utility.

    Section 1.7704-4(c)(8)(i) provides that an activity constitutes marketing if it is the

bulk sale of minerals or natural resources, and products under § 1.7704-4(c)(4), (5), or
(6). Except as provided in § 1.7704-4(c)(8)(ii), marketing does not include retail sales
(sales made in small quantities directly to end users), which includes the operation of
gasoline service stations, home heating oil delivery services, and local natural gas
delivery services. Section 1.7704-4(c)(8)(iii) provides that marketing also includes
certain activities that facilitate sales that constitute marketing under § 1.7704-4(c)(8)(i)
and (ii), including packaging.

    Section 1.7704-4(c)(10)(i) provides that, if the partnership is in the trade or

business of performing a section 7704(d)(1)(E) activity, qualifying income includes
income received to reimburse the partnership for its costs in performing that section
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 section 7704(d)(1)(E) activity, or providing office functions necessary
to the operation of that section 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.

PLR-137922-14 4

                                  CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

the income derived from the processing, transportation, storage, and marketing of wood
pellets and wood chips constitutes qualifying income within the meaning of
§ 7704(d)(1)(E).

    Except as specifically provided, we express or imply no opinion as to 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 the partnership will meet
the 90 percent gross income requirement of § 7704(c)(1) or whether any other type of
income not addressed in this ruling is qualifying income under § 7704(d). In addition,
this ruling does not apply to retail sales made directly to end users.

   This ruling is directed only to the taxpayer requesting it. However, in the event of

a technical termination of the partnership 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 it may not be used or
cited as precedent.

  In accordance with the Power of Attorney on file with this office, we are sending

copies of this letter to your authorized representatives.

   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 requests, it is subject to verification on examination.

                                   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