Oilfield fluid management and waste disposal produce qualifying income

Plain-English summary

A publicly traded partnership planned to transport drilling and fracturing fluids, move fluids between well sites, and collect, treat, recycle, and dispose of flowback, produced water, and drilling waste for oil and gas producers. The IRS ruled that income from these integrated fluid-management, transfer, and disposal services qualified under IRC § 7704(d)(1)(E), whether earned directly or through a joint venture. Income from supplying or transferring water and other injectants alone did not qualify unless the partnership also collected and handled the resulting produced water and waste. Income from recovering hydrocarbons during disposal also qualified, provided the hydrocarbons were not sold to retail end users.

Ruling snapshot

• Question: Is income from the partnership's oilfield fluid management, waste disposal, and hydrocarbon recovery qualifying income?
• Outcome: Approved with limits. The integrated services qualify, but stand-alone fluid delivery does not, and recovered hydrocarbons cannot be sold at retail.
• Key authorities: IRC §§ 7704(c), 7704(d)(1)(E)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201723004 Third Party Communication: None
Release Date: 6/9/2017 Date of Communication: Not Applicable
Index Number: 7704.03-00
Person To Contact:
---------------------------------------- ----------------------------, ID No. --------------
----------------------------------- -----------------
---------------------------------- Telephone Number:
---------------------------------------------------- ---------------------
Refer Reply To:
CC:PSI:01
PLR-125167-16
Date:
January 25, 2017

Legend

X = ------------------------------------------------------------------------------------------------------
------------------------
State = -------------

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

  This responds to your letter dated August 12, 2016, and subsequent

correspondence submitted on behalf of X, requesting a ruling under section
7704(d)(1)(E) of the Internal Revenue Code.

                                                   FACTS

   According to the information submitted, X is a publicly traded limited partnership

organized under the laws of State. X, through direct and indirect wholly owned and
disregarded subsidiaries, is engaged in certain midstream operations, and as part of
that business, X plans to provide fluid waste handling, treatment, and disposal services
to customers engaged in the exploration for, and development and production of, oil and
natural gas.

    As part of its fluid management services, X will supply and transport drilling and

fracturing fluids, including fresh water, brine, and other injectants, for use in drilling and
hydraulic fracturing. The fresh water supply will be obtained by X from through water
wells drilled by X, third-party landowners, upstream, lease rights, and/or government
entities and treatment facilities. X plans to transport the fluids to producers via
temporary and permanent pipelines. These pipelines will be used exclusively to
transport water to oil and gas well sites. X will design and develop the distribution
pipelines based on the specific needs and location of each group of oil and gas wells
served. During the provision of these services, X’s personnel will remain present at, or

PLR-125167-16 2

will remotely monitor, both the fluid source and the well site to oversee the process and
ensure proper functioning of the pipelines and related equipment. Lastly, X may
transport fluids to producers using trucking services provided by third parties.

    With respect to its freshwater services, X will remove freshwater from its sources,

transferring the water to above-ground storage tanks or to storage ponds. Because the
rate of water removal from the storage tanks and ponds may exceed the rate at which
water enters the storage tanks and ponds, X’s personnel will provide monitoring
services, onsite or offsite, on a real-time basis to ensure that equipment is functioning
properly and maintaining proper flow rates.

     X will also provide 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 will also treat and dispose of flowback, produced water, and other drilling

production wastes. Flowback and produced water will be transported by dedicated
pipeline or truck to X’s salt water disposal (SWD) wells. X’s personnel will coordinate
with oil and gas operators to develop pipelines at one or several groupings of well site
production tanks or centralized tank batteries. X’s operation may include fluid treatment
to allow the recycled fluids to be used in future drilling and fracturing operations.

   X will also provide hydrocarbon remediation services. As a part of these

services, X will remove hydrocarbons from the drilling waste at its facilities during the
waste treatment and disposal process and sell such reclaimed hydrocarbons.

   X makes the following representations:

1. X will supervise, direct, and control personnel for its fluid management,
  transportation, disposal, and storage services. These activities require personnel
  with specialized knowledge, unique training, and experience such as training in
  fluid pressure monitoring, spill prevention, and operating pumps critical to the
  operation of X’s and disposal facilities.
2. The provision of fluids and water transfer services are essential to the completion
  of oil and natural gas drilling and fracturing operations.
3. Processing, treatment, and disposal 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 will be performed
  on an ongoing basis throughout the exploration and production life cycle of each

PLR-125167-16 3

   producing property. X’s disposal facilities and related service equipment will be
   staffed and are equipped to allow for 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, 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)(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).

                                  CONCLUSION

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

that gross income derived by X from its fluid management, inter-well transfer , and
disposal services constitutes qualifying income within the meaning of § 7704(d)(1)(E),
regardless of whether the income is earned directly by X and its subsidiaries or through
its distributive share of a joint venture. This ruling is not applicable to any income
derived by X from the delivery and transfer of water, brine, or other injectants, including
recycled produced water, where X does not also collect and clean, recycle, or otherwise
dispose of produced water and drilling production waste after use.

  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 recovered hydrocarbons to end
users at the retail level.

PLR-125167-16 4

   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.
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
                                  (Passthroughs & Special Industries)

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

cc: