Crude oil pipeline agreement income qualified under section 7704

Plain-English summary

A limited partnership owned an interest in an entity that transported crude oil through a lateral pipeline and a larger pipeline. The entity earned per-barrel transportation fees and could receive repair surcharges and reimbursements for specified design, construction, maintenance, and related costs. The partnership asked whether its share of the income from the transportation agreements was qualifying income for the publicly traded partnership rules. The IRS concluded that all gross income described from those agreements was qualifying income under section 7704(d)(1)(E). The ruling did not decide whether the partnership met the separate 90% qualifying-income test for any taxable year.

Ruling snapshot

• Question: Was the partnership's gross income from the crude oil transportation agreements qualifying income under section 7704(d)(1)(E)?
• Outcome: approved
• Key authorities: IRC § 7704(c), (d)(1)(E); Treas. Reg. § 1.7704-4(c)(7), (10)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201736020                                            Third Party Communication: None
Release Date: 9/8/2017                                       Date of Communication: Not Applicable
Index Number: 7704.03-00
                                                             Person To Contact:
------------------------------------------                   ----------------------, ID No. ------------------
--------------------------------------------                 Telephone Number:
-----------------------                                      --------------------
-----------------------------                                Refer Reply To:
--------------------------------                             CC:PSI:B03
                                                             PLR-104652-17
                                                             Date:
                                                             June 07, 2017


                                                   LEGEND

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

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

Date                = ----------------------

Entity              = --------------------------------------------------------------------------------------------
                      ------------------------

Pipeline            = --------------------------------------------------------------------------------------------
                      --------------------------------------------------------------------------------------------
                      --------------------------------------------------------------------------------------------
                      -
a                   = ------

b                   = ----

c                   = ------

Agreement 1         = --------------------------------------------------------------------------------------------
                      --------------------------------------------------------------------------------------------
                      -------------------------------------------------

Agreement 2         = --------------------------------------------------------------------------------------------
                      --------------------------------------------------------------------------------------------
                      ------------------------------------------------------------

Agreement 3         = --------------------------------------------------------------------------------------------
                      --------------------------------------------------------------------------------------------
PLR-104652-17                                           2

                       -------------------------------------------------------------------------

Producers         = ----------------------------------------------------------------------------

Leases            = --------------------------------------------------------------------------------------------
                    --------------

Lateral           = --------------------------------------------------------------------------------------------
                    --------------------------------------------------------------------------------------------
                    --------------------------------------------------------------------------------------------
                    ------------------------

Facility 1        = --------------------------------------------------------------------------------------------
                    ---------------------------------------------------------------------------------------

Facility 2        = ----------------------------------------------------------------------------------------


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

        This letter responds to a letter dated January 31, 2017, submitted on behalf of X
by its authorized representatives, requesting a ruling under section 7704(d)(1)(E) of the
Internal Revenue Code (Code).

                                                   FACTS

         X is a limited partnership formed under State law on Date. X owns, operates,
develops, and acquires pipelines and other midstream assets. Among these assets is a
a% interest in Entity, which owns the Pipeline. ------------------------------------------------------
--------------------------

       Pursuant to Agreement 1, Agreement 2, and Agreement 3 (collectively, the
Agreements), Entity transports crude oil production of the Producers from the Leases to
designated delivery points. Oil produced is transported by Entity on its pipeline (the
Lateral) running from Producers’ Facility 1 to a tie-in (located at Facility 2) to the
Pipeline. Entity leases space from the Producers at Facility 2 for a pump station and
other pipeline assets.

        Pursuant to the Agreements, the Producers dedicate crude oil produced from the
Leases for transportation on the Lateral. Entity agrees to accept and transport the
dedicated crude oil delivered by the Producers at the designated point of receipt at
Facility 1. Entity is also responsible for operating the Lateral and the Pipeline through
its contracted operator.
PLR-104652-17                                             3

         The Agreements provide for a transportation fee based on the barrels of oil
transported. The shippers pay a separate fee for transportation on the Lateral and
for transportation on the Pipeline. During the first b years after first oil, the per-barrel
rate for transportation on the Lateral is -----------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------The transportation rate on the Pipeline is ---
---------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------Entity has
rights in certain cases to impose a repair surcharge to cover repairs on the Lateral and
the Pipeline.

       Persons other than the Producers may be the shippers of record if they purchase
the crude oil from the Producers at Facility 1. The shippers are then responsible for the
rates set forth in the Agreements.

        If Agreement 3 had been terminated prior to first oil because the Producers
elected to not complete construction of Facility 1, the Producers would have been liable
to Entity for certain costs expended with respect to the construction of the Lateral, plus
a service charge. Agreement 3 also provides that the Producers are responsible for
reimbursing Entity for reimbursable costs associated with certain direct and indirect
costs associated with design, engineering, construction, installation, maintenance,
repair, replacement, and abandonment of certain equipment located at or in the vicinity
of Producers’ Facility 1. These reimbursable costs are reimbursed at cost plus a b%
service charge.

                                              LAW & ANALYSIS

      Section 7704(a) provides that, except as provided in § 7704(c), a publicly traded
partnership will be treated as a corporation.

       Section 7704(c)(1) provides that § 7704(a) does not apply to a publicly traded
partnership for any taxable year if such partnership meets the gross income
requirements of § 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 § 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.
PLR-104652-17                                  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 1.7704-4(a) of the Income Tax Regulations provides that qualifying
income is income and gains from qualifying activities with respect to minerals or natural
resources as defined in § 1.7704-4(b). Qualifying activities are section 7704(d)(1)(E)
activities (as described in § 1.7704-4(c)) and intrinsic activities (as described in
§ 1.7704-4(d)).

      Section 1.7704-4(c) provides that section 7704(d)(1)(E) activities include the
exploration, development, mining or production, processing, refining, transportation, or
marketing of any mineral or natural resource.

        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.
Transportation includes moving or carrying (whether by owner or operator) products via
pipelines, gathering systems, and custody transfer stations and providing storage
services.

        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-104652-17                                  5

                                       CONCLUSION

       Based solely on the facts submitted and the representations made, we conclude
that gross income derived by X from the Agreements, as that income is described in the
Facts section of this letter, is qualifying income under section 7704(d)(1)(E).

       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)(2) 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,

                                        /s/


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


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