Treasury Department Proposes New Qualifying Income Standards for Natural Resource Activities in Publicly Traded Partnerships
Proposed regulations made public May 5, 2015, by the Treasury Department propose new guidance on whether income from certain activities with respect to minerals and natural resources is “qualifying income.” The proposed regulations (available here) use the term “qualifying activities” to describe activities relating to mineral or natural resources that generate qualifying income, such as the exploration, development, mining or production, processing or refining, transportation, or marketing of minerals or natural resources, and certain support activities that are intrinsic to those listed activities. The Treasury Department has requested comments regarding the proposed standards by August 4, 2015. When final regulations are issued after addressing comments, the Treasury Department intends for the regulations to provide an exclusive list of operations that comprise each of those activities. While the list generally reflects historical understanding of qualifying income concepts, the proposed regulations depart from prior standards with respect to the scope of processing and refining. For example, the Treasury Department has adopted standards that differ on an industry-by-industry basis, including broader views with respect to crude oil and natural gas, and more restrictive views with respect to natural gas liquids, certain minerals, and timber.
The proposed regulations confirm that certain activities in support of a qualifying activity, or “intrinsic activities,” also generate qualifying income. An “intrinsic activity” must meet a three-part test: (i) the activity must be specialized with respect to a qualifying activity, (ii) be essential to the completion of the qualifying activity, and (iii) require the provision of significant services.
Activities are “specialized” under the new test to the extent that the partnership’s personnel require training unique to the industry. The provision of specialized property will include the provision of water, lubricants, and sand for use as an injectant in hydraulic fracturing if the partnership collects and cleans, recycles, or otherwise disposes of the injectant after use in accordance with federal, state, or local regulations concerning such waste products. An activity is “essential” to a qualifying activity if it is required to physically complete the qualifying activity or comply with laws regulating such qualifying activity, such as water delivery and disposal services for fracturing operations. Finally, the provision of “significant services” is generally defined as having an ongoing or frequent presence at the site of the qualifying activity, while performing activities that are necessary for the partnership to provide its services or support the qualifying activity. Extensive offsite services, such as monitoring, may also be intrinsic activities.
To the extent that an existing publicly traded partnership’s activities do not meet the standards outlined above, the regulations outline a generous 10-year transition period from the date that final regulations are published for publicly traded partnerships that (i) have previously received a private letter ruling from the IRS holding that an activity produces qualifying income, or (ii) have been engaged in an activity prior to May 5, 2015 and have reasonably treated such activity as giving rise to qualifying income under the statute as reasonably interpreted prior to the issuance of the proposed regulations.
If you have questions or would like to discuss the IRS’ ruling process, please contact a member of the V&E MLP tax team:
Additional Background on Qualifying Income:
The Internal Revenue Code generally treats an MLP as a corporation, rather than a partnership, for federal income tax purposes unless 90 percent or more of the MLP’s gross income for every taxable year consists of “qualifying income.” For this purpose, “qualifying income” includes income derived from the exploration, development, mining, production, processing, refining, transportation, or marketing of minerals, natural resources, or industrial source carbon dioxide, and the transportation and storage of certain renewable fuels. Other types of qualifying income include dividends, interest (other than interest generated by a financial or insurance business), and certain income that would be qualifying to a real estate investment trust (REIT) or a regulated investment company (RIC).
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.