Master Limited Partnerships

Master Limited Partnerships

June 10, 2008

MASTER LIMITED PARTNERSHIPS cannot own power plants, the Internal Revenue Service said. 

Master limited partnerships — called MLPs — are partnerships with units that are traded on a stock exchange or over-the-counter market. Developers like them because they can be used to raise equity more cheaply; investors are willing to pay a higher multiple for units because the units can be resold into a liquid market. In addition, the partnerships do not pay income taxes. The partners are taxed on their shares of partnership income directly. Finally, they are good vehicles for rolling up assets or small businesses because the units can be used as a currency to make acquisitions.

As a general rule, any partnership whose units are publicly traded is taxed like a corporation.

However, the US tax laws make an exception. An entity will remain a partnership if at least 90% of its gross income each year is passive like interest and dividends. It is also good income if the partnership’s earnings are from producing, transporting or processing any mineral or natural resource,“including fertilizer, geothermal energy and timber.”

Many people have asked whether it is “processing . . . geothermal energy” to turn it into electricity. The IRS said no in June. The agency said in a private ruling that power plants that use geothermal energy, natural gas, wood chips, refined oil products and coal do not “process” minerals or natural resources.

It said,“The use of the word ‘processing’in the energy industry means a specific type of downstream activity encompassing refining and certain petrochemical activities, but this  meaning does not include”generating electricity. It pointed to language in Congressional committee reports when the master limited partnership rules were enacted that said it is processing oil to run it through a refinery to make gasoline, but not to use it farther downstream to make plastics.

The ruling was odd because most taxpayers withdraw their ruling requests rather than have the agency issue an unfavorable ruling. In this case, the taxpayer may have wanted to put the IRS on record to discourage competitors from attempting to use MLPs for power plants.

The ruling is Private Letter Ruling 200821021. The IRS made it public in early June. The agency opened the door last year to use of master limited partnerships by companies that own electric transmission grids by ruling privately that such grids are considered largely real property. Rents from real property  are considered good income for an MLP