The Internal Revenue Service made clearer in May where it plans to draw the line on the types of minerals and natural resources businesses that may operate as master limited partnerships or MLPs.

It said it will give most companies that are already operating as MLPs at least 10 years to adjust to the new rules.

The new rules are in the form of proposed regulations. They interpret section 7704(d)(1)(E) of the US tax code. The IRS is accepting comments through August 4.

An MLP is a partnership whose ownership interests are traded on a stock exchange or secondary market. The United States usually taxes publicly-traded companies as corporations. However, it makes an exception for partnerships that receive at least 90% of their gross income each year from passive sources, like interest or dividends, or from activities tied to minerals or natural resources. Such companies are able to operate without having to pay corporate income taxes. Their income is taxed to the owners directly.

The proposed regulations explain how closely tied a partnership’s activities must be to minerals or natural resources to produce good income.

The IRS has been fielding a growing number of requests for private letter rulings from companies that provide services to the oil and gas trade and want to operate as MLPs. It put a hold on any further rulings in February 2014 while it evaluated where to draw the line. For example, is a business that sends catering trucks to sell meals to workers at gas fracturing sites closely enough related to production of natural gas to be able to operate as an MLP? The agency lifted the hold in early March 2015 and said that proposed regulations would follow. It said it received more than 30 ruling requests in 2013 compared to fewer than five a year before 2008.

Proposed Line

The proposed regulations treat income as qualifying income only if it is from engaging directly in “exploration, development, mining or production, processing or refining, transportation or marketing” of minerals or natural resources or from providing a limited class of services to companies that are directly engaged in such activities.

The agency said the regulations provide an “exclusive list” of what direct activities qualify. Any additions to the list in the future will require an IRS notice or other written guidance that may be time consuming to obtain.

In general, any activity that involves retail sales or distribution to retail sellers or end users goes too far. Thus, for example, supplying gasoline to service stations does not qualify. However, there are exceptions for certain bulk and wholesale sales to end users, such as supplying fuel to electric utilities.

A number of paper companies had been considering converting parts of their operations into MLPs. The proposed regulations make clear that converting timber into wood chips, sawdust, untreated lumber, veneers (without any substances added), wood pellets, wood bark and rough poles is an acceptable activity for an MLP. However, it goes too far to produce pulp (at least if chemicals are added), paper, paper products, treated lumber, oriented strand board, plywood or treated poles. Many paper company shares were down on US stock exchanges shortly after the IRS announcement.

The IRS said making plastics and similar petroleum derivatives is not a qualifying activity. At least two chemical companies are using MLPs to own facilities that convert ethane and propane into olefins that are used to make plastics after receiving private rulings from the IRS in 2012 and 2013 that such businesses qualify. It appears that MLPs will still be able to earn income from some refinery-grade olefins, like ethylene, that are produced as an adjunct to making gasoline and other fuels. The IRS ruled out olefins because it believes they are produced through manufacturing rather than “processing.” Curt Wilson, the IRS associate chief counsel for MLP issues, said at a conference in New York in May that “Congress did not intend manufacturing activities to qualify, although it said processing does. Drawing that line has been very, very difficult, and so we relied on a lot of IRS engineers to tell us what [manufacturing] means.” Wilson said he remains open to being persuaded that olefins should qualify.

Services to the oil and gas trade qualify only if they pass three tests.

The services must be specialized, essential and significant to the direct activity being undertaken by the oil or gas company.

They are “specialized” if the workers who perform them require special training unique to minerals or natural resources industries. If the company is providing property, then the property must be of limited use outside the direct activity and not be easily converted to another use. An MLP can provide injectants, like water, lubricants and sand, for use in fracturing, provided it collects the injectants after use and cleans, recycles or otherwise disposes of them as required by law.

Services are “essential” if they are necessary physically to complete the direct activity or to comply with federal, state or local law regulating the direct activity. An example is water delivery and disposal to a gas fracturing site. Legal, financial, consulting, insurance and similar services are not considered essential.

To be considered “significant,” the services must require partnership employees to be an “ongoing or frequent presence at the site” and the employees must be doing something that is necessary for the direct activity. The IRS said the work can also be offsite. An example is offsite monitoring.

Transition Relief

Renewable energy companies have been lobbying Congress since 2004 for the ability to operate as MLPs. They are not able to do so currently mainly because their income does not come from “minerals or natural resources.” Energy sources like the sun or wind are not natural resources because they are inexhaustible. The phrase refers only to things that deplete. Senator Chris Coons (D.-Delaware) reintroduced a bill in late June to allow MLPs to own a broader class of assets. The assets include not only renewable power projects, but also fuel cells, combined-heat-and-power projects, electricity storage devices, renewable chemicals companies, installers of energy efficiency improvements, biofuels producers, power plants and large industrial facilities that capture and store their carbon dioxide emissions and gasification projects that gasify coal, petroleum residue, biomass or other materials and that capture and store a significant percentage of the carbon dioxide emissions.

Interest in MLPs among renewable energy companies has been waning after the industry discovered yield cos, which are a form of synthetic MLP and do not require any action by Congress to implement.

Most companies already operating as MLPs will have 10 years from the end of the partnership tax year in which the IRS republishes the proposed regulations in final form to adjust to the new rules. Republication will take at least another year. This transition relief will be given to any existing MLP that, before May 5, 2015, had a private letter ruling, treating as a qualifying activity, an activity that the IRS regulations now treat as ineligible or that was treating an activity as qualifying under a reasonable interpretation of the US tax code before the proposed regulations were issued. The IRS said merely having a “reasonable basis” for a position is not good enough.

There is no current plan at the IRS to revoke any existing private letter rulings. At least 10 to 12 such rulings are at odds with the proposed new rules. The rules are not yet final. In addition, some companies have been concerned that if the rulings were revoked, then they would not be able to rely on them during the transition period.

At least 149 MLPs are trading currently on US exchanges. Of that number, 93 involve oil and gas (including oilfield services MLPs). The remaining MLPs include seven that own coal mines, 10 that are engaged in marine transportation, four that are propane MLPs and 10 that are in other natural resources.

Keith Martin, in Washington