IRS Issues Proposed Regulations for Publicly Traded PartnershipsMay 15, 2015
On May 6, 2015, the Internal Revenue Service (IRS) issued notable proposed regulations (REG-132634-14) clarifying the publicly traded partnership (PTP) activities, in the minerals and natural resources sectors, that will produce qualifying income for the purposes of Section 7704 of the Internal Revenue Code of 1986, as amended.
As a general rule, PTPs are taxed as corporations. Section 7704(c) exempts PTPs from this rule if 90% or more of their gross income is "qualifying income." Qualifying Income is generally passive-activity income, and includes income from interest, dividends and rent. Section 7704(d)(1)(E) provides, however, that qualifying income also includes income derived from the exploration, development, mining or production, processing, refining, transportation, or marketing of minerals or natural resources (Section 7704(d)(1)(E) activities). Until now, the IRS had not issued regulations under Section 7704(d)(1)(E). The proposed regulations were issued in response to an increase in the number of requests for private letter rulings as to whether income derived from "support services" provided to businesses engaged in Section 7704(d)(1)(E) activities is qualifying income for the purposes of the 7704(c) exception.
The proposed regulations provide guidance as to which activities relating to minerals or natural resources generate qualifying income for PTPs. The proposed regulations refer to these activities as "qualifying activities." Qualifying activities include (i) Section 7704(d)(1)(E) activities, and (ii) certain limited support activities that are intrinsic to Section 7704(d)(1)(E) activities ("intrinsic activities"). The inclusion of intrinsic activities reflects the reality that activities intrinsic to Section 7704(d)(1)(E) activities inherently give rise to qualifying income, because the income is "derived from" the Section 7704(d)(1)(E) activities.
A support activity must satisfy three requirements to be an intrinsic activity. An activity will qualify as an intrinsic activity only if the activity is:
- specialized to support the Section 7704(d)(1)(E) activity;
- essential to the completion of the Section 7704(d)(1)(E) activity; and,
- requires the provision of significant services to support the Section 7704(d)(1)(E) activity.
Intrinsic activities must constitute active support of Section 7704(d)(1)(E) activities, and not merely the supply of goods. If all three requirements are satisfied, the activity will be deemed a qualifying intrinsic activity, and income derived from the activity will be qualifying income.
If finalized, the proposed regulations could overturn up to a dozen previously issued private letter rulings. The proposed rules are generally consistent with prior rulings issued to companies engaged in oil and gas exploration and transportation activities. The rules pertaining to other activities, and to natural resources other than oil and gas, however, represent a substantial departure from previously issued rulings. For example, the proposed rules provide that activities tied to injecting water and sand for hydraulic fracturing will be deemed "qualifying intrinsic activities," but activities involved in processing paper products from timber, or plastic from natural gas, will not.
The IRS has invited comments on the proposed regulations, which will not be operative until they are published as final. The proposed rules provide for certain transition periods.
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