IRS proposes changes to MLP taxation policy

OREANDA-NEWS. The US Internal Revenue Service (IRS) is proposing an update to the current master limited partnership (MLP) taxation policy, which would create different rules for refining and petrochemical operations.

In the US federal tax code, an MLP is subject to a single partnership income tax as long as 90pc of the MLP's income meets certain criteria. This differs from higher rates that corporations face, as well as the tax on dividends or distributions made to shareholders. This structure gives MLPs a lower cost of capital and makes them more attractive to investors seeking dividends.

The proposed IRS rule change clarifies the kinds of mineral and natural resource operation income that can be counted toward an MLP's qualification threshold.

For most energy companies, income from operations between the well-head and the wholesaler will still qualify, but the change casts a divide between oil and gas refining and petrochemical cracking. In the proposal, income from operations causing a "substantial physical or chemical change" to the product or that are related to the "production of plastics and similar petroleum derivatives" are not included as qualifying income. This would mean that petrochemical cracking for the production of ethylene or propylene, for example, would not qualify.

The proposal, however, classifies income from cracking operations with the end-goal of producing gasoline or fuel as acceptable qualifying income. In other words, if naphtha from a cracker is then hydrotreated and blended into gasoline, those profits will count as qualifying income.

Income from fractionation, splitting, gas processing and gasoline blending operations will all be counted as qualifying income, as will transportation, terminaling and storage services — as long as the transportation is not to a site which dispenses product to retail customers. This means income from transportation to bulk terminals will still qualify, but transporation to a retail gasoline station would not.

Companies can maneuver around the IRS' proposed classifications for qualifying income if they can prove that their operation is an ‘intrinsic activity' — one that uses specialized personnel and property, which has limited alternative applications and is frequent or ongoing at the operation site. One example of this would be the delivery, recovery and recycling of hydraulic fracturing flowback water.

The proposal allows for a ten-year transition period for MLPs currently claiming newly-excluded qualifying incomes; companies holding private letter ruling (PLR) from the IRS for an activity will also qualify for the transition period.

The IRS has asked for comments on the proposal and public hearing requests by 4 August.

The change was prompted by the growing number of PLR requests made by companies since 2008.