IRS Rules That Income from Fracking Activities Is Qualified Income under Publicly Traded Partnership Code

The IRS ruled that income received by a publicly traded limited partnership from supplying water used in a fracturing process to produce natural gas, from hydrocarbon remediation and from disposing of flowback, produced water, drilling mud and other production wastes which result from the fracturing processes, is "qualifying income" within the meaning of Section 7704 of the Internal Revenue Code. As a result, such limited partnership is not subject to taxation as a corporation for federal income tax purposes.

Under the Code, a partnership is taxed as a corporation if interests in that partnership are (i) traded on an established securities market or (ii) readily tradable on a secondary market (or substantial equivalent thereof). However, if in each year 90% or more of the gross income of such publicly traded partnership is "qualifying income," the partnership is not taxable as a corporation but is entitled to flow through tax treatment generally applicable to non-publicly traded partnerships. Under the Code "qualifying income" generally includes income or gains derived from the exploration, development, mining, production, processing, refining, transportation or marketing of any mineral or natural resource. Based on the facts presented and on the legislative history of Section 7704, the IRS ruled that the publicly traded partnership's income as described above was derived from exploration or development of natural resources, even though the partnership itself did not receive any revenues from the natural gas produced by the fracturing process.

See: IRS Fracking PLR.For more information, please contact Daniel Mulcahy and Mark Howe.