The IRS issued proposed regulations, REG-132634-14, 80 Fed. Reg. 25970 (5/5/15), because of an increase in requests for private letter rulings that income for support services provided to businesses engaged in activities in the minerals and natural resource industry is qualifying income. The requests involved publicly traded partnerships, which are taxed as corporations unless 90% or more of the partnership’s gross income is “qualifying income.” Qualifying income is generally passive-type income, such as interest, dividends, and rent. However, under §7704(d)(1)(E), qualifying income also includes income and gains derived from the (1) exploration, (2) development, (3) mining or production, (4) processing or refining, (5) transportation, or (6) marketing of minerals or natural resources. Under the proposed regulations, each of these six activities (“section 7704(d)(1)(E) activities”) is defined and listed as a “qualifying activity,” i.e., an activity that would generate qualifying income.
Certain limited support activities (“intrinsic activities”) would also be considered qualifying activities, if they: (1) are specialized to support a section 7704(d)(1)(E) activity; (2) are essential to the completion of a section 7704(d)(1)(E) activity (i.e., necessary to physically complete the activity or comply with applicable laws regulating the activity); and (3) require significant services to support a section 7704(d)(1)(E) activity (i.e., the activity must be conducted on an ongoing or frequent basis by the partnership’s personnel at the site of the section 7704(d)(1)(E) activity or offsite if the services are ongoing and frequent and offered exclusively to those engaged in a section 7704(d)(1)(E) activity).
An activity would be considered specialized if both the personnel performing the activity and any property used in the activity or sold to the customer performing the section 7704(d)(1)(E) activity are specialized. Personnel who have received training that is unique to the mineral or natural resource industries and that is of limited utility other than to perform or support a section 7704(d)(1)(E) activity would be considered specialized. Property would be considered specialized if (1) it is used only in connection with section 7704(d)(1)(E) activities, (2) it has limited use outside those activities, and (3) it cannot be easily converted to another use. Property would also be considered specialized if it is an injectant (e.g., sand used in connection with a section 7704(d)(1)(E) activity) and is properly disposed of according to applicable laws.
Note that fracking services would get favorable treatment under the proposed regulations, which list water delivery and disposal services as essential activities when provided for use in fracturing.
The proposed regulations would provide transition rules and would generally apply to income earned by a partnership in a taxable year beginning on or after the date they are finalized.
by Vera Barnes
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