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Last-minute tax ruling on MLPs may not survive changing of the guard

A last-minute tax ruling on what activities and income can be sheltered inside a master limited partnership is generally favorable to oil and natural gas interests, analysts said, but many experts suspect the new rule will not survive the change of White House administrations.

The U.S. Treasury and the IRS released their final rule on MLP income late Jan. 19 for publication in the Federal Register on Jan. 24, with President Donald Trump in office. Past presidents have routinely put a hold on pending regulations and orders of their predecessors.

"Obama, Bush, [and] Clinton all put their predecessors' pending rules on ice; why would Trump be different?" Height Securities LLC analyst Peter Cohn told his clients Jan. 20 hours before Trump was sworn in. "Even if Trump's staff fails to issue such a memo [withdrawing publication of all pending rules], ongoing tax reform efforts on Capitol Hill as well as other legislative vehicles such as appropriations bill 'policy riders' could block the rule from taking effect."

Hoping to stimulate construction and growth of energy infrastructure, Congress granted the tax-advantaged treatment of various natural resource activities in an MLP. The MLP distributes profits to its unit holders, leaving equity holders, not the partnership, liable for any taxes. The MLP structure has come to be a preferred corporate structure for oil and gas gathering, processing and transportation assets.

The new rule shows tax regulators shifting from a specific list of activities permitted inside the tax-free MLP to general categories of permitted activities.

"The concept of an exclusive list of qualifying activities included in the proposed regulations has been eliminated; instead, the final regulations provide a non-exclusive list that the IRS and the Treasury expect to be interpreted and applied in a manner consistent with their plain meaning," attorneys at Vinson & Elkins LLP said in a Jan. 19 note.

"The bias in favor of fuels over other products of crude oil and natural gas has been eliminated," Vinson & Elkins and analysts noted, eliminating the distinction between whether compounds like the plastics building block ethylene are made in a steam cracker or a refinery.

That is good news for chemical manufacturers such as Westlake Chemical Partners and parent Westlake Chemical Corp., Cohn said. They "would be made whole by the final rule as ethylene production is listed clearly among the qualifying sources of income in the final rule," he said.

Also added to the list of activities that can be dropped into the MLP structure are compression services and income from non-operated oil and gas wells. The rule indicated that the IRS would look sympathetically on MLP hedging income but said further guidance would be delayed into the future.

"The final regulations are largely an improvement over the proposed regulations," Vinson & Elkins said, but hard rock miners and LNG operators may not be entirely happy.

The rule declined to define LNG or liquefied petroleum gas as natural resources and has a narrow interpretation of mining that excludes coal coking, analysts said. Also excluded are methanol producers because methanol is not a product for which the U.S. Energy Information Administration collects data.

"Simply put: if EIA counts it in those surveys, it's a product of refining," energy analyst Kevin Book of ClearView Energy Partners said. "While this methodology could potentially drive producers of excluded products to lobby EIA for inclusion, we would suggest that modifying statistical surveys constitutes a high hurdle (data consistency and robustness require definitions to be fairly static)."

"The final rule emerged less than 24 hours before President-elect Donald Trump will take the oath of office, making it one of the last 'midnight' regulations issued during the waning hours of the outgoing Obama administration," Book said. He does not expect the new MLP tax rule to survive the traditional purge of orders and rules by the incoming president.