IRS Applies Brakes to MLPs

Agency reviewing approval process as partnerships catch fire beyond energy

IRS (CSP Daily News / Convenience Store Petroleum)

WASHINGTON -- Master limited partnerships (MLPs) are all the rage among energy companies, with even marketers such as Susser Holdings Corp. and Lehigh Gas Partners spinning off to take advantage of the tax-free structure; however, the Internal Revenue Service (IRS) is taking another look at its own process of approving MLPs.

The IRS is undergoing an internal review of MLPs and temporarily suspending its issue of guidance for companies interested in forming or growing one, according to a report in The Wall Street Journal. MLPs have become popular because companies do not have to pay corporate income taxes, but can instead pay out most of the cash flow to shareholders in dividend-like payments called distributions, the newspaper explained.

Energy companies--mainly in the midstream--have traditionally embraced the MLP structure because it helps them raise capital. But more recently the IRS has received inquiries about forming MLPs from businesses that are increasingly tangential to energy production, such as water recyclers and sand mines. The structure has become incredibly popular among investors who are attracted by the potentially high yields.

And the pace of businesses filing to form MLPs is up, with almost 70 of the partnerships filing IPOs during the last five years, effectively doubling in number. According to figures from Dealogic, 20 MLPs launched in 2013.

To qualify for an MLP, a business must generate 90% of its earned income from qualifying activities, most involving natural resources. MLPs have traditionally been limited to fee-for-service infrastructure businesses such as pipeline operators, although fuel marketers, refiners, offshore drillers and oil-and-gas exploration companies are now getting in the game. More recently, sand mines that serve hydraulic-fracturing companies have gravitated to the MLP structure to raise capital more easily and access debt markets to fuel future growth, the report said. Next to file for MLP status could be oilfield-services providers that manage the wastewater produced during fracking.

The IRS is taking a break from providing guidance in the form of "private-letter rulings" to companies inquiring whether their business meets the MLP tax-exempt requirements as it reviews its internal process. While describing the pause as temporary, the agency has not provided a timeline for resuming rulings, said the report.

Tax lawyers contacted by the Journal have interpreted the move as the IRS making sure it has not been too generous in its approvals. The agency issued 30 of these guidance rulings in 2013, compared to 21 in 2012 and 10 in 2011, according to the law firm Vinson & Elkins LLP.

"They're thinking about whether they've gone too far," Michael Bresson, a Houston-based legal specialist in tax issues at Baker Botts LLP, told the newspaper. "We don't think they have."

The IRS conducted a similar review in 2013 of its policies on another tax-advantaged structure--real-estate investment trusts (REITs)--but did not make any big changes.

Companies that want to form an MLP do not have to get the IRS' blessing first, said the report, and some choose not to. For example, StoneMor Partners LP, which owns cemeteries and funeral homes, formed an MLP in 2004, despite having no energy ties and without an IRS letter of approval. The IRS audited the firm in 2013 but did not challenge its MLP status.

However, some are wary of the level of risk involved in investing in MLPs, particularly the variable MLPs that do not guarantee a consistent distribution--a model popular with refiners. Some detractors of MLPs also caution that these businesses are too exposed to regulatory scrutiny, falling commodity prices and rising interest rates, which could threaten the size of cash distributions.

"Wall Street is going to continue to manufacture these things until they manufacture a few losers," Michael Peterson, an energy analyst at MLV & Co., told the paper.