Feds’ Proposed Regulations Slow MLP Uptick

By Deon Daugherty

Chemical companies and wood product producers would miss out on the tax advantaged status of being a master limited partnership under regulation proposed by the Internal Revenue Service.

Last summer, the agency announced it would stop issuing private letter rulings while agency leaders evaluated what should – and shouldn’t – qualify for the master limited partnership (MLP) status. Companies outside the parameters of traditional midstream services often ask the IRS to interpret Section 7704 of the tax code before they file an IPO. And as the business structure has become more popular, the IRS has seen a deluge of letter requests. Consequently, the decision to regroup on the interpretation was meant to clarify current rules.

In recent years, MLPs have enjoyed a good run. During the years immediately following their codification in 1987, only a handful of companies signed on for the tax advantaged status. Along with other changes brought to the industry under the influence of shale, MLPs grew exponentially as the need for midstream infrastructure grew. In 2014, about two dozen MLPs filed initial public offerings, bringing the total to more than 120 entities.

The IRS ruled chemical companies out of the MLP equation, unless they are part of a larger refining operation. Returns from timber products would also be left out.

Mary Lyman, executive director of the National Association of Publicly Traded Partnerships, a trade association based in Virginia, said the group expected some direction on oilfield services, but the impact to chemical companies was unexpected. All told, though, she said the impact to the sector won’t be dramatic.

Under the proposal, MLPs that would no longer meet the criteria would have 10 years to transition or sell non-qualifying assets. That would include companies such as Westlake Chemical Partners, which received a private letter ruling from the IRS before the company formed.

If you thought no one was paying attention to the IRS, consider the unceremonious end to the positive streak enjoyed by the MLP-focused Alerian Index, which happened right after the IRS laid out its plan. After seven weeks of climbing, the Alerian was down 2.4 percent. Not a freefall, but discouraging to MLP boosters nonetheless.

Hinds Howard, CBRE Clarion Securities’ MLP guru, put it in simple terms in a recent note to investors.

“MLPs crapped out this week,” he said in a May 10 note to investors, noting that in addition to the noise of the IRS ruling, heavy equity issuance, some weaker earnings and interest rate volatility all coalesced to marginalize MLPs.

As such, he named Westlake Chemical Partners the biggest loser of the week as it’s the company most impacted by the proposed regulations.

“It appears that in their current form, the new regulations would render their entire business non-qualifying,” he said.

For their part, Westlake Chemical acknowledged the hurdle that the proposal presents. Although the company had previously received a private letter ruling indicating its work would earn qualifying income, under the proposal, that would no longer be the case.

“If the proposed regulations become final in their current form, such final regulations would make it difficult or impossible for the partnership’s production, transportation, storage and marketing of ethylene and its co-products to continue to qualify as ‘qualifying income’ after the proposed ten-year transition period,” the company said in a statement.

Still, Lyman said, the vast majority of what MLPs are engaged in is not affected by the proposed regulations, and the proposals have a long way from being final. The IRS is accepting public comments on the proposal through August, and at that time, the agency may schedule a public hearing. Final approval and publication in the Federal Register could take months following a hearing, which would put the rules into effect next year.

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