IRS allows oil and gas company a bulk sale exception.

• Author: Van Leuven, Mary

Independent oil and gas producers should be pleased about the taxpayer-favorable position taken by the IRS in a recent private letter ruling. Although letter rulings cannot be used or cited as precedent, the position may provide helpful insights for oil and gas producers that contract for bulk sales to industrial, commercial, and governmental entities.

In a private letter ruling released January 14, 2011, the IRS allowed a bulk sale exception to the retailer exclusion, allowing an oil and gas company to claim percentage depletion. Letter Ruling 201102027 portrayed the taxpayer as an independent energy company primarily in the business of exploration, development, and production of crude oil, natural gas, and natural gas liquids. Beyond these activities, the taxpayer had no direct retail or refinery operations or activities, and it was not a related party to any entity or individual engaged in those activities.

The taxpayer had negotiated with three different buyers--a commercial entity, a school district, and a city government--separate, renewable, take-or-pay contracts for the sale of large quantities of compressed natural gas (CNG). In each contract, the CNG would be delivered to CNG distribution stations built, owned, and operated by the taxpayer. Except in the case of the contract with the commercial entity, which would allow sales of CNG to the taxpayer's employees for personal use, the stations would be solely used to refuel fleet vehicles owned by each buyer. There would also be no public access to any of the CNG stations and no retail sales (other than those to the taxpayer's employees as previously described) of CNG.

The taxpayer's question to the IRS was whether under these facts, the taxpayer's sale of CNG under each contract would qualify for the bulk sale exception to the retailer exclusion rule under Sec. 613A(c). As discussed below, qualification for the bulk sale exception directly affects the taxpayer's ability to use the most advantageous method of calculation for cost depletion.

Cost and Percentage Depletion

Properties containing natural resources, including oil and gas, are treated as diminishing in value as the natural resources are produced, because following production there are fewer natural resources, which effectively lowers the value of the property. Due to the diminished value of the property, a taxpayer holding an economic interest in oil or gas property is eligible to receive a deduction for depletion--if the...