The repair regulations: considerations for 'downstream' oil and gas businesses.

AuthorAtkinson, James

The oil and gas industry faces numerous challenges in applying the fact-intensive rules of the so-called repair regulations to costs incurred to repair and maintain property during its service life. This item focuses on refining, chemicals, and marketing (the downstream sector) and provides an analytical framework designed to help prepare the industry for the challenges ahead.

The repair regulations were issued by Treasury and the IRS in December 2011 to bring greater clarity and certainty in determining the proper federal tax treatment of costs associated with a taxpayer's tangible assets (T.D. 9564). These temporary regulations apply to costs incurred throughout the life cycle of tangible property, from acquisition through operation to disposition. Although the regulations provide discrete rules for each of these three "buckets" of costs, the second bucket--costs incurred to repair and maintain property during its service life--is at once the most complex and the most ambiguous.

Applying the repair regulations to the oil and gas industry presents numerous challenges, given the breadth and diversity of the assets involved. Roughly, the oil and gas industry can be divided into three principal sectors: exploration and extraction (upstream); transportation (midstream); and refining, chemicals, and marketing (downstream). While there is no universal definition marking when the product passes from upstream to midstream to downstream, a rough rule of thumb looks to the point at which the raw product has been extracted and gathered for transport to begin midstream activities and delivered to a refinery to initiate the downstream phase. This item focuses only on the application of the repair regulations to downstream operations.

Applying the repair regulations to downstream operations follows the same basic analytical path required for all industries. First, identify the appropriate unit of property. Second, determine whether a particular expenditure betters, restores, or adapts the property to a new or different use. Third, determine whether a special rule affects the application of the general standards.

Application to Refineries

Identifying the units of property in downstream operations is particularly critical with respect to refineries. Refineries represent a significant percentage of many downstream operations' fixed assets and require frequent and costly maintenance and operational expenditures. Because the capitalization standards focus on...

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