The Texas Comptroller’s Tax Policy Division recently issued a private letter ruling (PLR No. 201712002L) taking the position that an oil and gas joint venture, treated as a partnership for federal tax purposes only, created a separate taxable entity for Texas franchise tax purposes.
Company A ("Operator") and Company B ("Non-Operator") entered into a Joint Operating Agreement ("JOA") for the development of oil and gas leasehold interests. Operator paid all expenses and then charged Non-Operator for its respective share. The JOA provided for each participant to take its proportional share of oil and gas production in-kind and market it separately, although it provided that the Operator could sell on the Non-Operator’s behalf any production that the Non-Operator failed to take in kind.
For federal income tax purposes, the JOA created a tax partnership under Internal Revenue Code Section 761. For Texas franchise tax purposes, the PLR ruled that the JOA created a joint venture subject to Texas franchise tax because (i) it met Rule 3.581(b)(10)'s definition of a taxable "joint venture"—that is, a "partnership engaged in the joint prosecution of a particular transaction for mutual profit"—and (ii) the joint venture did not elect out of partnership treatment for federal income tax purposes, thereby failing to qualify for the exclusion under Texas Tax Code Section 171.0002(a) for ventures electing out of federal income tax partnership treatment.
The PLR fails to address important arguments that might be made against treating the joint venture as a taxable entity for Texas franchise tax purposes. Most critically, the PLR relies on Rule 3.581(b)(10) without analyzing whether the venture is a "partnership" within the meaning of that provision. Rule 3.581(b)(15) defines "partnership" by cross-reference to the Texas Business Organizations Code ("BOC") § 152.051, which contains factors relevant to determining whether a partnership exists and explicitly provides that "ownership of mineral property under a joint operating agreement" does not, by itself, create a partnership. The PLR does not analyze any of these BOC provisions.
Please contact us if you would like to discuss the implications of this PLR on the structuring and franchise tax reporting of Texas oil and gas ventures.
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