(Bloomberg) Packaging companies including International Paper Co. and Rock-Tenn Co. won’t be able to separate their containerboard operations into tax-advantaged vehicles, under rules proposed Tuesday by the IRS.

The rules include a narrow definition of the timber-related activities that can be housed inside a master limited partnership, which doesn’t pay corporate-level taxes in the U.S. That language limits paper companies’ ability to mimic the tax structure used by oil pipelines.

Under the new Internal Revenue Service rule, processing of timber includes making sawdust, untreated lumber and woodchips. The tax break is unavailable once chemicals or foreign substances are added and it’s turned into paper, pulp and plywood.

“This is something that no one really expected,” said Robert Willens, a tax consultant in New York. “This is the biggest surprise by far, the narrow definition of processing and the fact that it, certainly by any reading of this, it certainly eliminates the possibility of putting containerboard activities into an MLP.”

MLP Structure
Mark Weintraub, an analyst at Buckingham Research, said in a note to clients that the MLP structure appears to be “DOA” for paper companies, meaning dead on arrival.

“While disappointing to seemingly have an ‘option’ taken off the table, we had become increasingly skeptical that anything would happen on the MLP front,” he wrote.

The IRS rules effectively end the tax agency’s moratorium on private-letter rulings, in which government lawyers advise companies on whether their proposed structures will pass muster. They’re designed to make the rulings less common by setting clearer rules for what income qualifies for the tax benefit.

In some cases, the IRS is saying that some activities that qualified under previous private letter rulings no longer should count, said Timothy Devetski, a partner at Sidley Austin LLP in Houston.

‘Open Questions’
“There are lots of open questions in what they did,” he said, citing definitional questions about services performed alongside exploration companies.

The rules also may prevent chemical companies such as Methanex Corp. and Axiall Corp. from setting up MLPs that they had been considering, said Jason Miner, a Bloomberg Intelligence analyst.

Miner said the rules appear to create a 10-year sunset on tax-advantaged income at Westlake Chemical Partners LP, an MLP created last year after Westlake Chemical Corp. received a private letter ruling from the IRS before the moratorium.

Westlake said in an e-mailed statement that it was reviewing the regulations and would submit comments to the IRS.

All four companies’ shares declined on Tuesday. Westlake Chemical Corp. fell 5.2 percent to $70.50, for its biggest one- day drop in almost five months. Westlake Chemical Partners LP fell 10 percent to $25.89.

Some Exceptions
“The proposed regulations are largely consistent with the rulings the IRS has issued in the past, with some exceptions,” the IRS said in a statement. “Where the new guidance interprets the law more narrowly than in the past, Treasury and IRS believe the regulations more accurately reflect congressional intent.”

The rules may change once the IRS receives comments from companies and other interested groups, said Mary Lyman, executive director of the National Association of Publicly Traded Partnerships.

“For the vast majority of MLP activities, they will go on exactly as before,” she said.

Last month, Mark Sutton, the CEO of International Paper, had said the company was analyzing the potential move to an MLP structure and awaiting the IRS rules.

“While we had not made any determination to proceed with the formation of an MLP, the IRS proposed regulations appear to take this option off the table,” International Paper said in a statement Tuesday.
Rock-Tenn, which is acquiring Meadwestvaco Corp., also has been exploring the tax-saving idea.

Shares Declined
Shares of Domtar Corp., KapStone Paper and Packaging Corp., Graphic Packaging Holding Co. and Packaging Corp. of America also declined.

Domtar had been exploring the idea but hadn’t sought a private letter ruling, said Nicholas Estrela, director of investor relations.

“We’ve been one of the companies that have been waiting by the sidelines,” he said. “If this is the final decision, obviously, we’ll stop the work there.”

Spokesmen for Rock-Tenn and Packaging Corp. of America didn’t immediately return requests for comment.

—With assistance from Jack Kaskey in Houston.

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