Gilbert Zamora, CPA Retired
Director of Tax Policy
Former Texas Comptroller Auditor & Tax Policy Expert, 31 Years

Companies involved in the midstream movement of oil and gas from the well sites to the processing or downstream refineries generally utilize pipelines, tanker trucks, barges, rail, or oil tankers.

In Texas, oil and gas are primarily moved by pipeline. Texas has over 425,000 miles of pipelines within its borders that represent about 1/6 of the total pipeline structure in the United States. The Pipeline safety department of the Texas Railroad Commission is charged with the responsibility of enforcing compliance with federal and state laws and regulations by the more than 1,485 pipeline operators in Texas of intrastate gathering, transmission, distribution, and master-metered systems.

The construction, repair, and maintenance of these gathering, transmission, and distribution pipelines entail significant costs to the owners and operators of these lines. A significant cost that is many times overlooked is the Texas sales and use tax imposed on the purchase, repair, and maintenance of these lines. With proper planning and knowledge of the sales tax laws and exemptions applicable for local taxes, labor, and services a practitioner can help to minimize their client’s overpayment of these sales taxes. I’ve provided below a general overview of some of the Texas rules, regulations, policy rulings, and recent court cases that address issues that often arise in pipeline construction, repair, and remodeling [1].


The new construction of a gathering, transmission, or distribution pipeline is treated as the construction of an improvement to reality. Before construction begins surveys of the right of way, centerline placement of the pipeline, and confirming boundaries are performed. The taxability of these services is addressed in Policy Letter 8810L0903F12 as follows:

  • Establishing the right of way – involves determining the boundaries of the right of way and the boundaries of the property that the pipeline will cross. This is a taxable service.
  • Staking the center line – not taxable. Drawing alignment sheets and piping drawings that show the valve connections, meter runs, etc. at the end of each pipeline for use by the contractor in building the pipeline are not taxable.
  • Confirming boundaries – As-built surveys, which include restaking and confirming the boundaries after a pipeline is installed, are taxable.

    Comptroller Rule 3.291 – Contractors provide for an exemption from sales tax on the labor used to construct the new pipeline. The liability for the sales tax on the materials (pipe, fittings, valves, meters, etc.) depends on whether the contract is structured as a lump sum or a separate contract. Under a lump-sum contract the contractor is responsible for the sales tax on the installed materials (pipe) while under a separated contract, the contractor is treated as a seller and is required to collect sales tax on the charge for the pipe [2]. One significant benefit to structuring the contract as a separate contract is that the contractor’s job site (the place where the pipe is installed) is treated as the contractor’s place of business and dictates the local tax to be collected [3]. Because most pipelines are generally located outside populated areas (i.e., cities) city and MTA taxes may not apply. County taxes may still apply but are generally the only ¼ to ½ % with a few counties imposing a full 1%.

Many pipeline companies purchase the pipe, valves, fittings, vessels, meter, and component equipment directly from the manufacturer or distributor and then have a contractor install and construct the pipeline. In these cases, it may be beneficial for the pipeline company to secure a Direct Pay Permit [4] that allows the purchaser to issue a Direct Pay exemption certificate to the seller and then accrue the sales or use taxes based on the first storage or use.

A prerequisite for a Direct Pay Permit is that the applicant must be annually purchasing at least $800,000 worth of taxable items for the person’s own use and not for resale. The pipeline company should establish a pipe storage yard that is located outside the local taxing jurisdiction of a city and/or in a county that does not impose a local tax or if it does, does so at a relatively low rate. The company would then direct the seller to deliver the pipe to the yard and the purchaser would then accrue use tax when the pipe is removed from storage for use or when first received. The 1-2% savings in local taxes can be significant in the construction of a new pipeline.

Testing of Pipelines

Pipelines are generally tested using Hydrostatic testing. A hydrostatic test of a pipeline involves a high-pressure internal leak test using water. It may entail the use of pumps and operators to fill and pressure the pipeline with water. Technicians then use pressure monitoring equipment to observe the test. After the test is complete, technicians use air compressors and pigs to displace the water from the pipeline. Testing is not a taxable service as long as it is separately stated from the charge for any repairs that may be necessary [5].

Repairs and Maintenance

Due to the corrosive nature of natural gas and crude oil from high moisture and sulfur content, pipelines require regular testing, maintenance, and repair. In many cases, liners or coatings are added to repair or protect the pipeline from deterioration. In some cases, cathodic protection (CP) is used. CP is a method that, when connected to the pipeline, discharges an electrical current from a remote anode to the pipe. If enough current is discharged from the remote anode to the pipe, corrosion on the pipeline will not occur.

The Comptroller treats the addition of liners, coatings, or cathodic protection as the repair or maintenance of realty. The addition of cathodic protection to pipelines was upheld as taxable repair of realty in Chevron Pipe Line Company and West Texas Gulf Pipe Line Company v. Combs, et al. At issue was whether the installation of remedial cathodic protection devices in new holes or trenches dug adjacent to trenches hold the company’s existing underground pipelines (real property) was the repair of real property or new construction.

The Court of appeals analyzed the requirements for qualifying as non-taxable new construction and concluded that the addition of the cathodic protection devices was not new construction but instead was the taxable repair of the pipelines.

A second issue addressed in this case was the excavation and backfilling services performed by the same contractor that recoated the pipelines. Normally, excavation and backfilling provided on a stand-alone basis are not taxable services [6]. The Appeals Court ruled that because the pipeline companies did not separately contract for excavation and backfilling services and these services were a necessary and essential part of the recoating service, the services were not unrelated services and were taxable.

Many times, a long section of the pipeline is beyond repair. In these cases, the bad section will be abandoned in place and a new trench will be dug alongside the bad section and then tied into the remaining good sections of the pipeline. In these cases, the Comptroller policy is to treat the installation of the new section of pipe as new construction and the two points where the new section is tied into the existing good sections as taxable remodeling [7]. If billed for a single amount and the value of the tie-in is more than 5% of the total charge, you will need to have the service provider separate the taxable and nontaxable charges, otherwise, the total charge is taxable.

If the services to a pipeline qualify as maintenance, the labor charge for the service would not be taxable. Maintenance is defined as scheduled, periodic work on real property that is not broken. Maintenance is necessary to keep the property in good working order by preventing its deterioration. Charges for the maintenance of real property are not taxable. Sales tax is due on all taxable items bought for use in providing the nontaxable real property maintenance services. In addition, you must have a contract or maintain other documentation to prove that the services are scheduled and periodic [8].

Local Tax on Repair and Remodeling

Another area where local taxes are sometimes overpaid occurs where service providers of real property repairs and remodeling collect tax based on their place of business rather than the job site. Effective September 1, 2007, local tax statute Sections 321.203 and 323.203 were amended to require providers of nonresidential repair and remodeling services to collect local tax based on the job site location [9]. What this means to pipeline operators is that repairs or remodeling to pipelines that are located outside jurisdictions that impose local taxes should only sales tax at the 6 ¼% state sales tax rate and not the 8 ¼% sales tax rate that include city, MTA, and county taxes.

Oil Spill Cleanups

A clean-up operation for an oil spill that results from activities associated with the exploration, development, or production of oil, gas, or geothermal resources and any substance or materials regulated by the Texas Railroad Commission are not taxable when performed at the well site.

A clean-up operation for an oil spill performed at a plant or elsewhere on land away from the well site is a taxable service. This service is also taxable if performed on property other than the company’s property. The cleanup of oil spills in waterways is not taxed when the cleanup is subject to the requirements of Chapter 26 of the Water Code [10].

The exemptions and situations addressed above are some of the more common sales tax issues and tax-saving opportunities associated with pipelines. This article is not intended to cover all possible exemptions or taxable situations involving pipeline construction, repairs, and maintenance. Keep in mind that different facts involving similar situations may result in a different tax interpretation by the State.

[1] Pipeline Safety
[2] Rule 3.291 (b)(10)(B)
[3] Rule 3.291 (b)(10)(A)
[4] Rule §3.288
[5] See Policy Letter 8811L0919F08
[6] See Policy Letter 200102067L
[7] Policy letter 9207L1182E08
[8] See Publication 94-119 – Real Property Repair and Remodeling
[9] See HB 3319, 80th Regular Session
[10] See Policy Letter 9304L1234G12

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