The upstream sector of the Petroleum industry involves companies that search for potential underground crude oil and natural gas fields, drill exploratory wells, and subsequently drill and operate the wells that recover and bring the crude oil and/or raw natural gas to the surface. Sales taxes can be a significant cost for the companies exploring, drilling, and operating successful oil and gas wells.
Due to the significant expenses in preparation for drilling, drilling the well and the outlays for the casing, tubing, fishing services, fracturing services, drilling mud, fracking materials, surface equipment, gathering lines, flow lines, storage tanks, and disposal of produced water it is easy to overlook sales taxes that a seller of equipment or a provider of oilfield service may charge that may not be due.
Service providers and sellers of equipment (casing, tubing, pump jack, separators, heater treaters, pipe for gathering lines and flow lines, etc.) often will charge tax on these items to protect themselves in the event they are audited. Theorizing, that If they’ve collected tax on nontaxable items the auditor will tend to overlook this error, however, if they failed to collect tax the state will assess the tax, penalty, and interest against them and the odds of recovering the tax from the customer are not very favorable.
For this reason, it is imperative that the oil well operator’s accountant or accounts payable personnel familiarize themselves with the exemptions available for equipment and services purchased to drill and complete a well.
Generally, equipment that is used to process oil and gas such as heater treaters, dehydrators, scrubbers, separators, gun barrels, etc., qualify for exemption from tax as processing equipment. As such, any repairs and replacement parts for this equipment also qualify for an exemption. Oil storage tanks, saltwater storage tanks, pump jacks, flow lines, and gathering lines are not exempted because they are not involved in processing the oil or gas. Similarly, boosters, flow line heaters, gathering line compressors, and lease compressors used primarily to provide or aid in transportation do not qualify for an exemption.
Casing, tubing, downhole pumps are also not considered to be used in processing oil or gas. However, there is currently is a case  pending before the Texas supreme court challenging this position and could result in massive tax refunds if it is successful. As a protective measure, companies should file claims for sales taxes paid on casing, tubing, pumps, etc., in the event this challenge is successful.
In some cases, I have found where a seller of taxable items or services has failed to collect sales tax, either because they were unaware of the taxability or they simply weren’t permitted to collect and report tax. This creates a responsibility for the purchaser, your client, to report and remit the tax due to the Comptroller. The Comptroller can proceed against either the seller or the purchaser to collect the tax that is due and the purchaser is not protected unless they have a valid invoice that reflects the tax paid.
With the downturn in oil and gas prices over the last year, exploration and drilling for oil and gas have slowed significantly.
If your client has overpaid sales taxes on equipment or services, now may be a good time to review your client’s purchases for the last four years, identify the overpayments and seek to recover the overpaid taxes, or file protective claims for oil and gas issues that are in litigation.
See Comptroller Rules:
§3.324–Oil and Gas Well Services
§3.300 – Manufacturing; Custom Manufacturing; Fabricating; Processing
Tax Policy letters: 9609L1435A12, 9111T1141A07, 9002L0983B08
Southwest Royalties, Inc. v. Combs, et al