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

Are Fueling Services for Fracking Subject to Sales Tax as Equipment Rental?

Written by: Gilbert Zamora & Dino Marcaccio

Tex. Tax Code § 151.051 – SALES TAX IMPOSED
Rule 3.294 – RENTALS AND LEASES OF TANGIBLE PERSONAL PROPERTY
202009002L – AGENCY MEMO: SUBJECT: TAXABILITY OF FLOWBACK SERVICES (SEPT. 1 2020)
202008019H – SOAH DOCKET NO. 304-20-2317.26 CPA HEARING NO. 115,376 (APRIL 1, 2020)

To our knowledge, this question has not been clearly answered. Texas Tax Group has previously represented companies under sales tax audits that provide these services. In one audit the auditor believed it was taxable and, in another audit, non-taxable. That is, some auditors apply sales tax because they consider this to be a taxable rental of tangible personal property (TPP) . And other auditors believe this is a non-taxable service (with essential operator). Who is correct? Who knows? There appears to be no clear sales tax precedent addressing this exact transaction in existing administrative hearings, tax policy letters, agency memos or private letter rulings.

Texas Tax Group has also been contacted this year (2021) by two businesses (not under audit) that provide these services (i.e., fueling services, via gravity tanks or automated fueling systems, for fracking equipment and trucks at oil and gas well sites). Both companies have been charging sales tax because they believe this is a taxable rental of TPP. Their customers are claiming that this is a non-taxable rental of equipment with an operator. In each case their O&G customers demand sales tax refunds for significant sales tax charged in error for these services.

Note that equipment provided with these services may also include frac tanks to store fuel and diesel tank trailers used to fuel non-frac equipment. In addition, the fueling systems require the service company’s personnel to deliver, set up and monitor the equipment during the 10-14 day period that the equipment is onsite for the fracking operation.

The question raised is whether these clients are providing a nontaxable service (i.e., rental equipment with operators) or are renting taxable fueling systems or tanks to the O&G companies without an essential operator. Note: The charges for dyed diesel and clear diesel are not taxed under sales and use tax.

RESEARCH: FACTORS RELATED TO TAXABLE RENTAL OF EQUIPMENT

Texas imposes a tax on each sale of a taxable item in this state. Tex. Tax Code § 151.051. The term “taxable item” includes tangible personal property and taxable services. Tex. Tax Code § 151.010.

Subsection (a) of Comptroller Rule 3.294 – Rentals and Leases of Tangible Personal Property, defines rental and operator as follows:

(2) Lease or rental–A transaction, by whatever name called, in which possession but not title to tangible personal property is transferred for consideration. In this section, the words lease, and rental are used interchangeably.

(3) Operator–A person who actively guides, drives, pilots, or steers tangible personal property. A person who provides maintenance, repair, or supervision only is not an operator for the purposes of this section.

RESEARCH: FLOWBACK SERVICES – MEMO REVERSING POSITION

Tax Policy Letter 202009002L – SUBJECT: Taxability of “Flowback Services”

It is relevant to bring up a recently issued Tax Policy Letter 202009002L, dated September 21, 2021, which reversed a long-standing agency position that “flowback service providers” were exempt because the operators were considered essential operators. As of the memo’s date the agency reversed its position and now claims that all flowback services are taxable because the operators, in their opinion, are not considered essential. Therefore, the total charge for equipment and personnel are deemed to be taxable.

It is relevant to refer to this Tax Policy Letter because we believe that operators related to “flowback services” are even more “essential” than operators related to equipment used for fueling at frac sites.

To continue, the memo cynically claimed the change in position (non-taxable to taxable) was not a reversal but instead a “clarification”. Either way, it was a shock to flowback service providers because (1) for over 20 years, their service was considered non-taxable, and (2) there was no reasonable notice issued by the Texas Comptroller to these types of companies.

The memo states that the personnel setting up and maintaining flow back equipment during a well fracking operation were not “operators,” stating in part:

Charges for “flowback services” are taxed as the rental of equipment. Companies that provide “flowback services” are renting equipment to manage flowback pressure and manage the removal of frac fluids and proppants from the wellbore prior to transitioning the well into production status after a frac job. Sales or use tax is due on the total charge for the rental of equipment, including charges for transportation, installation, removal, and accompanying personnel. See Section 151.007 (“Sales Price” or “Receipts”) and Rule 3.324 (c)(1). This treatment applies regardless of whether the charges for equipment and personnel are billed as a lump-sum amount, separated amounts, or using two separate invoices.

With regards to the rental transaction, the customer obtains operational control of the equipment. They determine the location of the equipment and the rate at which the equipment operates. Once installed, the equipment works automatically and only needs minor adjustments made by the flowback personnel to meet the customer’s needs. The customer may use the equipment to perform testing after the flowback personnel are no longer onsite. The flowback personnel do not “actively guide, drive, pilot, or steer the equipment” while it is in use. See Rule 3.294(a)(3). Therefore, any flowback personnel, even supervisors, that accompany the equipment are not “operators” of the equipment for sales and use tax purposes.

The memo further states:

This memo is a policy clarification rather than a prospective change of policy and applies to all periods open within the statute of limitations. Tax Policy will supersede the following documents as they relate to equipment provided to control flowback and to the application of manufacturing exemptions for that equipment.

It is interesting to note that this memo instantly superseded two Tax Policy Letters (one of which is from 1997) and two Administrative Hearings that all clearly stated that flowback services were non-taxable services because of the essential nature of the operator. See below.

STAR Accession No. 200208347L (Aug. 12, 2002)
STAR Accession No. 200811221L (Nov. 20, 2008)
STAR Accession No. 9705464H – Comptroller Decision 33,749 (1997)
STAR Accession No. 200804075H – Comptroller Decision 44,588 (2008)

The memo provides the following “logic” for the reversal:

With regards to the rental transaction, the customer obtains operational control of the equipment. They determine the location of the equipment and the rate at which the equipment operates. Once installed, the equipment works automatically and only needs minor adjustments made by the flowback personnel to meet the customer’s needs. The customer may use the equipment to perform testing after the flowback personnel are no longer onsite. The flowback personnel do not “actively guide, drive, pilot, or steer the equipment” while it is in use. See Rule 3.294(a)(3). Therefore, any flowback personnel, even supervisors, that accompany the equipment are not “operators” of the equipment for sales and use tax purposes.

RESEARCH: FLOWBACK SERVICES – ADMINISTRATIVE HEARING (TAXABLE)

202008019H – SOAH DOCKET NO. 304-20-2317.26 CPA HEARING NO. 115,376

This Administrative Hearing pre-dates the above-described agency memo, which determined that flowback services are taxable. Before this decision, flowback services were considered non-taxable services for over the last 20 years.

It is interesting to note that the judge signed off on this hearing on Apr. 1, 2020. This decision really “came out of nowhere” and was simply one (SOAH) State Office of Administrative Hearing judge deciding to reverse the agency position and tax flowback services.

We believe that the agency memo (dated: Sept. 1, 2021) was prompted by this administrative hearing decision. We are not currently aware of any challenge in Texas District Court (or beyond) regarding the agency memo or this hearings decision. Note that the judge ruled that:

The transactions at issue are taxable rentals of tangible personal property.

To determine the tax status of contracts that incorporate both taxable and nontaxable elements, we look to the contracts’ primary purpose or ‘essence The final determination that must be made is the “essence of the transaction.” If the real object of a mixed transaction is the purchase of equipment which is taxable, and the service element is incident to that purchase, the entire transaction is taxable. On the other hand, if the essence of the transaction is the purchase of a nontaxable service, which incidentally includes the purchase of some other service or equipment that is taxable, the entire transaction is nontaxable. Chevron, 319 S.W.3d at 842; citing Rylander v. San Antonio SMSA Ltd. P’ship, 11 S.W.3d 484, 487 (Tex. App.—Austin 2000, no pet.) (“[w]hen a nontaxable service is bundled with a taxable sale or service, we apply the ‘essence‑of‑the‑transaction’ doctrine to determine whether the service is a part of the sale.”).

Claimant failed to show the essence‑of‑the‑transactions at issue was a service.

“A key element of ‘possession’ is ‘operational control’ over the tangible personal property…. A lessee must exercise operational control of the leased property in order to take possession thereof.” “Operational control,” in turn, means “using, controlling, or operating the tangible personal property.” Combs v. Chevron, Inc., 319 S.W.3d 836, 841 (Tex. App.—Austin 2010, pet. denied), citing Comptroller Decision No. 40,812 (2003).

SUMMARY – CONCLUSION

In our opinion, the question of whether Fueling Services for Fracking are subject to Sales Tax as Equipment Rental has not yet been determined. However, it seems that the Texas Comptroller will likely issue either a Private Letter Ruling or a definitive Administrative Hearing on the subject. It might even end up in Texas District Court, Court of Appeals, or even the Texas Supreme Court.

It is a shame there seems to be no clear precedent on this type of transaction.

There are dozens of companies providing these types of fueling services all over Texas. Most, to our knowledge, are charging sales tax on these services. However, there are Texas Sales Tax consultants out there that are telling their clients (i.e., the purchasers of these services) that they are being charged sales tax in error. In our opinion, this is a careless position not supported by any existing research that we are aware of.

In any case, this unknown sales tax question has resulted in a real “Texas Showdown” between the companies charging sales tax on these fueling services and their customers. These fueling service companies are stuck in the middle.

Do they refund these taxes to their customers? Do they issue a Letter of Assignment (LOA) and tell their customers to get the refund themselves? Some customers have told their service providers that they DO NOT want LOAs (they want the refund).

And what about future billings. If these service providers continue to charge sales tax, some of their customers have told them they will not pay the sales tax. Or they will find another service provider that will not charge sales tax. Stay tuned. Texas Tax Group will let you know when the agency issues a memo, letter ruling, or hearing decision on this type of transaction.