The procedure for auditing taxpayers in the oil and gas industry has changed. On January 26, 2021 a tax policy memo was issued to all Texas comptroller of public accounts audit personnel. Below you will find a summary of what that memo entails.
Chemicals Used in Oil and Gas Operations
Under the previous policy, oil soluble chemicals and chemicals that caused a direct change to the product above-ground qualified for an exemption at both oil and gas wells. The updated policy is as follows:
Chemicals Pumped Downhole:
Oil soluble chemicals pumped downhole will qualify for the resale exemption.
Oil soluble chemicals pumped downhole will be sent to settlement, but the exemption may still be granted with proof that the well produces oil.
Chemicals Injected at Surface:
Oil soluble and water-soluble chemicals can still qualify for the manufacturing exemption if they cause a physical or chemical change to the product. However, these will be sent to settlement until further guidance is issued by the Comptroller.
Historically, the Comptroller has allowed exemptions on purchases related to “flowback” if the Taxpayer was able to provide documentation showing an operator was present. Going forward, the Comptroller will now treat purchases related to “flowback” as taxable rentals of equipment. If any Taxpayers continue to claim their purchases qualify for the exemption, the contention will be forwarded to audit specialists who will review and make a determination based on the evidence provided.
Comptroller auditors have been instructed to determine whether water transfer services constitute taxable rentals of tangible personal property or the purchase of nontaxable services. Auditors will apply the following criteria:
Lump-Sum Charge – Taxable without proof of operator. Proof must show operator is onsite to operate water transfer equipment.
Separated Charges for Equipment and Operator – Operator charge is not taxable; Any equipment charges will be taxable rentals of tangible personal property.
Vapor Recovery Units (“VRU”)
The Comptroller provided clarification on when VRUs may qualify for the manufacturing exemption. To qualify for the exemption, Taxpayers’ must be able to document that recovered vapors are sold.
Proper documentation includes: Accounting Records, Lease Schematics showing VRU is connected to sales line, and Sales Invoices.
If the VRU is attached to multiple lines, the Taxpayer should be able show divergent use and quantify recovered vapor sold versus stored. The Comptroller will presume that: Vapors recompressed into a sales pipeline are sold. Vapors captured and stored in a tank on-site are not sold. If flares are included in a package or attached to equipment, the vapors are being burned off and not sold.
Mud Lost in Hole
There was no change in policy for mud lost in hole. Purchases of mud will be treated as a consumable and will not qualify for the Lost in Hole exemption provided in Rule §3.324(f)(1). Any untaxed purchases will be assessed sales tax in a Texas sales tax audit, while requests for refunds of tax paid on purchases of mud will be denied.
Lease Automatic Custody Transfer Unit (“LACT”)
There was no change in policy regarding LACT units. Auditors will treat LACT units as taxable tangible personal property used in the transportation of oil and not manufacturing equipment used in the processing of oil. Any untaxed purchases will be assessed sales tax in a Texas sales tax audit, while requests for refunds of tax paid on purchases of LACT units will be denied.
Environmental and Conservation Services
151.338 exempts labor to repair, restore, maintain tangible personal property used to protect the environment or conserve energy. Taxpayers must specify specific statutes or regulations on any claims of equipment used in environmental or conservation exempted under §151.338. The auditor will forward any documentation to Tax Policy where a determination will be made.