Tax Type
Retail Sales and Use Tax
Description
Equipment Used in Mining and Mineral Processing
Topic
Property Subject to Tax
Date Issued
09-14-2001
September 14, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****
This will respond to your letter in which you seek correction of the retail sales and use tax audit assessment issued to your client, ***** (the "Taxpayer"), for the period of May 1993 through April 1999. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer is in the gas well drilling and mineral processing business. The Taxpayer was audited and assessed tax on various items. The Taxpayer believes the assessed items are used directly in its mining and mineral processing operation and, therefore, are exempt pursuant to Code of Virginia § 58.1-609.3(12). The Taxpayer is requesting correction of the audit assessment.
DETERMINATION
Code of Virginia § 58.1-609.3(12) sets forth the exemption for the gas and oil drilling, extraction, refining and processing industry. This Code section exempts from the retail sales and use tax:
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- raw materials, fuel, power, energy, supplies, machinery or tools or repair parts therefor or replacements thereof, used directly in the drilling, extraction, refining, or processing of natural gas or oil and the reclamation of the well area. For the purposes of this section, the term "natural gas" shall mean "gas," "natural gas," and "coalbed methane gas" as defined in Section 45.1-361.1. For the purposes of this section, "drilling," "extraction," "refining," and "processing" shall include production, inspection, testing, dewatering, dehydration, or distillation of raw natural gas into a usable condition consistent with commercial practices, and the gathering and transportation of raw natural gas to a facility wherein the gas is converted into such a usable condition. Machinery, tools and equipment, or repair parts therefor or replacements thereof, shall be exempt if the preponderance of their use is directly in the drilling, extraction, refining, or processing of natural gas or oil for sale or resale, or in well area reclamation activities required by state or federal law.
The key factor used in determining whether or not an item qualifies for the exemption cited above is if it is "used directly" in drilling, extracting, refining, or processing of oil or natural gas. Code of Virginia § 58.1-602 defines the term "used directly" as follows:
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- those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing or mining process, but not including ancillary activities such as general maintenance or administration. When used in relation to mining, it shall refer to the activities specified above, and in addition, any reclamation activity of the land previously mined by the mining company required by state or federal law.
Keeping this definition in mind, and in an effort to address all issues set forth in your appeal, I have outlined below a list of the disputed items by category, with a brief explanation of those items the department believes to be taxable, exempt, or in need of further review.
TAXABLE:
Doghouse/with 3000 Tank: Based on the information provided, the doghouse is used for tools, equipment and record storage, and as shelter for workers. Repair and replacement parts for doghouse are also taxable. The storage tank used to store exempt fuel, however, does qualify for the exemption.
Pipe Tubs: These are used in the storage and transport of exempt equipment, a taxable activity.
Fifth Wheel & Winch/Headache Rack: Used to winch equipment onto a licensed truck for transportation purposes.
Gasboy 12VT Pump: Used to fuel dozers and excavators used in site prep and reclamation. This item is not used directly in actual drilling.
Lumber & Crib Blocks: Used to secure the drilling rig and provide a foundation for rigs. The blocks are not directly used in the drilling process.
First Aid Kits/Refills: The fact that a particular item's use is required by state or federal law or regulations does not, of itself, mean that the item is used directly in mining and processing operations. See Title 23 of the Virginia Administrative Code (VAC) 10-210-960(A). These kits and refills are not used directly in the drilling or processing operations.
Daily Drill Logs: The logs are used for administrative purposes and are not directly used in the drilling or processing operations.
Sample Bags: Administrative use, not directly used in drilling.
Oil Absorbent Pads: The fact that government and environmental regulations require use of these pads does not mean they automatically qualify the exemption. The pads are not used directly in drilling or processing operations.
Hand Tools, Wrenches, Etc.: While these items are essential for work on exempt equipment, they are not used directly in drilling.
EXEMPT:
Gasboy Electric Pump: Used to pump exempt fuel from storage to an exempt drill rig. This activity is an integral part of exempt drilling process.
Speedster Drill: Based on the information provided, the Speedster drill is part of the oil and gas-drilling unit. If this is the case, repair and replacement parts are exempt.
Heating Oil: Used as an additive to exempt diesel fuel to prevent the "jelling" of fuel in drill rig. This oil is used directly in exempt machinery.
11 HP Honda Engine: Attached to the drilling rig and used to measure bore depth. Direct use.
TAXABLE/EXEMPT BASED ON USE (Preponderance of use rule will apply when dealing with a single piece of equipment. Fungible items, i.e., fuel, repair and replacement parts for dual use equipment, may be pro-rated):
Nuts, Bolts & Truck Parts: Used on both taxable and exempt equipment. Pro-ration is necessary.
Backhoe Tires: The availability of the exemption depends on the use of the backhoe. If the backhoe is used in reclamation of the well area as required by state or federal law, the tires are exempt. If the backhoe is used to build, maintain, or reclaim access roads, the tires are taxable. Pro-ration may be necessary.
Replacement Parts for Generator: Pro-ration of parts may be necessary based on use of the generator. Exempt use: providing power directly to the drill rig. Taxable use: providing power to the doghouse or for well site illumination.
Replacement Parts for Trucks: The tax application is based on use of the truck. Proration may be justified. Further review is necessary.
Frac Tanks & Related Fittings: The Taxpayer states that Frac Tanks are not used in "fracing activities," but are used to mix and blend fluids that are essential to the drilling process. I recommend further review by the District Office to determine whether or not the frac tanks and related fittings are used directly in the drilling process.
Various Motor Oils, Antifreeze, Acetylene, and Diesel Fuel: See "Replacement Parts" above. Further review by the audit staff is necessary to determine if a pro-ration of the tax for motor oils is feasible.
Load Binders, Chain: The Taxpayer states that these items consist of replacement parts for an exempt drill rig. Further review by auditor is necessary to verify use and determine the appropriate tax application.
Culvert & Pipe: The auditor pro-rated these items as 40% taxable (reclamation of access roads) and 60% exempt (reclamation of well site). The Taxpayer claims that culvert and pipe were used only to reclaim the well site as required by state or federal law. Further review by the auditor is necessary.
John Deere Farm Tractor: The Taxpayer states that the preponderance of the tractor's use is for reclamation of the well site (direct use) and is used secondarily to remove drill bits, drill steel, etc. (indirect use). Upon verification of the tractor's use by the auditor, the tractor will be removed from the audit, if appropriate.
Sampling Methodology: The Taxpayer contends that five separate line items included in the general expense purchases sample period should not be extrapolated, but instead should be taxed as a fixed asset. Upon verification that the disputed items are being depreciated by the Taxpayer for federal tax purposes, such items will be moved from the general expense purchases listing to the fixed assets list.
Based on all of the above, I am returning the audit to the ***** for further review and possible revisions. If you should have any questions concerning this determination, please contact ****** Policy Development Office, at ****.
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Sincerely,
Danny M. Payne
Tax Commissioner
PDO/27744K
Rulings of the Tax Commissioner