Tax Type
Retail Sales and Use Tax
Description
Mining; Equipment used for drilling and excavation
Topic
Taxability of Persons and Transactions
Date Issued
04-20-1994
April 20, 1994
Re: §58.1-1821 Application: Sales and Use Tax
Dear********
This will reply to your letter of April 16, 1993 in which you, on behalf of your client, ****** (the "Taxpayer"), protest the findings of the recent sales and use tax audit for the period of March, 1985 though February, 1991.
FACTS
The Taxpayer is in the business of exploring, drilling, extracting, and transporting oil and natural gases. Set forth below are those items held taxable with which the Taxpayer is taking exception, along with a description of the function of each item.
Compressors - Used to lower the wellhead pressure of individual coalbed methane wells to facilitate the gas desorption process and increase the production of methane gas from individual wells.
Pond/Pit Liners - Used to collect drill cuttings and drilling fluids below surface during the drilling process.
Storage Tanks - Used to store fracing fluids and drilling water used in the drilling and perforation of the well shaft. Also used to store waste water during the drilling process.
Meters - Located at the well site and used in technical evaluation and testing of individual wells.
Access Roads - Reclamation of access roads and access roads as an integral part of the mining process.
Pipelines - Gathering lines which transport extracted gases from the well site to the dehydration plant for further processing.
The Taxpayer contends that all above referenced items are exempt under the mining exemption set forth in Va. Code §58.1-609.3.2(iii) and the Virginia Supreme Court's decision in Virginia Department of Taxation v. Wellmore Coal Corp., 320 S.E.2d 509 (Va. 1984).
DETERMINATION
Va. Code §58.1-609.3.2(iii) provides a sales and use tax exemption for machinery or tools or repair parts therefor or replacement thereof, fuel, power, energy or supplies "used directly" in processing, refining, mining or converting products for sale or resale. This exemption is further explained by Virginia Regulation (VR) 630-10-65.2, mining and mineral processing. VR 630-10-65.2 exempts tangible personal property used directly in mining and mineral processing. "Used directly" refers to those activities which are integral to the production of a product, including reclamation activities required by law on land which has previously been mined. Mining includes gas and oil drilling and other industrial removal of natural resources, minerals, or mineral aggregates from the earth.
Compressors and Meters
Based on the information provided in your letter, compressors and meters located at the well sites are clearly used directly in the extraction and processing of natural gas and would be exempt from the tax.
Pond/Pit Liners
In regard to the pond/pit liners, the Taxpayer contends that these items are used directly in pollution control and abatement and also used in the reclamation of the well site. For such liners to be exempt, they must (1) certified by the Department of Environmental Quality for the purpose of controlling or abating pollution, or (2) be mandated by either federal or state law for reclamation purposes.
Va. Code §58.1-609(3)(9) for a sales and use tax exemption for certified pollution control equipment and facilities, as defined in §58.1-3660. Va. Code §58.1-3660 defines "certified pollution control equipment and facilities" as follows:
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- Any property, including real or personal property, equipment, facilities, or devices, used primarily for the purpose of abating or preventing pollution of the atmosphere or waters of the Commonwealth and which the state certifying authority having jurisdiction with respect to such property has certified to the Department of Taxation as having been constructed, reconstructed, erected, or acquired in conformity with the state program or requirements for abatement or control of water or atmospheric pollution or contamination. (Emphasis added.)
VR 630-10-65.2(A)(3)(h) provides that reclamation is the restoring or conversion of mined land to a stable condition and reclamation activities required by state or federal law are part of the mining process and are therefore exempt.
As understood by this office, the purpose of the pond liner is to provide a means by which to gather well cuttings extracted from a well during the drilling process to prevent the contamination of ground water. Once the drilling is completed, the pond liner is used to encase the well cuttings and is then covered over during the reclamation process. The pond liners also allow the gathered water to settle so that the water may be re-used in the drilling process. While the pond and pond liners create an environment which is subject to reclamation activities, I feel that it is unreasonable to classify pit and pond liners as items used directly in reclamation. However, provided such liners are certified as pollution control equipment by the Virginia Department of Environmental Quality, such items will be removed from the audit.
Storage Tanks
While it is clear that the fracing fluids and drilling water used in the drilling and perforation of a well shaft are exempt as items used directly in mining, storage tanks for such fluids and water are not directly used and are therefore taxable. This position is supported by the Virginia Supreme Court's decision in Webster Brick Company. Inc v. Department of Taxation, 219 Va. 81, 245 S.E.2d 252 (1978), where the Court ruled that oil storage tanks may store exempt oil used directly in the manufacturing, however, the tanks themselves are not used directly in manufacturing and are therefore taxable.
It is also noted in your letter that these storage tanks may also be used to gather waste water during the drilling process. Based on the above discussion of pond liners, provided such tanks are certified as pollution control equipment, they will be removed from the audit.
Access Roads
VR 630-10-65.2(A)(3)(h) provides that reclamation of mined land that is required by federal or state law is part of the mining process when performed by the mining company on land which it has previously mined. As provided in your letter, the auditor held 40% of the "location restoration" expenses as taxable. It is understood by this office that the Taxpayer's reclamation expenses included not only the reclamation of the well location (a clearly exempt activity), but also the reclamation of access roads leading to the well site. As provided in the regulations, the reclamation exemption extends only to land which had previously been mined, therefore, reclamation of access roads does not qualify for the exemption as reclamation activities.
It is also noted that the Taxpayer feels the access roads are an integral part of the mining process and are therefore exempt. As provided above, in order to meet the mining and mineral processing exemption, tangible personal property must be used directly in mining and processing. As provided in VR 630-10-65.2, "direct use" in mining begins with the drilling of the shaft and ends with the conveyance of the mined product. While access roads may serve a facilitative or convenience function to the gas drilling operation, they are not "directly used" in the gas mining operation and are therefore taxable.
Pipelines
With regard to the gathering pipelines, you contend that such pipelines are analogous to the coal haul roads found to be exempt in Wellmore. Such roads were found to be exempt because they facilitated the transportation of coal from the mines to the tipple for further processing. I agree that the gathering pipelines are analogous to the coal haul roads and therefore exempt.
Based on the above, the audit will be adjusted accordingly. If you should have any questions, please feel free to contact this office.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/6990K
Rulings of the Tax Commissioner