This site uses cookies. By continuing to browse the site you are agreeing to our use of cookies.
While the rest of the country celebrates paying less at the gas pump, the oil industry and states like Texas face the darker side of slumping oil prices. Profits are down, likely affecting tax revenues for states dependent on the oil industry. Fortunately for Texas, the state just netted a gigantic win to the tune of $4.4 billion, as reported by Laurel Brubaker Calkins in Bloomberg BNA’s Daily Tax Report.
The Texas Supreme Court’s unanimous June 17 decision rejected Southwest Royalties’ claim to a manufacturing exemption for equipment the company used during the extraction of hyrdocarbons. That’s industry-speak for the collection of oil, gas, and other stuff coming out of ground. Had Southwest Royalties, a Texas gas and oil exploration and production company, won its case, state officials would have had to find a way to refund billions in sales taxes to the state’s entire oil industry. The popular story surrounding this case is the big savings for Texas. Indeed, before the Texas Supreme Court even heard oral arguments, Texas Comptroller Glenn Hegar warned that a favorable decision for the oil company could eliminate a projected budget surplus for the state.
Beyond the fiscal impact, however, the Southwest Royalties, Inc. v. Hager, case serves as a reminder of the highly-nuanced nature of applying the sales tax exemption for manufacturing equipment. Few areas are as frustrating in sales and use tax as the manufacturing exemption because determining what qualifies as exempt manufacturing equipment often feels like trying to slice a shadow.[1]
The issue in the Texas case turned on whether the steel pipes for which Southwest Royalties claimed the manufacturing exemption were actually used in “processing,” one of the necessary requirements under Texas’ exemption statute. The company claimed its steel casing and tubing was used to separate the hyrdocarbons being extracted into oil, gas, and condensates, thereby “processing” the hydrocarbons by causing a physical change to them. But the Texas high court agreed with a lower court’s findings that the direct causes of the separation of the hydrocarbons into different substances were pressure and temperature changes that occur naturally during extraction. Southwest Royalties’ equipment was just an indirect cause of the physical change to the hydrocarbons, and thus, did not qualify for the manufacturing exemption allowed for equipment used in “processing.”
Consider a recent case out of Arkansas’ Supreme Court – another illustration of how vexatious analyzing the manufacturing exemption can be. In Walther v. Carrothers Constr. Co. of Ark., LLC, the Arkansas high court denied an exemption for a company that used a three-part process to turn raw surface water into potable drinking water. The company’s process of removing trash from the raw water, then chemically treating the water, then purifying the water did not convince the Arkansas court that the water treatment process constituted manufacturing eligible for a sales tax exemption. The court stated, “[i]t was water in the beginning, and it was water in the end.”
State legislatures favor sales tax exemptions for manufacturing, processing, fabricating, and the like because those exemptions encourage the location of new businesses in the state or the expansion or upgrading of existing businesses. Nevertheless, one sometimes wonders if the incentive is worth all the analytical effort. For Texas, at least this time around, the reasoning worked out in the state’s favor.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How do you assess the significant differences in the states’ application of the sales tax exemption for manufacturing equipment?
Take a free trial to Premier State Tax Library , a comprehensive research service that delivers deep, unique analysis, and time-saving practice tools to help practitioners make well-informed decisions.
By René Y. Blocker
[1] Tax practitioners may recall the U. S. Supreme Court’s statement in Container Corp. v. Franchise Tax Board, likening allocating income among various states to “slicing a shadow.”
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to books@bna.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to research@bna.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)