Did supplying drilling tools and supervising their use make the charge a service when the customer's employees actually operated the drilling equipment?

Plain-English summary

A Texas company's unreproduced June 29, 1970 letter called its offering a controlled directional-drilling service and said rented/used tools remained under its operator's control. For rented Dyna-Drill, it paid upstream tax on combined tool-run and hourly usage, then separately billed customers a daily supervision rate and tool-run charge. It billed the same way for owned Turbodrill and furnished other owned/rented tools.

The company asked counsel to expand a July 20, 1966 Board letter saying a driller who furnishes tools and actually performs and supervises directional drilling provides service rather than taxable rentals. The full earlier letter is absent.

This taxpayer's classification had already been litigated administratively. A May 1, 1963-June 30, 1966 audit included separately stated Turbodrill/tool amounts in taxable measure as Exempt Rentals and Services Overstated. A 1967 determination included tax and interest. Another company petitioned on taxpayer's behalf; after extended correspondence, the Board again found rentals, allowed material-cost credit, adjusted the tax and made redetermination final. None of those records appears.

Prior counsel explained that furnishing and supervision were insufficient: the company also had to perform operations. Its tools were understood to run on equipment owned, operated and staffed by customers. With no evidence the operation changed after the audit period, owned Turbodrill and other tool charges remained taxable rentals.

For rented Dyna-Drill/other tools, current counsel could not determine whether they appeared in the old audit. He nonetheless assumed business method did not depend on tool ownership, treated them as rerented, and assumed substantially same form. Under former Ruling 70(c)(2)(H), taxpayer could pay tax measured by upstream rent to the tool owners. The identified enclosure is not reproduced.

Live Annotation 330.2889 publishes only the furnish/supervise/actually-operate rule and customer-employee-operation lease result. It omits the company's control assertion, tool/charge types, multi-year audit and final redetermination, absent prior writings, no-change and ownership-independence assumptions, rented-tool uncertainty, same-form assumption and missing Ruling 70.

No request, 1966 letter, tool/equipment list, operator/control/staff record, customer agreement, upstream lease/tax, invoice/rate/payment, 1963-66 audit, 1967 determination, representative petition, counsel correspondence, material-cost credit/final adjustment, Ruling 70 enclosure, return, later audit, assessment, claim, appeal or outcome appears.

What this means for you

Document who owns, possesses, controls, staffs and actually operates every tool/equipment component. Preserve separately stated charges, upstream leases/tax, same-form evidence and any prior audit resolution. Supervision alone did not equal performance here.

Common questions

Was separately billed supervision enough for service?

No. The customer's personnel actually operated the equipment.

What additional fact supported service treatment?

The supplier itself would have to perform as well as supervise the directional-drilling operations.

Did tool ownership change the classification?

No. Owned tools were rented; rented-in tools were rerented under the same customer-operated model.

Why did the prior audit matter?

The Board had already treated the company's tool charges as rentals, and the company supplied no facts showing a changed operation.

Were rented Dyna-Drill tools proven part of that audit?

No. Counsel could not determine that from material in his possession.

What assumptions supported rerental treatment?

That method did not vary by ownership and rented-in tools remained substantially the same form.

Is Ruling 70(c)(2)(H) reproduced?

No. It is identified as an enclosure but absent.

Citations and references

• Former Ruling 70(c)(2)(H) — rerental method; enclosure absent
• July 20, 1966 Board letter — quoted core rule; full letter absent
• 1963-66 audit, 1967 determination, petition/correspondence and final adjustment — absent
• Request and all tool/operator/customer/lease/tax/charge/outcome records — absent
• Live Annotation 330.2889 — core rule without procedural/evidence posture

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 330.2889
• Original supporting opinion: 330.2889 PDF

Original ruling text

330.2889

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

December 28, 1970

E--- O--- W--- S--- Company
P. O. Box XXXXX
---, TX XXXXX
SY -- XX-XXXXXX
Attention:

Mr. C--- W---

Gentlemen:
Your letter dated June 29, 1970 addressed to the California State Board of Equalization was referred to me for reply. Please excuse the delay in my response. You state that you offer a controlled directional drilling service and that in the performance thereof you rent and/or use tools which remain under the control of your operator performing said service. In some cases, you furnish a Dyna-Drill tool which you rent, paying tax therefore on a combination tool run and hourly usage basis, and for which you bill a stated rate per day for directional drilling supervision and a separate charge for tool runs. In other cases, you furnish a Turbodrill tool which you own and for which you similarly bill a stated rate per day for directional drilling supervision and a separate charge for tool runs. In addition, you furnish other tools which you own or rent and for which you bill your customers. Referring to a letter dated July 20, 1966 from Mr. J--- Q--- to D--- Company, you request that we expand upon a statement therein to the effect that as a tool was used in a service as opposed to rerental no further tax would be applicable. Having reviewed that letter, I assume that your are referring to the last paragraph on page one wherein Mr. Q--- stated: “A directional oil driller who furnishes drilling tools and actually performs and supervises directional drilling operations is performing a service and not making taxable rentals.” The issue as to whether you have been renting drilling tools or using such tools in the performance of a service has previously been considered by the board and resolved upon the basis that you were renting such tools. In the course of a 1966 audit, it was concluded that you were renting tools, including Turbodrill tools, to your customers and separately stated amounts received therefore were included in the taxable measure as Exempt Rentals and Services Overstated. In 1967, a Notice of Determination issued in your name for tax and interest included tax on those amounts. Thereafter, A--- Company filed a Petition for Redetermination on your behalf, extended

E--- O--- W--- S--Company

-2-

December 28, 1970
330.2889

correspondence ensued between Mr. G--- G--- of that company and Tax Counsel Glenn L. Rigby, it was again concluded that you were renting tools and that your charges therefore were properly included in the taxable measure, credit was given for material cost reported on such tools, and as adjusted, the tax was redetermined and became final. In the course of that correspondence, Mr. Rigby advised in regard to the above-quoted paragraph as follows: “The key to Mr. Q---’s decision is that not only must the oil driller furnish and supervise the drilling operations, but he must actually perform them. This latter requisite appears to be missing in the E--- operation since we understand the tools are utilized on equipment owned, operated and staffed by E---’s customers.” With regard to Turbodrills and other tools which you own, we have no information that you are conducting your business in a manner which differs from that in which you conducted it during the May 1, 1963 to June 30, 1966 audit period. Thus, for the reasons set forth in the course of the above-mentioned prior correspondence, we would continue to regard you as renting such tools and amounts received therefrom would continue to be subject to tax. With regard to Dyna-Drill and other tools which you rent, I have referred to them separately since from the materials in my possession, I am unable to ascertain whether you rented such tools during the period of the prior audit. In any event, as we have no information that the manner in which you conduct your business is dependent upon whose tools you use, we would regard you as rerenting such tools, and assuming that you rerent the tools in substantially the same form, you can pay tax measured by the rental receipts paid to D--- Company or to other companies from whom you rent. (ruling 70(c)(2)(H), copy enclosed). Very truly yours,

J. Kenneth McManigal
Tax Counsel

JKM:smb
Enclosure