Can a petroleum terminal operator claim the sales tax exemption on the natural gas it uses to heat customer-owned fuel oils, on the theory that the heating is part of processing (blending) or part of transporting a material extracted from the earth?

Plain-English summary

A petroleum terminal operator sells integrated storage and terminal-use services to oil refiners, distributors, marketers, and traders — it never owns the product itself (gas oils and residual/bunker fuel oils). After receiving product by barge or ship, the company uses natural gas to heat the oil into a liquid state (which it calls "blending"), then stores it in 26 heated tanks until it's loaded for transport by truck; without ongoing heating, the large tank volumes could take days or weeks to reheat if allowed to cool. The parent company's financial reports showed 81% of consolidated revenue came from storage fees, with only 14% from "ancillary services" (heating, mixing, blending, transferring between tanks, rail loading/unloading) and 4% from "additive services" (injecting gasoline additives, dyes, etc.).

The company asked the Comptroller to rule that its natural gas charges for (1) initial heating and (2) keeping the oil in a heated state during transport aren't taxable. The Comptroller declined both requests, for lack of proof rather than a categorical rejection of the legal theory:

• Processing exemption (Section 151.317(a)(2)): This exemption covers gas/electricity used to power equipment that itself qualifies for the manufacturing exemption (Section 151.318) — equipment that directly causes a chemical or physical change to a product being processed for sale. The company never explained why its heating/blending activities constituted manufacturing, never identified specific equipment, and never provided customer contracts substantiating the claimed blending activity. Meanwhile, its own parent company's financials showed the overwhelming majority of revenue came from plain storage — and the manufacturing exemption specifically excludes equipment used to store tangible personal property (Section 151.318(c)(4)). Even if the company had shown some processing occurred, it would still need a predominant-use study proving the gas was predominantly used for that exempt purpose (Section 151.317(e); Rule 3.295(e)) — something a company failed to do in a similar 1986 case the taxpayer itself cited (Comptroller's Decision No. 18,870), which the Comptroller distinguished on its facts anyway (that petitioner's business was substantiated as primarily blending via customer contracts; this taxpayer offered only unsupported assertions).

• Extracted-material transportation exemption (Section 151.317(a)(4)): This exemption requires the gas be used to directly transport a material extracted from the earth (like crude oil, sand, or gravel) — and critically, per Rule 3.295(h)(3), the transportation must happen before any additives are combined with the material. The company provided both "ancillary" and "additive" services involving adding substances to customer product, undercutting a pure-transportation theory. It also never showed it actually provides transportation itself (as opposed to merely storing product that customers later move by ship, barge, or truck) — the ruling distinguished this from cases involving field compressors/line heaters that facilitate active pipeline flow, since this company doesn't heat or compress product to keep it moving from a wellhead.

The bottom line: the Comptroller didn't rule the company's activities could never qualify — it ruled the company simply hadn't proven its case, having provided a "sparse" description with no supporting documentation.

What this means for you

Petroleum terminal, storage, and blending operators

If you want a gas/electricity exemption for heating stored product, be ready to substantiate it thoroughly: identify the specific equipment, explain exactly what "blending" or "processing" means for your operation, produce customer contracts if relevant, and — if some of your gas use is for a nonexempt purpose (like plain storage) — commission a predominant-use study. A revenue mix dominated by storage fees (as here, 81%) will work against a processing-based exemption claim unless you can show the processing/blending function is genuinely central to your business.

Businesses claiming the extracted-material transportation exemption

Remember the additives timing rule: under Rule 3.295(h)(3), transportation-related gas/electricity use only qualifies for the exemption if it occurs before additives are combined with the material. If your operations routinely involve injecting additives, dyes, or blending agents, be prepared to separate out (and document) any pre-additive transportation-related gas use from post-additive processing use.

Accountants and tax professionals

This ruling is a good illustration of how thin factual records sink an otherwise plausible exemption theory — the Comptroller repeatedly notes the taxpayer's failure to identify equipment, provide contracts, or otherwise substantiate its claims, rather than rejecting the legal theories on their merits. It's a reminder that PLR requests should be built on a complete evidentiary record, not bare assertions.

Common questions

Q: Does heating stored petroleum products always fail to qualify for a gas/electricity exemption?
A: Not necessarily — the Comptroller distinguished a 1986 case where a similarly situated terminal operator's blending-as-primary-business claim succeeded because it was substantiated with customer contracts and other documentation. This taxpayer's claim failed for lack of proof, not because heating/blending activities can never qualify.

Q: What does the "predominant use" requirement mean here?
A: Even if some processing occurs, a taxpayer must show through a predominant-use study that the gas is used predominantly (not just partly) for the exempt purpose, per Section 151.317(e) and Rule 3.295(e) — otherwise the exemption fails even where some exempt use exists.

Q: Does adding additives to a product affect the transportation exemption?
A: Yes. Rule 3.295(h)(3) requires that transportation of a material extracted from the earth occur before any additives are combined with it, to qualify for the Section 151.317(a)(4) exemption.

Q: Can another terminal operator rely on this ruling?
A: No. This is a private letter ruling binding only on the Comptroller as to this taxpayer and these facts, and cannot be relied upon by any other taxpayer.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.317(a)(2) (gas/electricity exemption for exempt processing equipment)
• Tex. Tax Code § 151.317(a)(4) (gas/electricity exemption for transporting extracted materials)
• Tex. Tax Code § 151.317(e); 34 Tex. Admin. Code Rule 3.295(e) (predominant use requirement)
• Tex. Tax Code § 151.318(a)(2), (c)(4) (manufacturing exemption; storage exclusion)
• Tex. Tax Code § 151.3185 (motion picture/audio-video exemption, inapplicable)
• 34 Tex. Admin. Code Rule 3.295(h), (h)(1), (h)(3) (transportation of extracted material; additives timing)
• 34 Tex. Admin. Code Rule 3.1 (Private Letter Rulings and General Information Letters)
• 34 Tex. Admin. Code Rule 3.10 (Taxpayer Bill of Rights; detrimental reliance)

Prior authority discussed:

• Comptroller's Decision No. 104,635 (2012) (denied refund for compressors also used for storage/maintenance/transportation)
• Comptroller's Decision No. 18,870 (1986) (distinguished; petitioner's blending business was substantiated with customer contracts, but ultimately lost for lack of a predominant-use study)
• Comptroller's Decision No. 102,368 and STAR Accession No. 200404645L (distinguished; involved field compressors/line heaters facilitating active pipeline flow)
• STAR Document No. 200010846L (Oct. 27, 2000) (transportation exemption requires pre-additive movement)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201512602L

Original ruling text

December 2, 2015

Re: Private Letter Ruling No. 151170339

Dear *****:

This letter is in response to your submission dated April 21, 2015, and your

revised submission dated June 1, 2015, requesting a private letter ruling

related to the exemptions set out in Section 151.317 [ENDNOTE 1] (Gas and

Electricity), particularly subsections (a)(2) and (a)(4). We issue this private

letter ruling in accordance with Rule 3.1, Private Letter Rulings and General

Information Letters. Detrimental reliance relief is provided in accordance with

Rule 3.10, Taxpayer Bill of Rights.

Relevant Facts Presented:

COMPANY A sells an integrated terminal use and storage service to oil refiners,

distributors, marketers, and traders. The product that COMPANY A handles for

its customers includes gas oils and residual oils, such as vacuum gas oil, No.

6 oil, and bunker fuel. COMPANY A does not own any product, and does not

purchase or sell any product on behalf of its customers.

After receiving product from customers by barge or ship, COMPANY A uses natural

gas to heat the product to transform it into a liquid state. COMPANY A states

that this is done “for blending.” COMPANY A then stores the product until it is

loaded onto a vehicle for transport. All product is stored in a heated state

because some of the product will not pump well if allowed to cool below a

certain temperature. The COMPANY A terminal includes 26 tanks, all of which

are heated. Tank volumes are quite large and, if allowed to cool, would

require many days or even weeks to heat a tank back up to a suitable

temperature.

Specific facts regarding COMPANY A’s terminal operations have not been

established. COMPANY A has not provided any explanation of the blending

activities it performs and has not provided any customer contracts to

substantiate the description of the services provided. With respect to the

facility itself, COMPANY A has not provided schematics or identified any

equipment powered by natural gas.

COMPANY A is a subsidiary of COMPANY B, a publicly-traded partnership.

According to COMPANY B’s 2014 Annual Report, 81 percent of the parent company’s

revenues were generated by fees for storage services. The remaining revenues

were generated from ancillary and additive services. Ancillary services, which

generate 14 percent of COMPANY B’s revenue, include heating, mixing, and

blending customer products; transferring customer products between storage

tanks; and rail car loading, unloading, and docking operations. Additive

services, which generate four percent of COMPANY B’s revenue, include injecting

generic gasoline, proprietary gasoline, lubricity, red dye and cold flow

additives to customer products.

Requests:

A charge for the natural gas used for initial heating of material or its

component extracted from the earth is not taxable.

A charge for the natural gas used to keep material or its component extracted

from the earth in a heated state is not taxable when the heating is an integral

part of the transportation process.

Rulings and Analysis:

Section 151.317(a)(2)

Section 151.317(a)(2) exempts, in relevant part, natural gas and electricity

from Texas sales tax when sold for “use in powering equipment exempt under

Section151.318 or 151.3185 by a person processing tangible personal property

for sale as tangible personal property.”

Section 151.3185, which provides a sales tax exemption for tangible personal

property used in the production of motion pictures or audio or video recordings

or broadcasts, does not apply to COMPANY A’s activities.

Section 151.318 provides, among others, an exemption from sales tax on the

sale, lease or rental of equipment that directly makes or causes a chemical or

physical change in tangible personal property being manufactured for ultimate

sale. [ENDNOTE 2] In the ruling request, COMPANY A appears to be claiming that

it is entitled to a sales tax exemption on its natural gas purchases because it

uses that gas to power equipment that is exempt manufacturing equipment under

Section 151.318.

COMPANY A does not explain why its activities constitute manufacturing or

identify any specific equipment used in performing the services it provides its

customers. To the contrary, COMPANY B’s financial statements show that more

than 80 percent of the parent company’s revenues are from storage fees. The

equipment COMPANY A uses to perform storage services is not exempt

manufacturing equipment under Section 151.318. See Comptroller’s

Decision No. 104,635 (2012) (denying the Claimant’s refund request for taxes

paid on its purchases of compressors and other equipment used to process

natural gas at its storage facility because the compressors and other equipment

were also used for maintenance, storage, and transportation purposes).

The manufacturing exemption does not extend to equipment used to store tangible

personal property. See Section 151.318(c)(4). Consequently, COMPANY A’s

purchase of natural gas is not used to power exempt manufacturing equipment.

If COMPANY A were to demonstrate that it uses the natural gas at issue to power

equipment that qualifies for the exemption under Section 151.318, it would

still need to show that the natural gas is predominantly used for that purpose,

as required by Section 151.317(e) and Rule 3.295(e). For example, in

Comptroller’s Decision No. 18,870 (1986), which COMPANY A cites as support for

its first requested ruling, the Petitioner did not ultimately qualify for a

refund of sales tax paid on its natural gas purchases because it did not show

that the predominant use of the natural gas was to power exempt equipment.

Based upon the facts presented, COMPANY A has not established that it qualifies

for a sales tax exemption under Section 151.317(a)(2).

Section 151.317(a)(4)

Section 151.317(a)(4) exempts gas and electricity from sales tax when sold for

“use directly in exploring for, producing, or transporting, a material

extracted from the earth.”

Rule 3.295(h) explains when natural gas is used in the transportation of a

material extracted from the earth. Rule 3.295(h)(1) states in part, “Examples

of materials or components extracted from the earth would be oil, natural gas,

coal or coal slurry, crushed stone, sand and gravel, and water.” In order to

qualify for the exemption, the transportation of the material extracted from

the earth must occur before any additives are combined with the material. See

Rule 3.295(h)(3); see also STAR Document No. 200010846L (Oct. 27, 2000).

COMPANY A has not described the content of the product it handles other than to

make the bare assertion that the products are “basic components of petroleum.”

The facts provided indicate that COMPANY A provides both ancillary and additive

services, both of which involve the addition of additives to customer product.

COMPANY A also has not shown how its facilities are used to transport customer

product. It states that product is delivered to the terminal by ship or barge,

and then leaves the terminal by ship, barge or truck. In other words, COMPANY

A has shown that it provides access to multiple modes of transportation;

the facts provided do not demonstrate that COMPANY A provides transportation.

COMPANY A also cites to Comptroller’s Decision No. 102,368 and STAR Accession

No. 200404645L for the proposition that field compressors and line heaters

facilitate transportation by preventing a change in the temperature or pressure

of natural gas because “the natural gas could not flow if the pressure were to

drop to [sic] low.” Unlike the taxpayers in the two documents cited, COMPANY A

does not heat or compress product in order to facilitate transportation of the

product from the well head.

Based on the facts presented, COMPANY A does not qualify for an exemption under

Section 151.317(a)(4) because it is not transporting a material extracted from

the earth.

Comptroller’s Decision No. 18,870

COMPANY A cites to Comptroller’s Decision No. 18,870 as evidence that the

comptroller considers “the primary and overwhelming purpose” of a marine

terminal operator’s business to be blending and transporting customer product.

The Petitioner in Comptroller’s Decision No. 18,870 operated a marine terminal

at which it received fuel products owned by its customers and mixed and blended

those fuel products with other weights of fuel products for transportation to

the ultimate purchasers. The Petitioner was also engaged in storage of the

fuel products. The Petitioner claimed an exemption from sales tax on the

purchase of natural gas pursuant to Section 151.317(c)(2)(A) and (B) for the

relevant audit period.

The law in effect at the time of the hearing has since been amended. During

the audit period at issue in the hearing, Section 151.317(a) exempted gas and

electricity from sales tax except when sold for commercial use. Subsection

(c)(2) defined commercial use but exempted in subdivision (A) “processing of

tangible personal property for sale as tangible personal property” and in

subdivision (B) “exploring for, or producing and transporting, a material

extracted from the earth.”

In Comptroller’s Decision No. 18,870, the comptroller determined that the

Petitioner’s primary business consisted of processing and that without the

steam heating of the various grades of fuel oil, processing (the mixing or

blending of fuel products) could not occur. These facts, which were

substantiated through customer contracts, supported the comptroller’s

conclusion that the natural gas was directly used during the actual processing

of fuel products. Since the Petitioner was engaged in processing, the natural

gas was directly used during processing, and the Petitioner could have been

entitled to the exemption allowed by Section 151.317(c)(2)(A). As noted above,

the Administrative Law Judge ultimately ruled in favor of the Tax Division

because the Petitioner failed to provide a predominant use study showing that

the predominant use of the natural gas was for an exempt purpose. [ENDNOTE 3]

Unlike the facts in this Comptroller’s Decision, it does not appear that the

primary and overwhelming purpose of COMPANY A’s business is to blend or

transport fuels. In fact, other than an unsupported assertion that it blends

product, no information was provided to show that the blending it conducts is

in fact a processing activity.

Summary:

COMPANY A’s description of its business operations is sparse and it has not

provided written documentation in support of its statement of facts. No

statutory basis has been identified that would support the requested rulings.

The comptroller declines to issue the requested rulings as the facts are

insufficient to show a statutory basis for the requested exemption.

If you have any questions about this response, please email through our website

at https://www.comptroller.texas.gov/taxhelp and reference Private

Letter Ruling #151170339.

Tax Policy Division – Indirect Taxes

State Comptroller of Public Accounts

ENDNOTES

1. Unless otherwise indicated, all references herein to “Section” are to Tex.

Tax Code Ann. (Vernon 2008 and Supp. 2015) and all references to “Rule” are to

34 Tex . Admin. Code (2015).

2. This specific exemption is found in Section 151.318(a)(2). It appears to be

the provision that would apply to COMPANY A’s blending activity, if the

activity constituted manufacturing.

3. The requirement for a predominant use study is currently in Rule 3.295(e).

At the time of the hearing, the predominant use study requirements were in Rule

3.295(d).