Does converting customer-owned natural gas into liquefied natural gas (LNG) under a tolling arrangement -- where the processor never owns the gas -- still qualify as exempt 'processing' for Texas's manufacturing exemption?

Plain-English summary

Important flag from the Comptroller's own posted STAR page: the two Comptroller's Decisions this ruling relies on for its ownership analysis (Nos. 42,108 and 25,285) have since been superseded. The bottom-line holding about LNG liquefaction being "processing" appears unaffected, but the specific supporting authority for the ownership point should be independently verified before being relied on today.

A company planned to build a natural gas liquefaction and export facility with two "liquefaction trains" that cool natural gas into liquefied natural gas (LNG) for overseas export. The company would sometimes buy its own natural gas, liquefy it, and sell the resulting LNG to customers (an "F.O.B. Arrangement"); other times, a customer would buy the natural gas itself and simply pay the company a fee to liquefy the customer's own gas so the customer could export and resell it (a "Tolling Arrangement"). The company asked whether the Tolling Arrangement version — where it never owns the gas — still qualifies as exempt "processing" under Texas's manufacturing exemption (Tax Code § 151.318).

The Comptroller ruled yes. Liquefying natural gas — removing contaminants (carbon dioxide, water, mercury) and then cooling/compressing the gas into a liquid — meets Rule 3.300(a)(10)'s definition of "processing" (physically modifying tangible personal property's characteristics) regardless of who owns the gas. Texas's manufacturing exemption can be claimed either by the person who sells what's being processed, or by the person who sells the processing service itself — ownership of the underlying property isn't a prerequisite. So the company's liquefaction activity qualifies as manufacturing/processing whether it's selling LNG under the F.O.B. Arrangement or selling a processing service under the Tolling Arrangement.

Two important limits: the Comptroller did not rule on the taxability of any specific piece of equipment the company might purchase for the facility — that requires its own separate analysis under Section 151.318 and Rule 3.300. And machinery/equipment used merely to maintain or store the LNG (e.g., keeping storage tanks at the required pressure/temperature) is explicitly excluded from the manufacturing exemption under Section 151.318(c)(4), even though the liquefaction process itself qualifies.

What this means for you

LNG producers, gas processors, and toll-processing businesses

You don't need to own the raw material you're processing to qualify for Texas's manufacturing exemption — providing a processing service on someone else's property can qualify just as much as processing your own property for sale, as long as the activity itself meets the "processing" definition (a physical/chemical change to the property).

Companies purchasing processing equipment for a manufacturing facility

Getting a favorable ruling that your core activity is "processing" doesn't automatically make every piece of equipment at your facility tax-exempt — storage and maintenance equipment is carved out under Section 151.318(c)(4) even at a facility that otherwise qualifies for the exemption. Expect to need item-by-item analysis for specific equipment purchases.

Accountants and tax professionals

Note the superseded-authority alert prominently on this one: the Comptroller's own STAR posting flags that Comptroller's Decisions 42,108 and 25,285 — the specific precedent cited for the "processing without ownership" holding — have been superseded. The underlying statutory analysis and the ultimate conclusion in this specific ruling remain posted as-is, but don't cite those two superseded decisions as current authority in your own work; check current Comptroller guidance first.

Common questions

Q: Does the company need to own the natural gas to get the manufacturing exemption on its liquefaction activity?
A: No. The ruling confirms ownership isn't required — selling a processing service on customer-owned gas qualifies just as much as processing and selling gas the company owns itself.

Q: Does this ruling tell me whether my specific compressors/equipment are tax-exempt?
A: No. The Comptroller expressly declined to rule on the taxability of specific tangible personal property purchased for the facility — that requires separate analysis, and equipment used only to maintain or store the LNG is excluded from the exemption regardless.

Q: Can I cite Comptroller's Decisions 42,108 and 25,285 today based on this ruling?
A: Be careful — the Comptroller's own STAR posting for this ruling flags that both decisions have since been superseded. Verify current authority independently.

Q: Can another LNG or toll-processing company 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 § 151.318(a)(2), (4) (manufacturing exemption)
• Tex. Tax Code § 151.318(c)(4) (maintenance/storage equipment exclusion)
• 34 Tex. Admin. Code Rule 3.300(a)(9) (manufacturing definition)
• 34 Tex. Admin. Code Rule 3.300(a)(10) (processing definition)
• 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 (NOTE: superseded per the Comptroller's own alert):

• Hearing No. 42,108 (2009) (superseded)
• Comptroller's Decision No. 25,285 (1990) (superseded)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201602747L

Original ruling text

ALERT: Comptroller's Decisions 42,108 and 25,285 which are cited in this Private Letter Ruling have been superseded.

February 22, 2016

Re: Private Letter Ruling #152850221

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter

Rulings and General Information Letters [ENDNOTE 1], in response to your

request dated July 22, 2015. Detrimental reliance relief is provided in accordance

with Rule 3.10, Taxpayer Bill of Rights.

Your client, ***** (Taxpayer), plans to develop a natural gas

liquefaction and export facility at City, Texas (the facility). You are

requesting guidance about whether the activities within the facility to convert

natural gas into liquefied natural gas (LNG) for export are processing for

purposes of Section 151.318.

Facts Presented

LNG is natural gas that, through a cooling process, is reduced to a liquid

state. Liquefying natural gas allows it to be exported to other parts of the

world where natural gas is in higher demand.

Taxpayer’s facilities will include two liquefaction trains. The natural gas

will be delivered to the site via a feed gas pipeline and will be treated,

liquefied, and stored on site. Taxpayer will begin liquefying the feed gas by

removing any potential contaminants, including carbon dioxide, water and

mercury. For example, carbon dioxide will be removed through a solvent system

using an amine solution. Taxpayer will then cool the pretreated gas in a

refrigeration process that involves compressing and condensing the gas. The

“sub-cooled” LNG will be stored at negative 260 degrees Fahrenheit in one of

two single containment LNG storage tanks, each with a net capacity of 160,000

cubic meters. From the storage tanks, the LNG will be loaded onto LNG carriers

for export out of the country.

Taxpayer may enter into two types of arrangements with customers: (1) F.O.B.

Arrangements; and (2) Tolling Arrangements. Under an F.O.B. Arrangement,

Taxpayer will purchase natural gas that will be delivered by pipeline to the

facilities, process its own natural gas into LNG, and sell the LNG to its

customer. Title to the LNG will pass to Taxpayer’s customer when the LNG is

offloaded from the facility onto a carrier for export. Under a Tolling

Arrangement, Taxpayer's customer will purchase the natural gas for delivery via

pipeline to the Facility, and Taxpayer will process the customer-owned natural

gas into LNG so that the customer can export the LNG for resale.

Requested Ruling

You request a ruling that Taxpayer’s liquefaction activity qualifies as

“processing” for purposes of the manufacturing exemption when the activity is

performed under a Tolling Arrangement (i.e., on customer-owned gas).

Relevant Authorities

Section 151.318(a)(2) and (4) states, in relevant part, that the following

items are exempt if sold, leased, or rented to, or stored, used, or consumed

by, a manufacturer:

(2) tangible personal property directly used or consumed in or during the

actual manufacturing, processing, or fabrication of tangible personal property

for ultimate sale if the use or consumption of the property is necessary or

essential to the manufacturing, processing, or fabrication operation and

directly makes or causes a chemical or physical change to:

(A) the product being manufactured, processed, or fabricated for ultimate sale; or

(B) any intermediate or preliminary product that will become an ingredient or

component part of the product being manufactured, processed, or fabricated for

ultimate sale;

…

(4) actuators, steam production equipment and its fuel, in-process flow through

tanks, cooling towers, generators, heat exchangers, transformers and the

switches, breakers, capacitor banks, regulators, relays, reclosers, fuses,

interruptors, reactors, arrestors, resistors, insulators, instrument

transformers, and telemetry units that are related to the transformers,

electronic control room equipment, computerized control units, pumps,

compressors, and hydraulic units, that are used to power, supply, support, or

control equipment that qualifies for exemption under Subdivision (2) or (5) or

to generate electricity, chilled water, or steam for ultimate sale;

transformers located at an electric generating Facilities that increase the

voltage of electricity generated for ultimate sale, the electrical cable that

carries the electricity from the electric generating equipment to the step-up

transformers, and the switches, breakers, capacitor banks, regulators, relays,

reclosers, fuses, interruptors, reactors, arrestors, resistors, insulators,

instrument transformers, and telemetry units that are related to the step-up

transformers; and transformers that decrease the voltage of electricity generated

for ultimate sale and the switches, breakers, capacitor banks, regulators, relays,

reclosers, fuses, interruptors, reactors, arrestors, resistors, insulators, instrument

transformers, and telemetry units that are related to the step-down transformers.

Section 151.318(c)(4) excludes machinery and equipment or supplies, to the

extent not otherwise exempted under Section 151, that are used to maintain or

store tangible personal property.

Rule 3.300(a)(9) defines manufacturing as follows:

Manufacturing--Each operation beginning with the first stage in the production

of tangible personal property and ending with the completion of tangible

personal property…:

(A) Processing and fabrication are two activities that are performed during

manufacturing. For example, the person who takes raw steel and makes pipe is

engaged in fabrication. The workers who coat or thread the pipe are engaged in

processing.

Rule 3.300(a)(10) provides, in relevant part, that processing means “[t]he

physical application of the materials and labor necessary to modify or to

change the characteristics of tangible personal property.”

Analysis and Ruling

Taxpayer plans to construct two liquefaction facilities at City, Texas, where

it will liquefy natural gas so that the LNG can be transported overseas,

regasified and ultimately sold in a foreign country as natural gas. At the

liquefaction facilities, Taxpayer will change the chemical composition and

physical characteristics of natural gas in order to convert the gas into a

liquid. These activities constitute “processing” as that term is defined in

Rule 3.300(a)(10).

As described above, Taxpayer will not own all of the gas that it liquefies at

the facilities. Some portion of its activities will be performed pursuant to a

Tolling Agreement, under which Taxpayer will liquefy customer-owned natural

gas. Manufacturing exemptions can be claimed either by persons who sell the

product being processed or persons who sell the processing itself. See Hearing

No. 42,108 (2009) (citing Comptroller’s Decision No. 25,285 (1990) (holding

that intermediate processing can be done by a non-owner of the property being

processed)). Taxpayer’s liquefaction of the gas constitutes processing whether

Taxpayer is selling the gas or selling a processing service.

Taxpayer’s liquefaction of natural gas into LNG is a manufacturing activity,

and Taxpayer will be entitled to claim the sales and use tax exemption (subject

to the limitations in Section 151.318 and Rule 3.300) regardless of whether

Taxpayer enters into an F.O.B. Arrangement or Tolling Arrangement.

For purposes of this ruling, we conclude that some processing, as contemplated

by Section 151.318 and Rule 3.300, will occur at the Facilities based on the

facts presented. We do not provide a ruling regarding the taxability of

specific items of tangible personal property that will be purchased and used at

the facilities. Note that machinery and equipment used to maintain the LNG at

the required pressure or temperature during storage and the tanks used to store

the LNG before export do not qualify for the manufacturing exemption. See Tax

Code, 151.318(c)(4) (“The exemption does not include…. machinery and equipment

or supplies... used to maintain or store tangible personal property…”)

If you have questions about this private letter ruling, please email us through

our website at https://www.window.state.tx.us/taxhelp/ and reference Private

Letter Ruling #152850221.

Sincerely,

Tax Policy Division

ENDNOTE

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

CODE ANN. (Vernon 2008 and Supp. 2013) and all references to “Rule” are to

Title 34, Texas Administrative Code.