Are water transfer services and frac fluid treatment services provided to oil and gas drillers subject to Texas sales tax, or to the state's oil/gas production or oil well service taxes?

Plain-English summary

A service company provides two related but distinct services to oil and gas drillers: first, it transfers fresh water on-site from a source (owned by the client or someone else) into frac tanks at the drilling location. Second, after the client uses that water — now transformed into chemically-treated "frac fluid" — for hydraulic fracturing, the company treats the used fluid above ground (outside the wellbore) with chlorine dioxide to neutralize hydrogen sulfide and bacteria so the client can re-inject it into the well. The company asked whether either service triggers sales tax, or one of Texas's separate oil/gas production or well-service taxes.

Texas split the answer cleanly. Water transfer is not taxable, because transportation of tangible personal property (in this case, plain fresh water) isn't one of the specifically enumerated taxable services under Texas law — moving water from a source to frac tanks is just transportation, full stop.

Frac fluid treatment is taxable, but for a different reason: by the time the company treats it, the fluid is no longer plain water — the client has already mixed in polymers, crosslinkers, and other chemicals to create "frac fluid," a distinct manufactured taxable product. Removing contaminants (hydrogen sulfide, bacteria) from that fluid using chlorine dioxide counts as the taxable "repair and restoration" of tangible personal property — the company is restoring already-manufactured frac fluid to a usable condition, not treating raw water. The ruling specifically distinguishes this from a 1996 ruling about treating contaminated industrial wastewater, since frac fluid is already tangible personal property (not water) by the time this company touches it.

Neither service falls under the state's specialized energy taxes: the company isn't a gas/oil "producer" or "first purchaser" (it returns any skimmed oil/gas to its client rather than using, refining, or selling it), so the Gas Production Tax and Oil Production Tax don't apply; and because its frac fluid treatment happens after the primary fracking service is complete, it also falls outside the Oil Well Service Tax's three enumerated well-bore services.

What this means for you

Water transfer and oilfield logistics companies

Pure water transportation/hauling services to a well site remain untaxed. But be careful about scope creep — if your service starts to include any chemical treatment or restoration of fluids that have already been converted into a manufactured product (like frac fluid), that portion crosses into taxable territory.

Frac fluid recycling and treatment companies

Treating used frac fluid to remove contaminants for reuse is taxable as a repair/restoration service, distinct from the nontaxable treatment of ordinary wastewater. This is a narrower reading of the older wastewater-treatment guidance (STAR 9604125L) — don't assume that guidance covers frac fluid recycling.

Accountants and tax professionals in the oilfield services space

This ruling is a useful three-question template: (1) is the base activity transportation (nontaxable) vs. repair/restoration of a product (taxable), (2) does the taxpayer's role as a mere pass-through of skimmed oil/gas keep them out of production-tax "producer"/"first purchaser" status, and (3) does the timing of the service (before/during/after primary well-bore fracking) keep it out of the Oil Well Service Tax's narrow three-service list.

Common questions

Q: Why is treating used frac fluid taxable when transporting fresh water isn't?
A: Because by the time it's treated, the fluid is no longer plain water — it's a chemically altered, manufactured product (frac fluid) that the client created for fracking. Restoring that product to reusable condition is a taxable repair/restoration service; transporting untreated water is just transportation, which isn't a listed taxable service at all.

Q: Does the company owe Gas or Oil Production Tax on the skim gas/oil it recovers during treatment?
A: No — because the company gives the skimmed gas and oil back to its client rather than using, refining, or selling it, it doesn't meet the definition of "producer" or "first purchaser" under either production tax statute.

Q: Is this service subject to the Oil Well Service Tax since it relates to fracking?
A: No. That tax covers only three specific well-bore services (casing cementing; fracturing/acidizing formations; and instrument-based surveying/testing within the wellbore) — the company's above-ground, post-fracking treatment service doesn't fit any of them.

Q: Does this ruling apply to my water transfer or fluid treatment business?
A: Not automatically. This is a private letter ruling binding only on the Comptroller as to this taxpayer's specific facts. A different chemical treatment process or a different point in the well's lifecycle could change the analysis.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.051, § 151.010 (sales tax imposition; taxable item)
• Tex. Tax Code § 151.0101(a) (list of taxable services — transportation not included)
• Tex. Tax Code § 151.0101(a)(5) (repair and restoration of tangible personal property)
• STAR Accession No. 9604125L (Apr. 16, 1996) (distinguished — industrial wastewater treatment)
• Tex. Tax Code § 201.051, § 201.001(5), § 201.251 (Gas Production Tax)
• Tex. Tax Code § 202.051, § 202.001(a)(2), (a)(4), § 202.251 (Oil Production Tax)
• Tex. Tax Code ch. 191, subch. E; 34 Tex. Admin. Code § 3.143(c)(5) (Oil Well Service Tax)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/202005021L

Original ruling text

May 7, 2020

RE: Private Letter Ruling No. PLR 20190522093504

*, Taxpayer No. *

Dear ****:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE: (1)] We are responding to your request dated May 17, 2019 and supplemental information provided by email on July 16, 2019. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on the taxability of water transfer and frac fluid treatment services provided by your client to the oil and gas drilling industry.

Facts Presented

**** (Taxpayer) provides two types of services to the oil and gas exploration industry: water transfer services and “frac fluid” water treatment services. The relevant facts are based upon Taxpayer's request for a Private Letter Ruling and subsequent documents provided by Taxpayer, including a sample contract and invoice.

Taxpayer states it provides on-site water transfer services for its clients. The water sources are either owned by their clients or others. Taxpayer does not own any of the land where the water is sourced. For a fee Taxpayer transfers fresh water from its source to frac tanks at their client's oil and gas production site.

Taxpayer also provides on-site treatment services of “recycled water” for its clients after their client has used the fluid for fracking and removed it from the well. Taxpayer’s clients cannot re-use this frac fluid because it contains hydrogen sulfide (H2S) and sulfite reducing bacteria (SRB) that create hydrogen sulfide.

Taxpayer treats the used frac fluid by oxidizing the H2S and the SRB so that the clients can re-inject it into the well. To treat the used frac fluid Taxpayer creates chlorine dioxide by injecting three precursor elements that form chlorine dioxide into frac tanks that are located above ground and outside the client’s well bore. Taxpayer does not remove chemicals their client added to the fresh water to produce the frac fluid, although they do remove other oil- souring impurities and separate the oil and gas that comes up with the frac fluid. All of Taxpayer's services are performed above ground and outside their client's wellbore.

As a result of Taxpayer’s water treatment, skim gas and skim oil are separated from the frac fluid. Taxpayer does not use, refine or sell the gas or oil; instead the gas and the oil are given back to the client who removed the gas or oil from the well.

Questions, Rulings, and Analysis

Our restatement of your questions are shown below, followed by our responses and analysis.

Question One: Are the Taxpayer's water transfer services subject to sales and use tax under Tax Code, Chapter 151 (Limited Sales, Excise, and Use Tax)?

Ruling One: Taxpayer's water transfer services are not subject to sales and use tax.

Analysis Question One: Texas imposes a sales tax on each sale of a taxable item in this state. Section 151.051 (Sales Tax Imposed). The term “taxable item” includes tangible personal property and taxable services. Section 151.010 (Taxable Item). The term “taxable services” includes only those services listed in Section 151.0101 (“Taxable Services”).

Taxpayer provides transportation of tangible personal property to their client’s frac tanks. Transportation of tangible personal property is not a listed taxable service under section 151.0101(a), therefore Taxpayer’s water transfer service is not a taxable service.

Question Two: Are Taxpayer's frac fluid treatment services subject to sales and use tax under Tax Code, Chapter 151?

Ruling Two: Taxpayer's frac fluid treatment services are subject to sales and use tax.

Analysis Question Two: Taxpayer’s clients take fresh water and add chemicals to produce frac fluid for use in oil and gas fracking. This process takes water that is tax exempt tangible personal property and creates frac fluid, which is taxable tangible personal property.

The frac fluid that Taxpayer’s clients remove from the production well is a water-based fluid that has been thickened with high molecular weight polymers and treated with crosslinkers, fluid loss agents and breakers to insure the there is no premature settling of the proppant.

Frac fluids usually contain water, proppant and a small amount of nonaqueous fluids designed to reduce friction pressure that typically include gels, friction reducers, crosslinkers, breakers and surfactants similar to household cosmetics and cleaning products. See Schlumberger Oilfield Glossary, (viewed 9/18/2019) and Advanced Fracturing Fluids Improve Well Economics, Oilfield Review, Autumn 1995).

The repair and restoration of tangible personal property is a taxable service in Section 151.0101(a)(5). Taxpayer's treatment of used frac fluid with chlorine dioxide (ClO2) is the restoration of tangible personal property and is subject to Texas sales and use tax.

Taxpayer’s treatment of frac fluid is distinguished from the treatment of wastewater referenced in STAR Accession No. 9604125L (Apr. 16, 1996). The facts of that letter apply to contaminated industrial Class I and Class II nonhazardous wastewater from industry. The wastewater was generated by machine shops or underground storage tanks (USTs) undergoing remediation work. In contrast, Taxpayer treats frac fluid, which is no longer water and is instead tangible personal property produced by Taxpayer’s clients for use in their oil and gas wells.

Question Three: Are Taxpayer’s water transfer and frac fluid treatment services subject to the Gas Production Tax under Texas Tax Code Section 201.051 (Tax Imposed), or the Oil Production Tax under Texas Tax Code Section 202.051 (Tax Imposed), or the Oil Well Service Tax under Texas Tax Code, Chapter 191, Subchapter E (Miscellaneous Occupations Taxes, Oil Well Service)?

Ruling Three: The Taxpayer’s water transfer and frac fluid treatment services are not subject to the Gas Production Tax, the Oil Production Tax or the Oil Well Service Tax.

Analysis Question Three: Section 201.051 (Tax Imposed) imposes a gas production tax on gas that the producer removes from the earth. Tax liability is shared with the first purchaser under Section 201.251 (Liability of Producer and Purchaser). Taxpayer has indicated that they do not use, refine, or sell the gas skimmed from the frac fluid and instead they give it back to their client. Taxpayer is not a “producer” as defined by Section 201.001(5) (Definitions) as they do not remove the gas from the earth. Taxpayer returns the skim gas instead of buying it from the producer, thus they are not a “first purchaser” as defined by Section 201.001(3). Taxpayer is not subject to the gas production tax under Chapter 201.

Section 202.051(Tax Imposed) imposes an oil production tax that must be paid by the first purchaser or the producer of the oil under Section 202.251 (Liability of Producer and Purchaser). Taxpayer does not use, refine or sell the oil skimmed from the frac fluid and instead returns the oil to their client the oil producer. As Taxpayer returns the oil instead of purchasing the crude oil from their client they are not a “first purchaser” as defined by Section 202.001(a)(2) (Definitions). They are not a “producer” as defined by Section 202.001(a)(4) as they were not the person who took the oil from the earth. Taxpayer is not subject to the oil production tax under Chapter 202.

Tax Code, Chapter 191, Subchapter E imposes an occupation tax on persons performing certain oil well services. See also Rule 3.143 (Oil, Gas, and Related Well Service). There are three primary services subject to the tax, (1) cementing the casing seat of an oil or gas well; (2) shooting, fracturing, or acidizing the sands or other formations of the earth in any such well; and (3) surveying or testing formations or the contents thereof, in any such well through the use of instruments or equipment at least a portion of which are located within the well bore when the survey or test is made.

Taxpayer is not performing any of these primary taxable services or a service in conjunction with a primary oil well service. Rule 3.143(c)(5) defines nontaxable receipts to include “any receipts for service performed before or after a taxable service has been commenced or completed.” Taxpayer’s frac fluid treatment service is provided after the primary fracking service is complete. Taxpayer is therefore not subject to the Oil Well Service Tax under Chapter 191.

Comptroller’s Decisions and STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 20190522093504.

Sincerely,

Tax Policy Division – Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.