Was oil-based drilling mud treated as rented property or as a taxable sale when consumed during drilling?

Plain-English summary

The requester sought a refund of sales tax charged on oil-based drilling mud described as rented and lost during a well operation. The Comptroller denied the refund.

Rule 3.324(e) treated a well-service company's charges for items lost or damaged while providing well service as reimbursement rather than a sale. But neither the mud seller nor its customer was the well-service company that used the mud, so that provision did not apply.

The Comptroller also found that drilling mud was a consumable supply, not machinery or equipment, and was expected to be consumed or incorporated into the well. The seller therefore sold rather than rented the mud. The transaction was a sale with deferred compensation: part of the price was paid on delivery and the balance after drilling. Sales tax had been properly billed on the mud consumed.

Common questions

Was consumed drilling mud considered “lost”? No. The letter treated consumption as the expected use of the supply.

Did Rule 3.324(e)'s reimbursement rule apply? No, because the relevant seller and customer were not well-service companies.

Was the transaction a rental? No. It was a sale with part of the payment deferred until drilling ended.

Was the refund granted? No.

Citations and references

• 34 Tex. Admin. Code Rule 3.324(e) — charges for items lost or damaged by a service company while providing well service.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8603L0823E01

Original ruling text

March 25, 1986

Dear ***

We have reviewed your request for a sales tax refund on lost oil based
drilling mud rented to CORP A.

Section (e) of Rule 3.324 states that "any charges by the service company
for items lost or damaged while providing the well service will not be
considered a sale of such items, but a reimbursement of cost by the
customer." (Emphasis added.) CORP B is a retailer, not a well service
company. ***, a staff accountant for CORP A, stated that a
drilling contractor (a well service company) used the mud, not CORP A.
Neither CORP B nor CORP A is a well service company thus, section (e)
of Rule 3.324 does not apply.

Drilling mud is a consumable supply, not machinery or equipment, which is
consumed or expended in or incorporated into the well. It is not lost.
The
realistic expended is that some of the mud will be consumed. The norm in
the well service industry is to purchase only the amount of drilling mud
used or consumed.

We find that CORP B sold and did not rent drilling mud to CORP A. The
transaction was a sale with deferred compensation. A part of the con-
sideration (payment) was received at the time the mud was delivered and
the balance of the consideration was received when drilling was
completed.
Sales tax was properly billed on the mud consumed.

Your request for sales tax refund is denied.

If you have any questions or need more information, please call me at
1-800-252-5555 toll free from anywhere in Texas. The regular number is
512/463-4600. You may write me at the Tax Administration Division.

Sincerely,

Eddie C. Washington
Tax Policy Section
Tax Administration Division