How did Texas determine whether an installed pipeline sale involved real property or tangible personal property, and could the sale qualify as an occasional sale?

Plain-English summary

An oil-and-gas company leased a pipeline under an agreement treating it as personal property, exercised a purchase option, and soon sold the pipeline to another company on an installment basis.

The Comptroller said a pipeline in place generally qualified as real property. When status was doubtful, the parties could give it a character by good-faith agreement. Without such an agreement, the Hutchins v. Masterson fixture analysis looked to annexation to realty, fitness or adaptation to the realty's use, and the annexing party's intent that the item become a permanent part of the property.

The letter also quoted Attorney General Opinion M-298 factors bearing on pipeline character, including useful life, initial investment, installation cost and labor, effect on property value, and whether the pipeline would be removed when no longer used.

If the transaction involved taxable personal property, the sale could qualify as an occasional sale of an identifiable segment when the books separately showed income and expenses attributable to pipeline operations after purchase. Otherwise, tax timing followed the seller's sales-tax accounting method unless the transaction used the financing arrangement identified in Rule 3.294(f)(3)(B).

The Comptroller rejected the idea that earlier audits established approval of the original 2% lease rate merely because auditors had not questioned it. Without more transaction details, the rate should have increased with changes in law unless legislative prior-contract protection applied. If only state tax was legally due on the pipeline lease, the letter said 4% tax on the option purchase price was correct.

Common questions

Was an installed pipeline real property? The letter said a pipeline in place generally qualified as real property.

What fixture tests applied without a controlling good-faith agreement? Annexation, adaptation to the realty's use, and intent to make a permanent accession.

Could the sale qualify as an occasional sale? Potentially, as an identifiable segment, if the company's records separately showed the pipeline operation's income and expenses after purchase.

Did prior audits lock in the old 2% lease-tax rate? No. The fact that prior audits did not question the payments did not prevent a later assessment.

When would tax on a taxable installment sale be due? Under the seller's sales-tax accounting method unless the financing arrangement described in Rule 3.294(f)(3)(B) applied.

Citations and references

• Hutchins v. Masterson — three-part fixture test quoted in the letter.
• Texas Attorney General Opinion M-298 — pipeline-classification factors quoted in the letter.
• 34 Tex. Admin. Code Rule 3.316(d)(3) — identifiable-segment occasional sale.
• 34 Tex. Admin. Code Rule 3.294(f)(3)(B) — tax timing identified in the letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8608L0751B04

Original ruling text

August 12, 1986

Dear **:

Thank you for your letter dated July 23, 1986 the lease and subsequent sale of
a pipeline by your company, ** (COMPANY).

COMPANY and affiliated companies are in the business of oil and gas exploration
and production, natural gas processing and marketing, and crude oil marketing.

We were making lease payments under a lease purchase agreement on a pipeline
from one of our plants to a nearby plant operated by non-affiliated company. In
early 1983, we exercised an option to buy the pipeline. Shortly thereafter, we
sold the pipeline to the other company on an installment sale basis, with
payments computed as a percentage of our charge to the purchaser for
transporting their fractionated product from our gas processing plant to their
plant.

Questions:

1. Would the sale of the pipeline be exempt from sales tax as a sale of real
   property vs. tangible personal property?

Answer: A pipeline in place generally qualifies as a sale of real property.
Where the status of property is doubtful, it is permissible for the parties by
agreement to impress it with the character of so long as the agreement was
made in good faith. In the absence of such an agreement, the now classic
Hutchins v. Masterson decision is used to make the determination.

"It is said, the weight of modern authorities establish the doctrine that the
true criterion for determining whether a chattel has become an immovable
fixture, consists in the united application of the following tests:

"1st. Has there been a real or constructive annexation of the article in
question to realty?

"2nd. Was there a fitness or adaptation of such article to the uses or purposes
of the realty with which it is connected?

"3rd. Whether or not it was the intention of the party making the annexation
that the chattel should become a permanent accession to the freehold? - (a)
this intention being inferable from the nature of the article, (b) the relation
and situation of the parties interested, (c) the policy of the law in respect
thereto, (d) the mode of annexation and purpose or use for which the annexation
is made."

Attorney General Opinion M-298 discusses the sale and or rental of a pipeline
and states in part,

. . . The character of the property should also be determined from the
intention of the parties . . . which may be ascertained from deciding whether
the pipeline has: e.g., (1) a long useful life; (2) a relatively high initial
investment which can only be recouped from prolonged usage of the pipeline; (3)
an appreciable amount of cost and labor to insure a long useful life . . .; (4)
whether the pipeline increases the property value for Ad Valorem Tax purposes;
(5) and after the pipeline is no longer used, whether it is left in the ground
or extracted.

The answer to these questions will make the determination on personalty v.
ready.

2. The provisions of the lease-purchase agreement under which we were leasing
   the pipeline required the company to treat the property as personal property.
   Sales tax was paid on the lease payment. Does this have any impact on our
   subsequent sale of the pipeline?

Answer: Same as one.

3. Since we are not in the business of selling tangible personal property
   subject to sales tax, could this transaction be excluded from tax as a casual
   sale?

Answer: The sale may qualify under the occasional sale provision as an
identifiable segment, if income and expenses attributable to the operation of
the pipeline after the purchase, are discernible from your books and records.
See Rule 3.316 (d)(3).

4. If, in your opinion, the transaction is taxable, would tax be due only on
   the payments received during the year or is the full amount of tax due in the
   year of sale?

Answer: If the transaction is taxable then tax would be due and payable based
on the seller's accounting method for sales tax, unless it was sold via a
financing base executed after October 2, 1984. See Rule 3.294 (f)(3)(B).

Another issue is the proper sales tax rate to us on lease payments. As noted in
question 2 above, we have been paying tax to the State on lease purchase
arrangements which specify the property is to maintain its character as
tangible personal property. The leases were executed in 1967 when the tax rate
was 2%. We understand there was an informal arrangement with the State to pay
only 2% tax for the term of the lease, but we have been unable to find any
documentation.

These lease payments and the accrual of the tax have been the subject of prior
audits by the State. Does that indicate any precedence on the part of the State
in approving use of the 2% tax rate?

Answer: Without having full details of the transaction I would have to say that
the tax rate should have accelerated with the law changes barring any prior
contract limitations provided for by the legislators with each change. Simply
because these payments were not questioned in the prior audits does not
preclude the state from now accessing the tax.

When we exercised our option to buy the pipeline under the lease purchase
agreement, we paid 4% tax on the option price. Was that in error?

Answer: If only state tax was legally due on the lease of the pipeline then
only 4% tax was due on the purchase.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

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,

F. Wayne McDonald
Tax Policy Section
Tax Administration Division

cc: **