Is electricity used to dig a flood-drainage tunnel and haul the dirt and rock to the surface exempt from Texas sales/use tax under the gas-and-electricity extraction exemption?

Subject

Tunnel For Flood Drainage Construction — Electricity Used In Digging Out And Transporting Dirt And Rocks To Surface Is Not Exempt

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9307L1250A01

Plain-English Summary

This letter (dated July 19, 1993) tells a taxpayer that the Comptroller's Taxability Response (TR) Committee reviewed a request for the gas-and-electricity extraction exemption and denied it. The taxpayer had contracted to construct a flood-drainage tunnel under the City of San Antonio — a federal and state drainage project supervised by the Corps of Engineers, 150 feet below ground and 24 feet in diameter — and used electrically powered equipment to dig out the tunnel and transport the dirt and rocks to the surface. The taxpayer argued this qualified for the exemption in Tex. Tax Code Sec. 151.317(c)(2)(A)(ii), which exempts gas and electricity used by a person "producing and transporting a material extracted from the earth."

The TR Committee disagreed. Because the taxpayer was acting as a contractor digging and removing material only as a necessary part of fulfilling a contract to improve real property (the drainage tunnel), the electricity was treated as a consumable supply used in improving realty rather than as electricity used in extracting a marketable material from the earth. The letter states the taxpayer "has not complied with Rule 3.291(b)(2); therefore, the contractor owes tax on the electricity." The letter also notes the writer had told the taxpayer's representative of this determination by phone earlier, apologizes for the delay in sending written confirmation, and says the Refunds Claims Section was notified of the determination so it could act on a refund request the representative had submitted on the client's behalf.

Attached to (and included with) the taxpayer letter are two other internal documents on the same issue:

1. A May 19, 1993 internal TR Committee memo ("TO TR Committee, FROM: Tax Administration Division, SUBJECT: Electricity Exemption") laying out the same facts and question, and reaching the same conclusion — the taxpayer is extracting and transporting material from the earth only as a necessary part of improving real property, the electricity is a consumable supply, Rule 3.291(b)(2) was not satisfied, and tax is owed. This memo bears the Taxability Response Committee's approval signatures (Wade Anderson, Assistant Director, Tax Administration; Martin Cherry, Chief General Law; Harold Lee, Manager, Audit Division; Joe Vogel, Assistant Manager, Audit Division).

2. A January 30, 1993 letter from the taxpayer's representative to Tom Poole, Assistant Manager, Tax Administration, requesting reconsideration of an earlier Comptroller letter issued January 24, 1992 by Al Van Allen, which had denied the exemption on the theory that the Legislature "intended" to limit the gas-and-electricity exemption to "mining." The representative's letter — the facts described are "Taxpayer uses equipment to break up compacted dirt in the ground into loose dirt and transports the loose dirt elsewhere" — argues at length that the statutory text of Sec. 151.317 and Rule 3.295 is unambiguous and covers "exploration for, or producing and transporting, a material extracted from the earth" without a "mining" limitation, citing Tex. Gov't Code Sec. 312.002(a) (plain-meaning canon), the original 1961 statute (TEX TAX -- GEN ART 20.04(1)) and 1961 Comptroller Ruling No. 12's definition of "mining," a 1963 Texas Commission on State and Local Tax Policy report, and two Texas appellate decisions (Matthews Construction Co., Inc. v. Jasper Housing Construction Co., 528 S.W.2d 323 (Tex. Civ. App.-Beaumont 1975); Ely v. State, 582 S.W.2d 416 (Tex. Crim. App. 1979); State v. Arkansas Dock & Channel Co., 365 S.W.2d 220 (Tex. Civ. App. 1963)). Despite this reconsideration request, the ultimate outcome recorded in this same document (the May 1993 memo and July 1993 letter) confirms the exemption was denied — though on the narrower "improving realty" rationale (the contractor's tunnel-digging activity was incidental to a real-property-improvement contract) rather than the "mining" rationale the representative's letter had argued against.

A closing note on the document reads: "NOTE: Previous Accession Number 9308052L.9 and/or 9308052L," indicating this document supersedes or cross-references an earlier-numbered accession.

What This Means For You

Digging as part of a construction contract is not the same as "extracting a material from the earth" for exemption purposes. The gas-and-electricity exemption in Sec. 151.317(c)(2)(A)(ii) is aimed at producing and transporting a material extracted from the earth (the letter's underlying policy area is materials like oil, gas, and other extracted resources). Where a contractor digs a tunnel, removes dirt and rock, and transports it to the surface only as a necessary step in building something (here, a flood-drainage tunnel to improve real property), the Comptroller treats the electricity used as a taxable consumable supply used to improve realty — not as electricity used in an exempt extraction activity.

Contractors doing excavation for construction projects should not assume the extraction exemption applies. If your business excavates or removes earth/rock as part of a construction, drainage, tunneling, or similar real-property-improvement contract, this letter indicates the Comptroller will look at whether the digging is incidental to improving real property (taxable) versus a genuine extraction-for-production activity (potentially exempt). Compliance with Rule 3.291(b)(2) is specifically called out as a requirement the taxpayer here failed to meet.

The "mining" argument didn't carry the day, but a different rationale did. The taxpayer's representative made a detailed legal argument that the exemption's "producing and transporting a material extracted from the earth" language is not limited to activities that fit the ordinary meaning of "mining," pointing to oil, gas, and water extraction as examples the Comptroller had already treated as exempt without being "mining" in the ordinary sense. The Committee's ultimate written determination in the May 1993 memo and July 1993 letter does not rely on the mining/non-mining distinction the representative's letter rebuts — instead it denies the exemption because the digging was incidental to a real-property-improvement contract. Businesses should read Comptroller determinations carefully for the actual stated rationale, since it may differ from an earlier or superseded letter's reasoning on the same facts.

A refund claim was pending when this letter was sent. The July 19, 1993 letter states the writer notified the Refunds Claims Section of the TR Committee's determination "and requested that they take appropriate action on the refund request" the representative had submitted on the client's behalf — meaning this letter's denial of the exemption would also have been used to resolve that specific refund request.

Q&A

Q: Does electricity used to dig a tunnel and remove dirt/rock qualify for the Sec. 151.317(c)(2)(A)(ii) gas-and-electricity exemption?
A: Not in this case. The Comptroller determined that a contractor building a flood-drainage tunnel is not entitled to the exemption on electricity used in digging the tunnel, because the contractor was extracting and transporting material from the earth only as a necessary part of fulfilling a contract to improve real property.

Q: Why was the exemption denied if the taxpayer was clearly extracting material from the earth?
A: The letter explains that the electricity is treated as a consumable supply used by the taxpayer in improving the realty (the tunnel), rather than as electricity used in producing and transporting a material extracted from the earth for its own sake. The taxpayer also had not complied with Rule 3.291(b)(2).

Q: What was the underlying construction project?
A: A flood-drainage tunnel constructed under the City of San Antonio as part of a federal and state drainage project supervised by the Corps of Engineers. The tunnel was 150 feet below ground level and 24 feet in diameter, and the taxpayer used electrically powered equipment to dig it out and transport the dirt and rocks to the surface.

Q: What argument did the taxpayer's representative make in the January 30, 1993 reconsideration letter?
A: The representative argued the exemption statute (Sec. 151.317) and Rule 3.295 are unambiguous and cover "exploration for, or producing and transporting, a material extracted from the earth" without a judicially-invented "mining" limitation, citing the plain-meaning canon in Tex. Gov't Code Sec. 312.002(a), the 1961 predecessor statute, a 1961 Comptroller ruling defining "mining," a 1963 legislative-policy-commission report, and several Texas court decisions.

Q: Did the reconsideration request succeed?
A: The exemption was still denied, but based on a different rationale than the "mining" theory the representative's letter argued against — the May 1993 internal memo and July 1993 taxpayer letter both deny the exemption because the digging was incidental to a contract to improve real property, and because Rule 3.291(b)(2) was not satisfied.

Q: Who approved the Comptroller's determination?
A: The May 19, 1993 internal memo shows Taxability Response Committee approval from Wade Anderson (Assistant Director, Tax Administration), Martin Cherry (Chief General Law), Harold Lee (Manager, Audit Division), and Joe Vogel (Assistant Manager, Audit Division). The taxpayer letter was signed by Mona Ezell Shoemate, Tax Administration.

Original ruling text

July 19, 1993

Dear ***:

The Taxability Response (TR) Committee has reviewed the information
you submitted concerning the exemption for gas and electricity used
in extracting materials from the earth and approved the attached response
on the issue.

The TR Committee determined that a taxpayer that contracts to
construct a flood drainage tunnel is not entitled to the exemption
on its purchases of electricity used in digging the tunnel. The
taxpayer is acting as a contractor and is extracting and
transporting material from the earth as a necessary part of
fulfilling its contract to improve realty.

The electricity is a consumable supply used by the taxpayer in
improving the realty. The taxpayer has not complied with Rule
3.291(b)(2); therefore, the contractor owes tax on the electricity.

I apologize for the delay in sending you this written verification
of our telephone conversation and appreciate your patience. I have
notified the Refunds Claims Section of the TR Committee's
determination and requested that they take appropriate action on the
refund request you submitted on behalf of your client. If you have
any questions or need more information, please call me.

Sincerely,

Mona Ezell Shoemate
Tax Administration

May 19, 1993

TO TR Committee

FROM: Tax Administration Division

SUBJECT: Electricity Exemption

Facts: Taxpayer contracted to construct a flood drainage tunnel
under the City of San Antonio. This is a federal and state
drainage project with supervision by the Corps of Engineers. The
tunnel will be 150 feet below ground level and 24 feet in diameter.
The taxpayer uses electrically powered equipment to dig out this
tunnel and transport the dirt and rocks to the surface. The
taxpayer wishes to claim the exemption for electricity in Sec.
151.317(c)(2)(A)(ii) for producing and transporting a material
extracted from the earth.

Question: Does the taxpayer qualify for the exemption in Sec.
151.317(c)(2)(A)(ii)?

Response: The taxpayer is acting as a contractor and is extracting
and transporting material from the earth as a necessary part of
fulfilling its contract to improve real property. The electricity
is a consumable supply used by the taxpayer in improving the realty.
The taxpayer has not complied with Rule 3.291(b)(2); therefore, the
contractor owes tax on the electricity.

Taxability Response Committee Approval:

Wade Anderson
Assistant Director, Tax Administration

Martin Cherry, Chief General Law

Harold Lee, Manager, Audit Division

Joe Vogel, Assistant Manager, Audit Division

January 30, 1993

Mr. Tom Poole
Assistant Manager
Tax Administration
Comptroller of Public Accounts
P O Box 13528
Austin, TX 78711

Dear Tom

On January 24, 1992 Mr. Al Van Allen issued the attached letter on
the gas and electricity exemption. My client asked me to review the
letter based on my research, I believe the letter to be legally
unsupportable. Therefore, I respectfully request that the letter
opinion be reconsidered

The basic facts are

Taxpayer uses equipment to break up compacted dirt in the ground into
loose dirt and transports the loose dirt elsewhere

The legal/factual question is

Does the above described activities constitute production or
transportation of material extracted from the earth?

TEX TAX CODE Section 151.317 exempt from the sales and use tax gas
and electricity used by a person engaged in exploring for, or
producing and transporting, a material extracted from the earth."
Sales Tax Rule 3.295 describes the exempt activities as "exploration
for or production or transportation of material extracted from the
earth."

Essentially the January 24, 1992 letter says the exemption does not
apply because the state legislature "intended" to limit the exemption
to "mining." On page two, the first sentence begins," While the
Comptroller has extended the meaning of 'mining'."

While I may understand the Tax Administration Section's desire for the
opinion given. I strongly disagree With the letter based on the following
reasons:

(1) WORDS IN A STATUTE ARE TO BE GIVEN THEIR ORDINARY MEANING THIS
LEGAL PRINCIPLE HAS BEEN CODIFIED IN gov't code section 312.002(a).

The ordinary meaning of both the statutory and rule language differ from the
ordinary meaning of the word mining. Examples of materials extracted from
the earth (i) to which the gas and electricity exemption has been applied by
the Comptroller's Office both (ii) that are not mined in the ordinary sense
include the following: Oil is not mined. Gas is not mined. Water is not
mined from a lake. Pumping salt water from the earth is not mining.

Furthermore, the Comptroller's Office has allowed persons engaged in simple
transportation of materials extracted from the earth to quality for the
exemption. Transportation alone of any material would not quality as mining
in its ordinary sense.

(2) CLEAR, UNAMBIGUOUS STATUTORY LANGUAGE MUST BE GIVEN EFFECT ACCORDING TO
ITS TERMS. Matthews Construction Co., Inc. v. Jasper Housing Construction
Co., 528 S.W. 2d 323 (TX Civ. App-Beaumont, 1975).

Personally, I find the statute language unambiguous. If the Tax
Administration Section believes the statutory language is ambiguous, I
would appreciate some examples of the ambiguity.

Please Note: Only if the statutory language is ambiguous is legislative
intent appropriate in order to interpret a statutory provision.

(3) IF THE STATUTORY LANGUAGE IS AMBIGUOUS, LEGISLATIVE INTENT IS ONLY ONE
METHOD OF CONSTRUING THE LANGUAGE.

THE CASE OF ELY V. STATE, 582 S.W. 2D 416 (TX CR APP 1979) SAYS:

In absence of special definitions, statutory language under attack as
vague can be measured by common understanding and practices or construed
in sense generally understood.

(4) IN DECIDING ON LEGISLATIVE INTENT, THE CONTEMPORANEOUS HISTORY IS TO BE
EXAMINED. State v. Arkansas Dock & Channel Co, 365 S.W. 2d 220 (TX Civ App
1963), writ ref'd n.r.e., Austin v. Collins, 200 S.W. 2d 666 (TX Civ App
1947), writ ref'd n.r.e.

The original (1961) sales tax statute exempted gas and electricity used in
"mining" TEX TAX -- GEN ART 20.04(1). Using the legal principle set forth
in item (10--using the ordinary meanings of statutory language--the then
Comptroller issued Ruling No. 12 on August 30, 1961. Ruling No. 12
contained the following definition of "mining".

(b) Mining "Mining" shall mean the process or business of extracting from
the earth the precious or valuable metals, either in their native state
or in their ores. The term does not include the extraction from the
earth of rock, marble, or slate, which is common described as "quarrying"
although coal and salt are' "mined" nor does it include sinking wells or
shafts for petroleum or natural gas.

The Comptroller's MIS contains a copy of a memorandum from an
unidentified source on why the "Comptroller's Ruling No. 12 was wrong on
the definition of mining (61001L0120B11). The memorandum attempts to
graft judicial interpretations of other statutes as to the oil and gas
industry onto the sales tax exemption.

Court action had been initiated challenging the Comptroller's
interpretation of mining.

It was against this background of administrative interpretation of and
judicial challenge to denying the exemption to the oil and gas industry
that the Texas Commission on State and Local Tax Policy issued its report
in 1963. On the mining issue, the Commission specifically counters the
Comptroller's Ruling No. 12. On page 20 of the report, the Commission
writes:

The Commission believes that the term "mining" was intended to cover
the exploration for and production of oil and gas and that quarrying
would be considered as a form of mining although there is a technical
and legal difference between the two.

Mr. Van Allen says the Commission was formed with a "view to making
recommendations for clarifying the language for certain provisions of
the Act." (page 1 of letter) Actually the Commission said it was
recommending a number of substantive changes in the Limited Sales Tax
statute, but considering the number of provisions in the law, these do
not add up to anything like a complete rewriting of the statue. The
Commission feels, however, that members of the Legislature will be
able to evaluate these proposals better if they are introduced in the
form of a complete amendment of the statute. (pages 7 & 8 of report)

But yes, the Commission did say in the section on the exemption that the
suggested change was a clarification. The Commission also said the court
challenges were to clarify the statute. (page 20 of report) As a person
who has drafted legislation for over 20 years, I know that substantive
changes are quite often labeled "clarifications" to make the changes more
palatable or obscure (depending on the nature of the change). Also as an
attorney, I would articulate inquiries about a provision to the
Comptroller as an attempt to seek "clarification". By the time a court
suit is filed, there usually are opposing points of view. A court suit is
to have a judge or judge and jury decide which point of view prevails.

And yes, the Commission did say its changes to 20.04(Q) would be revenue
neutral. Looking to the total scope of the recommendation (pages 20 & 21 of
report), the recommendation may well be revenue neutral. Besides changing the
mining provision, the Commission recommended substituting "processing tangible
personal property for sale as tangible personal property" for the word
"industrial" (page 57 of report) The broadening of the exemption from just
"mining' would be revenue negative; the narrowing of the exemption from
"industrial" use would be revenue positive.

In summary, the "clarification" (if one wishes to use such a euphemism) was to
"clarify" that the oil and gas industry would get the exemption it had been
denied.

(5) THE INTENT OF THE DRAFTER OF LEGISLATION IS NOT PROOF OF THE INTENT OF THE
LEGISLATURE IN PASSING THE LEGISLATION.

This axiom should be self-evident. As a drafter of legislative bills, I would
never consider my knowledge and what I intend for certain words to mean to be
what one state legislator much less the whole legislature intends for the words
to mean.

The Comptroller's office is fond of using the terminology that an activity is
once removed from that allowing an exemption. The analogy of the Commission
report would be that the report is at least once removed from the intent of the
legislature. The Commission was not the legislature.

(6) THE LONG STANDING ADMINISTRATIVE INTERPRETATION SINCE 1963 IS CONTRARY TO
THAT EXPRESSED IN THE LETTER. As noted in item 1, the Comptroller had long
held activities to trigger the exemption which could not possibly be considered
mining as the term is commonly understood. Since 1963, the Comptroller's
office has consistently interpreted the statutory language as it existed, not
as it existed prior to the 1963 exemption. In fact, after extensive research,
I have found no other Comptroller's document that contains the "mining"
interpretation.

Logically, if the legislative intent was to limit the exemption to "mining", it
would not have amended the statute.

Also, if in fact, the legislative intent was to limit the exemption to mining,
all the Comptrollers since 1963 have violated the legislative mandate

SUMMARY

In summary, I submit:

1. The statutory language is clear and must be administered by the common
   meanings of the words.

2. There exists no legal justification for even using the 1963 Texas
   Commission report to construe the statutory language.

3. Even if legislative intent were relevant, the obvious facts are that the
   Comptroller had denied the exemption to oil and gas industry, there was much
   opposition to the Comptroller's interpretation, there was a court challenge to
   the Comptroller's interpretation, and that the Commission's recommended changes
   were substantive regardless of how the report may have tried to sugarcoat the
   recommendations. If legislative intent could even really be proven, it would
   in all probability be to insure the oil and gas industry received the exemption
   it had been denied. It was the legislative intent to broaden the exemption
   from mining.

4. The long standing administrative interpretation of this provision does not
   equate the statutory language with the word mining.

5. It is a difficult proposition to sell that after 30 years of contrary
   interpretation of this exemption by all the Comptrollers since 1963, the Tax
   Administration Section has now discovered the "legislative intent" behind the
   exemption.

As I said earlier in my letter, I do understand the Section's desire for the
letter opinion, but legally it has no foundation.

NOTE: Previous Accession Number 9308052L.9 and/or 9308052L