Does a directional drilling company have to collect Texas sales tax on its services to well owners?

Subject

Directional Drilling Services For Well Owners: Taxable Service Or Equipment Rental?

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9308138L

Plain-English Summary

An accountant wrote to the Comptroller on behalf of a client who is a directional drilling company (DDC). Well owners hire the DDC to directionally drill their wells: the well owner tells the DDC where the well should be drilled, and the DDC takes over figuring out the optimal method for drilling the path to that specified location. The DDC supplies both the necessary equipment and the contract labor, and it purchases and manufactures its own equipment (paying sales tax on that equipment as it acquires it). The DDC bills its clients one daily rate covering everything.

The letter asked whether the DDC should collect sales tax from well owners, given that it plans how a well is drilled but not where it is drilled, and whether it could use a resale certificate if it broke its bill into a separately stated, taxed equipment-rental line.

The Comptroller's response draws a line between two scenarios:

• Nontaxable service: if the DDC plans and performs the engineering and planning needed to give the well owner a drilling guideline, provides all necessary equipment and personnel for the drilling, controls when the specialized equipment is attached to the drill pipe, and monitors the drilling's progress to ensure it complies with the original guidelines, then the DDC is performing a nontaxable service — even though it does not decide where the well is drilled. Sales tax is instead due, at the time the DDC buys, leases, or rents the drilling equipment, on that equipment. For equipment the DDC builds itself, tax is due on the materials, supplies, and equipment used to construct it (but not on the employee labor used to construct it).
• Taxable equipment rental: if instead a well owner contracts with the DDC just to provide a DDC supervisor and DDC tools at a well site for a specified period to advise the well owner during drilling — where the supervisor may monitor the DDC equipment's performance against the well owner's own plan but only acts in an advisory capacity — that is a taxable rental of equipment. In that case the DDC collects tax on the rental of the equipment and can issue resale certificates to its own suppliers for the equipment (or materials to construct it) used exclusively in that advisory arrangement.

As with other letters of this kind, the Comptroller notes the opinion is based on the facts presented, and that other, similar facts might produce a different result.

What This Means For You

Directional drilling companies and oilfield service providers. Whether your service is taxable turns on who is really in control. If you plan and perform the drilling engineering, supply your own equipment and crew, decide when specialized tools attach to the drill pipe, and monitor for compliance with the drilling plan, the letter treats that bundle of activities as a nontaxable service — regardless of whether the well owner (not you) picked the drilling location.

Watch how you pay tax on your own equipment. Even when your service to the well owner is nontaxable, this letter says sales tax is still due on the equipment you purchase, lease, or rent to perform that service, and — for equipment you build yourself — on the materials, supplies, and equipment used to construct it (though not on the labor of your own employees who build it).

Advisory-only arrangements are treated differently. If your arrangement with a well owner is limited to supplying a supervisor and tools in an advisory capacity — without your company controlling the drilling process itself — the letter treats that as a taxable equipment rental, meaning you must collect tax on the rental charge. The upside is that in that scenario you can issue resale certificates to your own suppliers for the equipment or construction materials used exclusively for that rental.

This letter turns on its specific facts. The Comptroller expressly says the opinion is based on the facts presented and that other, similar facts could produce a different result — so a contract structured differently from the one described here may not get the same treatment.

Q&A

Q: Does a directional drilling company have to collect sales tax from well owners for its drilling services?
A: Not if the company plans and performs the engineering and planning to provide a drilling guideline, provides all necessary equipment and personnel, controls when specialized equipment is attached to the drill pipe, and monitors the drilling's progress for compliance with the original guidelines — the letter treats that as a nontaxable service.

Q: Does it matter that the drilling company doesn't decide where the well is drilled?
A: No. The letter states that the fact the client does not plan where a well is to be drilled does not make this a taxable service or rental.

Q: If the drilling service itself is nontaxable, is any sales tax owed at all?
A: Yes. Sales tax is due, at the time of purchase, lease, or rental, on the drilling equipment used to perform the nontaxable service. For equipment the company builds itself, tax is due on the materials, supplies, and equipment used to construct it, but not on the employee labor used to construct it.

Q: What makes an arrangement a taxable equipment rental instead?
A: A taxable equipment rental occurs if a well owner contracts with the DDC to provide a DDC supervisor and DDC tools at a specified well site for a specified period to advise the well owner during drilling, where the supervisor (even if monitoring the DDC equipment's performance against the well owner's plan) acts only in an advisory capacity.

Q: In a taxable equipment rental arrangement, can the drilling company use a resale certificate with its own suppliers?
A: Yes. The letter states the company would collect tax on the rental of the equipment and would be able to issue resale certificates to its suppliers for the purchase, lease, or rental of (or materials to construct) the equipment used exclusively in that manner.

Q: Does this ruling apply to every directional drilling arrangement?
A: No. The letter states the opinion is based on the facts presented, and that other facts, though similar, may provide a different result.

Original ruling text

August 27, 1993

Dear Mr. **:

This is in response to your letter requesting a ruling on the taxability of
your clients services.

FACTS

Your client is a directional drilling company (DDC) who is hired by well owners
to directionally drill their wells. The well owner instructs the DDC as to
where the well is to be drilled. The DDC then takes control over determining
the optimal method for drilling the path as specified by the well owner. The
DDC provides the necessary equipment as well as the required contract labor.

The DDC both purchases and manufactures its own equipment, while paying the
appropriate sales tax, for use on such jobs. It bills its clients based on one
daily rate which is totally inclusive of all services rendered.

QUESTION

Should the DDC collect sales tax from the well owners for remittance to the
State of Texas? The DDC does not plan where a well is to be drilled, but does
plan how a well is to be drilled. Can the DDC obtain a resale certificate if it
chooses to break down its bill to show rental of equipment separately and
collects tax on that portion of the bill?

RESPONSE

Your client is performing a nontaxable service if it:

plans and performs the engineering and planning required to provide a
drilling guideline for the well owner,

provides all necessary equipment and personnel for the drilling,

controls when the specialized equipment is attached to the drill pipe, and

monitors the progress of the drilling to ensure compliance with original
drilling guidelines.

The fact that your client does not plan where a well is to be drilled does not
make this a taxable service or rental.

Sales tax is due, at the time of purchase, lease or rental, on the drilling
equipment used by your client to perform a nontaxable service. For
self-constructed assets, tax is due on the materials, supplies and equipment
used to construct those assets. Sales tax would not be due on employee labor
used to construct the asset.

A taxable equipment rental occurs if a well owner contracts with a DDC to
provide a DDC supervisor and DDC tools to be at a specified well site for a
specified period of time to advise the oil and gas company during the
directional or horizontal drilling phase. The DDC supervisor might also monitor
the performance of the DDC equipment to ensure it is performing in a manner
according to the plan developed by the well owner, however, the supervisor
provided with the equipment only acts in an advisory capacity. If your client
contracts for this type of service with a well owner, it would collect tax on
the rental of the equipment and would be able to issue resale certificates to
its suppliers for the purchase, lease or rental of (or materials to construct)
the equipment used exclusively in this manner.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

If you have other questions or need more information, you may call me at
1-800-531-5441, extension 3-4502. The regular number is 512/463-4502. You may
also write to Tax Administration Division at the above address.

Sincerely,

Gilbert Zamora
Tax Administration Division

August 10, 1993

Comptroller of Public Accounts
State of Texas
Sales Tax Division
Austin, TX 78774

Dear sir or madam:

One of my clients is a directional driller who provides services as detailed
below. There has been much confusion in this area as to what is and is not
subject to sales tax in the State of Texas. I hope you can provide a definitive
answer with regard to the specific facts as pertaining to my client such that
we are in compliance with the law.

The company in question is hired by well owners to directionally drill their
wells. The well owner instructs the company as to where the well is to be
drilled. The company then takes control over determining the optimal method for
drilling the path as specified by the well owner. The company provides the
necessary equipment as well as the required contract labor.

The company both purchases and manufactures its own equipment, while paying the
appropriate sales tax, for use on such jobs. It bills its clients based on one
daily rate which is totally inclusive of all services rendered.

Should the directional drilling company collect sales tax from the well owners
for remittance to the State of Texas? The company does not plan WHERE a well is
to be drilled, but does plan HOW a well is to be drilled. Can the company
obtain a resale certificate if it chooses to breakdown its bill to show rental
of equipment separately and collects tax on that portion of the bill?

Thank you for your time in reviewing this situation.