If a company leases drilling tools that are delivered to and picked up in Texas, but then actually used at drilling sites in another state (New Mexico), does the lessee owe Texas sales tax on the lease charges?

Plain-English summary

This letter responds to a refund request from a company that leases tools — drill collars and subs — used in horizontal and directional drilling services. There was no written lease agreement; the lessor set minimum charges, a daily rate, and (in some cases) a cheaper monthly rate. The leased tools were picked up at the lessor's location by a common carrier and delivered to Odessa, Texas (the bill of lading showed delivery to a Texas location). From there, the lessee's own service vehicles carried the tools to drilling sites in New Mexico, where they were actually used, before being brought back to Texas and returned to the lessor. The lessee sought a refund of the Texas state and local sales tax it had paid on these leased tools, arguing they were really used in New Mexico.

The Comptroller denied the bulk of the refund. Under 34 Tex. Admin. Code § 3.294(f)(1)(A), an operating lease executed while the property is within Texas is subject to Texas sales tax on the total lease amount for the entire lease term, regardless of where the property is later used, if the lessee takes delivery in the state. Because the lessee took possession of the tools in Texas, the leases were taxable — including the minimum charges and the monthly-rate charges (the letter cites specific invoices, H28479, H28737, and H28539, billed at the monthly rate, as taxable fixed-term leases). The lessee owed 6.25% state sales tax and 1% Houston city sales tax on the minimum and monthly lease charges. The 1% Houston MTA (transit authority) tax did not apply because the tools were shipped by common carrier outside the Houston MTA boundaries. However, the lessee separately owed 0.5% Midland County use tax because of the delivery of the tools into that county, under 34 Tex. Admin. Code § 3.253(b)(1).

The rule does carve out one exception: additional charges tied to contract renewals, extensions, or options exercised while the property is outside Texas are not subject to Texas tax unless the property re-enters the state. The Comptroller found this could apply only to the additional daily charges (over and above the minimum charge) incurred while the tools were actually located in New Mexico — but the lessee bears the burden of overcoming a presumption that those charges are taxable. The invoices the lessee had submitted (its own invoices to its drilling customers for services performed in New Mexico) were not sufficient documentation, because they didn't show that the New Mexico drilling services actually used the specific tools leased from this lessor. The letter suggests that truck manifests or drilling service logs identifying the leased tools by serial number, showing they were taken to and used in New Mexico, would be the kind of documentation needed to support a refund on those additional daily charges.

What this means for you

Businesses that lease equipment for use across state lines

Where you take delivery of leased property controls Texas tax, not where you ultimately use it. If you (as lessee) take possession of leased tangible personal property in Texas — even if a common carrier's bill of lading is the only evidence of that Texas delivery — the lease is taxed in Texas for its full term, regardless of subsequent out-of-state use.

Oil and gas service companies leasing drilling tools

Minimum charges and monthly-rate lease charges tied to a Texas delivery are taxable in full. Only additional daily charges incurred while the equipment is verifiably located and used outside Texas may escape tax, and only if you can prove it.

Accountants and tax professionals preparing refund claims

A refund claim based on out-of-state use needs to overcome a presumption of taxability with specific documentation — truck manifests or drilling logs identifying the actual leased equipment by serial number and showing its location when charges were assessed. General invoices to the lessee's own customers describing services performed out of state are not enough, because they don't tie the specific leased items to that out-of-state use.

Businesses tracking local/MTA tax exposure

Local tax exposure can diverge: this lessee avoided the 1% Houston MTA tax because the carrier shipped the tools outside the Houston MTA, but still owed 0.5% Midland County use tax because delivery was made into that county. Check both the city/MTA and county tax rules separately.

Common questions

Q: If I lease equipment that's delivered to me in Texas but I only ever use it in another state, do I owe Texas sales tax?
A: Yes, generally. Under Rule 3.294(f)(1)(A), an operating lease executed while the property is in Texas is taxable on the full lease amount if the lessee takes delivery in Texas, regardless of where the property is subsequently used.

Q: Are the minimum and monthly lease charges taxable here?
A: Yes. The letter treats the minimum charges and the monthly-rate charges (invoices H28479, H28737, and H28539) as taxable fixed-term lease charges because the tools were delivered to, and possession taken in, Texas.

Q: Is any part of the lease charge potentially non-taxable?
A: Possibly — additional daily charges (beyond the minimum charge) assessed while the tools were actually located in New Mexico may not be subject to Texas tax, per the renewal/extension/option exception in Rule 3.294(f)(1)(A). But the lessee must overcome a presumption of taxability with adequate documentation.

Q: What documentation is needed to support a refund on those out-of-state daily charges?
A: The lessee's own invoices to its drilling customers were not sufficient because they didn't connect the specific leased tools to the New Mexico work. Truck manifests or drilling service logs identifying the leased tools by serial number, and showing they were taken to and used in New Mexico, would be adequate documentation.

Q: Did local taxes apply here?
A: The 1% Houston city/MTA sales tax was not due because the tools were shipped by common carrier outside the Houston MTA. However, 0.5% Midland County use tax was owed because the tools were delivered into that county.

Citations and references

Regulations:

• 34 Tex. Admin. Code § 3.294(f)(1)(A) (operating leases — tax on delivery within the state)
• 34 Tex. Admin. Code § 3.253(b)(1) (county use 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/9506L1350F08

Original ruling text

June 2, 1995

Dear **:

Thank you for your May 26, 1995, letter and our phone conversation concerning
the refund requested by **

Situation:

* leases tools (drill collars and subs) from your company that
are used in horizontal and directional drilling services that * provides.
There is no written lease agreement between the lessor (*) and lessee
(*). ** has set terms for leasing the tools. There is a minimum
charge even if the tools are leased for a day or two. There is also a daily
rate per tool that is leased. In some cases, customers choose to pay based on
your monthly rate on leases of tools because it is cheaper than paying the
daily rate on a certain number of days.

The leased tools are picked up at *'s location by a common carrier
(*, etc.) and then delivered to Odessa, Texas. The bill of
lading from the common carrier reflects a delivery to a location in Texas.
* has its service vehicles deliver the leased tools to drilling sites in
New Mexico. * then uses the tools to perform drilling services in New
Mexico. When the drilling services are completed, * brings the leased
tools back to Texas for return to *. ** is requesting a refund on
Texas state and local sales taxes paid on tools leased in Texas for use in New
Mexico.

Response:

The enclosed Rule 3.294(f)(1)(A) addresses operating leases subject to sales
tax in Texas. That section of the rule states:

An operating lease executed while the property is within the state is subject
to sales tax. Tax will be due on the total lease amount for the entire term of
the lease regardless of where the property is used if the lessee takes delivery
in the state.

Therefore, because * took possession of the leased tools in Texas, the
leases are taxable. The minimum charges and the monthly charges are taxable
fixed term leases. For example, invoices H28479, H28737, and H28539 are
taxable because the charges are based on a monthly rate. * owes 6.25%
state sales tax and 1% Houston city sales tax on the minimum charge for leased
tools and on any monthly charge for leased tools. The 1% Houston MTA is not
due on the lease if the tools are shipped by common carrier outside the Houston
MTA. However, ** would owe .5% Midland County use tax because of the
delivery of the leased tools to that county. See enclosed Rule 3.253(b)(1) on
county use tax.

However, Rule 3.294(f)(1)(A) also states:

Any renewal of the contract, extensions, or options exercised while the
tangible personal property is outside the state willnot be subject to Texas
tax unless the property reenters the state.

This provision would only be applicable to any additional daily charges (over
and above the minimum charge) while the leased tools are actually located in
New Mexico. * must overcome the presumption that these daily charges are
taxable by presenting documentation that the leased tools were taken to New
Mexico and were located in New Mexico when the additional daily charges were
assessed. * has sent you copies of invoices to their customers for
drilling services performed in New Mexico. However, these invoices do not show
that the services performed in New Mexico actually used the same tools leased
from **.

Therefore, the documentation (*'s invoices to their customers) is
insufficient to base a refund of Texas tax on the additional daily charges.
The invoices only show that * provides drilling services in New Mexico.
Copies of truck manifests or drilling service logs that describe the leased
tools (with the serial numbers) taken to New Mexico and used in New Mexico
would be examples of documentation needed by ** to overcome the presumption
that the additional daily charges are taxable.

This opinion is based on the facts you submitted. Other facts, though similar,
may yield different results.

You may call me toll free at 1-800-531-5441, ext. 5-0030. The direct line is
512/475-0030. You may also write to Tax Administration, Comptroller of Public
Accounts.

Sincerely,

David Somerville
Tax Administration Division

NOTE: Previous Accession Number 9506137L