Do compressors used in oil and gas processing qualify for Texas's manufacturing exemption, and how does a company refund sales tax collected in error on exempt equipment?

Plain-English summary

A company that leases compressors to oil and gas customers asked the Comptroller two things: how to get a refund for tax collected in error, and whether its leased compressors qualify for a manufacturing/processing exemption.

Refund procedure: the company should get a letter requesting exemption and a completed exemption certificate from the lessee, then either refund the tax directly (or credit the lessee's account with their written consent), amend prior returns, or take credit on future returns. Local tax credits must correspond to the same local jurisdiction reported on the original return. If a direct refund/credit isn't possible, the company can assign the refund to the customer using a Vendor's Request for Refund and Assignment of Right to Refund, with the customer then requesting the refund directly, supported by a signed letter and invoice schedule.

Compressor exemption: effective January 1, 1995, a manufacturer or processor can claim exemption on machinery/equipment (including air compressors) necessary and essential to manufacturing, processing, fabricating, repairing, or rebuilding products for sale, plus exempt repair/maintenance services and equipment leased under a one-year-or-longer operating lease. Applying that to oil and gas compressors: compression equipment necessary to operate field dehydrators, heater treaters, separators, and scrubbers is processing equipment and qualifies, as do compressors used to compress already-processed, soon-to-be-sold gas to required pressure before it enters a sales line. But compressors in the field used only to boost the gas stream's pressure to get it to the plant are transportation equipment, not processing equipment, and don't qualify regardless of who owns the gas. If a compressor becomes a permanent improvement to realty (installed with anchor bolts, etc.), it stops being tangible personal property and becomes real property -- losing the exemption entirely, including for repair/remodeling services. The letter also covers Texas tax on leased equipment used outside the state: tax is due on the full lease term if delivery happens in Texas, but renewals/extensions exercised while the equipment is outside Texas aren't taxed (per Rule 3.294(f)(1)) unless the property re-enters the state, and no Texas tax applies if the equipment is delivered outside Texas by the company's own trucks or a common carrier.

What this means for you

Oil and gas companies and equipment lessors

Whether your compressor is exempt depends on its actual function: compressors running processing equipment (dehydrators, separators, scrubbers) or pressurizing already-processed gas for a sales line are exempt; compressors that just move gas toward the plant are taxable transportation equipment. Once equipment is permanently affixed to realty, it loses exemption eligibility entirely.

Businesses seeking a sales tax refund on exempt equipment

Follow the documented process: obtain an exemption certificate from the lessee, then refund/credit directly, amend returns, or assign the refund via the Vendor's Request for Refund and Assignment of Right to Refund form, sending requests to the Credits Verification Section, Revenue Accounting Division.

Accountants and tax professionals

Note the sharp functional line the Comptroller draws between "processing" and "transportation" equipment in the oil and gas context, and the separate real-property trap once equipment is permanently installed.

Common questions

Q: Are all compressors used in oil and gas operations tax-exempt?
A: No. Per this letter, only compressors used directly in processing (e.g., running dehydrators/separators/scrubbers, or compressing sale-ready gas to line pressure) qualify; compressors that merely move gas toward the plant are taxable transportation equipment.

Q: Does a compressor stay exempt once it's bolted into a permanent foundation?
A: No -- per this letter, once installed as a permanent improvement to realty, it becomes real property and no longer qualifies for the exemption, including for repair services.

Q: Is tax due on leased equipment used outside Texas?
A: Per this letter and Rule 3.294(f)(1), tax applies to the full lease term if the lessee took delivery in Texas, but renewals/extensions exercised while the property is outside Texas are not taxed unless the property re-enters the state; no tax applies if delivery itself occurs outside Texas.

Citations and references

Rules:

• 34 Tex. Admin. Code Rule 3.294(f)(1) (tax on leased equipment used outside Texas)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9702256L

Original ruling text

February 13, 1997

Dear **:

Thank you for your letter of February 5, 1997. You asked that we address the
procedures for issuing a refund of taxes and the taxability of compressors you
lease to customers.

Your company should obtain a letter requesting the exemption and a properly
completed exemption certificate from the lessee. You may then refund the tax
collected in error; or, with the lessee's written consent, credit the tax due
to their account. You may then either amend the previous reports on which the
tax was reported and paid; or, you may take credit on future returns by
reducing the amount of taxable sales. You may take credit for local taxes as
well, but the credit taken on the future returns must correspond to the local
juridictions reported on the original return.

If you are unable to refund your customer directly or credit their account, you
may assign the refund to your customer by completing the attached Vendor's
Request for Refund and Assignment of Right to Refund. If this method is
chosen, your customer would request the refund from us by mailing the refund
assignment and a signed letter stating the grounds upon which the claim is
founded and the amount of the refund requested, and scheduled invoice
information providing the same data as the enclosed sample schedule. You must
provide the invoice information as the assignment form states. We may request
additional information or documentation at a later date to determine the
validity of your request.

Please send all sales tax refund requests to the following address:

Credits Verification Section
Comptroller of Public Accounts
Revenue Accounting Division
P.O. Box 13528
Austin, Texas 78711-3528

Effective January 1, 1995, a manufacturer or processor may claim an exemption
from state and local taxes when buying machinery and equipment that is
necessary and essential to and used directly in manufacturing, processing or
fabricating, or repairing or rebuilding products that will be sold. This
includes air compressors used to run manufacturing or processing equipment.
That means a manufacturer or processor may also claim an exemption on taxable
services, such as maintenance, repair, restoration or remodeling of the exempt
equipment. The exemption applies to equipment leased under the terms of an
operating lease for period of one year or more.

Therefore, compressors will qualify for exemption if used directly in
processing oil or gas that will be resold, or if it is required by law or
regulation to control pollution that results directly from the activity of
processing oil or gas that will be resold. Replacement parts for and labor to
repair qualifying machinery or equipment also qualify for exemption. We have
developed the following guidelines regarding compressors used in the oil and
gas industry:

Compression equipment necessary for the operation of field dehydrators, heater
treaters, separators and scrubbers are considered processing equipment.
Therefore, compressors used in connection with this equipment qualify for the
manufacturing exemption. Also, compressors used by your customer, to compress
processed gas he owns and is selling, to a required pressure prior to entering
a sales line qualify for the exemption. However, compressors in the field that
are used to increase the pressure of the gas stream to get it to the plant are
considered transportation equipment, not processing equipment, and therefore
they do not qualify regardless of ownership of the gas.

Once installed as a permanent improvement to realty, machinery or equipment,
such a compressor, is no longer tangible personal property; it is real
property. The exemption I mentioned earlier for repair, remodeling or
restoration services does not extend to services performed on realty.

Regarding the equipment you lease that is used outside of Texas, 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. Any renewal of the contract, extensions, or options exercised while the
tangible personal property is outside the state will not be subject to Texas
tax unless the property reenters the state. Please refer to Subsection (f)(1)
of Rule 3.294.

If you deliver the leased equipment outside of Texas by means of your delivery
trucks or deliver the equipment to a common carrier for delivery outside of
Texas, Texas tax is not due on the lease.

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

You may call me toll free at 1-800-531-5441, ext. 5-0037. The direct line is
512/475-0037. You also may write to Sales Tax Policy Division, Comptroller of
Public Accounts.

Sincerely,
Lindey Osborne
Sales Tax Policy Division