Does Texas sales tax apply to a sale-leaseback financing of pipeline separators and meters that stay attached to an existing pipeline?

Plain-English summary

A company that had operated a natural gas transmission pipeline for many years wanted to raise financing by structuring a sale-leaseback of the "Pipeline Components" -- separators (tanks and piping bolted to concrete pads) and meters (steel brackets, valves, and sometimes electronic monitoring equipment) that were bolted onto the pipeline and had been in place roughly ten years. Under the deal, the company would "sell" these components to an unrelated lender for approximately their fair market value, then immediately lease them back for about 15 years, with an early buy-out option the company expected to exercise (since the components were integral to keeping the pipeline running). The components never moved -- they stayed attached to the pipeline throughout.

The Comptroller agreed with the taxpayer: this is a sale-leaseback of real property, not tangible personal property, so no Texas sales or use tax applies to either the initial "sale" to the lender or the lease-back to the pipeline owner. The reasoning relies on longstanding Comptroller policy that transmission pipelines are permanent improvements to real property no matter whether they sit above or below ground (TR 1241), and that attachments like separators and meters that are part of the pipeline share that same real-property treatment (Comptroller's Decision No. 30,668 and a series of older interpretive letters). Because the financing structure doesn't change what the components physically are or where they sit, the sale-leaseback doesn't create a taxable transaction.

What this means for you

Pipeline owners and oil & gas companies

If you're financing pipeline-attached equipment (separators, meters, valves, and similar components) through a sale-leaseback, and the equipment stays physically attached to a transmission pipeline throughout, Texas treats the whole arrangement as a real-property transaction exempt from sales and use tax -- the financing structure itself doesn't convert real property into a taxable sale of tangible personal property.

Accountants and tax professionals

The controlling question is whether the equipment is treated as part of the real property (the pipeline) under existing Comptroller policy, not how the financing is papered. A sale-leaseback of components that remain attached to a pipeline classified as real property carries that classification through both legs of the transaction.

Common questions

Q: Is a sale-leaseback of pipeline equipment automatically exempt from Texas sales tax?
A: Not automatically -- it depends on whether the equipment is treated as part of a real-property pipeline. In this letter, separators and meters attached to and part of the transmission pipeline qualified as real property under existing Comptroller policy, so the sale-leaseback wasn't taxable.

Q: Does it matter that the components will eventually be bought back?
A: The letter doesn't hinge the answer on the buy-out options -- the real-property classification of the attached components is what controls, regardless of the financing mechanics.

Q: What if the equipment isn't attached to a pipeline treated as real property?
A: This ruling is specific to components physically attached to and part of a transmission pipeline already classified as real property; equipment that isn't attached in that way could be analyzed differently.

Citations and references

Rulings and prior policy cited:

• TR 1241 (110891) (Fiche No. 1141A07) — main transmission lines are permanent real-property improvements regardless of above/below-ground placement
• Comptroller's Decision No. 30,668 (1993) and a series of prior interpretive letters (1985–1993) treating meters, valves, storage tanks, separators, and similar pipeline attachments as improvements to real property

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9807678L

Original ruling text

July 22, 1998

Dear **:

This is in response to your request for a written ruling regarding the
applicability of Texas sales and use tax to the transactions described below.
I have restated your fact situation and question below, followed by my
response:

Company A owns and operates a natural gas transmission pipeline that has been
in place for many years. Company A now plans to enter into a financing
arrangement with respect to separators and meters that are attached to and part
of the transmission pipeline and which, on average, have been in place for at
least 10 years (collectively, "Pipeline Components"). The separators are
comprised of tanks and piping that are attached to the transmission pipeline
and bolted to supports that are sunk into concrete pads adjacent to the
pipeline. The meters are comprised of steel brackets and valves that are
attached to the transmission pipeline, and may include electronic
communications equipment that transmits information regarding gas volume and
pressure to centralized control facilities. The Pipeline Components remain in
place attached to the transmission pipeline during the transactions described
below.

The financing arrangement involves an unrelated lender ("Lender") and is a loan
structured as a sale-leaseback. Under the terms of the sale-leaseback, Company
A will "sell" the Pipeline Components to the Lender for an amount ("Principal
Amount") approximately equal to the fair market value of the Pipeline
Components.

The sale is conditioned upon the Lender immediately leasing the Pipeline
Components back to Company A pursuant to a Lease Agreement ("Lease"). The Lease
will have a term of approximately 15 years. Company A continues to be
responsible for maintenance, property taxes and insurance on the Pipeline
Components. The Lease contains representations, warranties, covenants and
events of default commonly found in Company A's other credit agreements, such
provisions are not typically found in a true lease. The remedies available to
the Lender upon an occurrence and continuance of an event of default are those
which a typical secured creditor would have. The Lease also provides for the
creation and perfection of a security interest in the Pipeline Components in
favor of the Lender to secure the Lease payments and obligations.

Payments under the Lease, together with the amount payable pursuant to the
early buy-out option ("EBO"), 2 are calculated to repay the Principal Amount,
with interest, through the date the EBO is exercised. The interest rate is
determined based on Company A's long-term credit rating.

It is expected that Company A will exercise the EBO because the Pipeline
Components are integral to the transmission pipeline. In the unlikely event
that Company A fails to exercise the EBO by the end of the Lease term, Company
A could exercise a fixed buy-out option ("FBO"), which is not a nominal amount
and is more than the EBO, or could renew the lease for successive periods at a
fair market value rental.

In the unlikely event that Company A fails to exercise the EBO or FBO or renew
the Lease, the Lender would be permitted to remove the Pipeline Components from
the transmission pipeline.

Discussion

We submit that, for Texas sales and use tax purposes, the sale-leaseback of the
Pipeline Components constitutes a sale-leaseback of real property that is not
subject to Texas sales and use tax. In this connection, the separators and
meters are attached to and part of a transmission pipeline that is treated as
real property for Texas sales purposes pursuant to the policies set forth in TR
1241 (110891) (Fiche No 1141A07). TR 1241 provides that main transmission
lines are permanent improvements to real property without reference to where
such lines are above or below ground. The separators and meters are attached to
and part of the transmission pipeline and, therefore, are treated as
improvements to real property pursuant to the Comptroller's policies. See
Comptroller's Decision No. 30,668 (1993); Letter dated April 19, 1993 (Fiche
No. 1234F11) (meters, valves, storage tanks, separators, flow computer,
pressure tester, and gas sampler attached to and part of pipeline are
improvements to real property); Letter dated February l9, 1988 (Fiche No.
0862E06) (meters located on pipeline are part of real property). Letter dated
January 31, 1985 (Fiche No. 0646C1l) (manifolds, meter runs, cattle guards,
fire walls, culverts, pits and pipelines are treated as improvements to real
property).

Further, we submit that the financing arrangement does not affect the character
of the separators and meters, which have been in place and will remain in place
on the transmission pipeline, as real property. See Letter dated November 2,
1986 (Fiche No. 0787G02) and Memorandum dated November 25, 1986 (Fiche No.
0787E12).

We respectfully request that your office issue a written ruling confirming that
Texas sales and use tax will not apply to the sale-leaseback of the separators
and meters described above.

Response: The sale and subsequent lease-back of the transmission pipeline,
along with the Pipeline Components, qualify as the sale of real property.
Texas sales tax would not be due on the initial sale of the pipeline and
pipeline components to Lender, nor on the subsequent lease-back to Company A.

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

I hope this information answers your questions. If you need additional
information, please
call me toll-free at 1-800-531-5441, extension 3-4502. The direct line is
512/463-4502. You may also write to Tax Policy Division, Comptroller of Public
Accounts. You may also e-mail our tax help section at:

Sincerely,

Gilbert Zamora
Tax Policy Division