On March 8, 2016, the Texas Supreme Court heard oral arguments in Southwest Royalties, Inc. v. Glenn Hegar, Comptroller of Public Accounts. At issue is whether oil-and-gas well equipment, including casing, tubing, pumps, and related equipment, used to extract oil and gas, qualifies as "property used or consumed in or during the actual manufacturing, processing, or fabrication of tangible personal property . . ." for purposes of the Texas sales and use tax manufacturing exemption under Texas Tax Code Section 151.318.
At the trial court level, the judge, in a bench ruling, indicated that the oil and gas equipment used for below ground mineral extraction did qualify for the Texas sales and use tax manufacturing exemption. However, in his written opinion, the trial court judge reversed himself, and the Texas Court of Appeals, Third District, upheld the lower court's ruling.
Southwest Royalties has taken the position that the oil and gas equipment used in the extraction of crude hydrocarbons from underground reservoirs constitutes "processing of tangible personal property" under the statute because the hydrocarbons, as they move from below-ground to the surface, undergo a physical change as they are separated into oil, liquid, gas, and condensates (including contaminates).
Conversely, the Comptroller has taken the position that: (1) the extraction of minerals is not "actual manufacturing, processing, or fabrication," (2) underground minerals are not tangible personal property, and (3) it is the longstanding policy of the Comptroller that mineral extraction is not covered by the manufacturing exemption.
Should the Supreme Court rule in favor of Southwest Royalties, there will be refund opportunities for taxpayers who have paid Texas sales or use tax on oil and gas downhole production equipment. While a decision is pending, taxpayers should consider filing protective refund claims for taxes paid for periods remaining open under Texas' four-year statute of limitations on sales and use tax refund claims.
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