Chris Wallace, Weaver
Numerous states offer very generous sales tax exemptions to the energy industry. Those existing exemptions can reduce a company’s tax expenditures on operational purchases such as equipment, supplies and services.
The bad news is the exemptions can be complicated, subject to change over time, and difficult to track when considering how many vendor invoices a company processes.
Those complications are particularly relevant for a company operating in multiple states, and such a company needs to be proactive to benefit from various states’ exemptions.
Sales tax rules and regulations also vary greatly from one industry segment to another (i.e., upstream vs. downstream). Generally speaking, states have specific rules for mining operations, which cover energy industry upstream activities. States also have rules for manufacturers that apply to downstream energy industry operations and supply companies. Depending on the state, midstream energy industry operations may be treated as mining or manufacturing activities, or both.
Here is a brief review of sales tax exemptions in a few states where the energy industry is currently active: Texas, Kansas, Missouri, Ohio, Pennsylvania and West Virginia.
Texas offers sales tax exemptions to all energy industry segments, but the exemptions tend to be very specific and can be tricky to apply.
The most beneficial exemption for upstream companies applies to downhole services which start or stimulate production at a well. Texas exempts oil-soluble chemicals as well as numerous lease services.
Midstream, downstream and manufacturing companies benefit from Texas’ manufacturing exemption, which generally applies to equipment and supplies that directly cause a change to the item being produced for sale.
Sales tax exemptions offered by Kansas are much more broad-based. Consumable purchases are generally exempt if used in a manufacturing, mining, drilling or refining process. Qualifying purchases must be necessary and essential to the process. Purchased items must also be completely consumed within one year.
In addition to consumable items, manufacturers may purchase machinery and equipment tax-free if those items are directly used in a manufacturing or refining process.
Missouri provides some very generous exemptions to both mining and manufacturing companies. Machinery, equipment and related repair parts used in a mining or manufacturing typically qualify as tax-exempt. Qualifying equipment must be used directly in mining or in manufacturing products to be sold.
For mining companies, Ohio exempts all supplies and equipment used directly in the exploration and production processes. Interestingly, Ohio also extends that exemption to service companies within the mining industry. States rarely apply such exemptions to service companies.
Manufacturers also benefit from Ohio’s sales tax exemptions because supplies and equipment used primarily in a manufacturing operation are exempt from tax.
Pennsylvania and West Virginia
Pennsylvania and West Virginia exemptions for mining and manufacturing companies are very similar. Both states broadly exempt supplies and equipment directly used in either a mining or manufacturing operation.
Regrettably, not all states offer the type of exemptions provided by Texas, Kansas, Missouri, Ohio, Pennsylvania or West Virginia. For example, Louisiana and New Mexico offer very few, if any, specific exemptions for either mining or manufacturing operations.
Utah exempts machinery and equipment used in a mining process but excludes oil and gas operations from this exemption. Utah also exempts machinery and equipment used in a manufacturing process, but unfortunately does not extend that exemption to a natural gas plant.
Taking advantage of sales tax exemptions offered to the energy industry is a three-step process. First, managers need to understand available exemptions in states where the company has operations.
Company managers then need to identify vendors from whom they make exempt purchases. The company may have erroneously been charged sales tax in the past on those exempt purchases.
Lastly, managers must inform vendors of those tax exemptions and provide any required exemption certificates. Future purchases then need to be monitored to minimize or eliminate tax overpayments.
Companies cannot just assume that vendors are charging tax correctly. Reviewing all vendors who make a material amount of sales is the best way to improve sales tax compliance and reduce both overpayments and underpayments.
About the author
Chris Wallace, CPA is a senior manager in the State and Local Tax Services at Weaver, the largest independent accounting firm in the Southwest with offices throughout Texas.