Document Number
12-73
Tax Type
Retail Sales and Use Tax
Description
Pollution control exemption or the exemption for businesses engaged in the drilling, extraction or processing of natural gas or oil.
Topic
Assessment
Exemptions
Date Issued
05-09-2012
Superseded by PD 13-2

May 9, 2012




Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *****:

This will reply to your letter in which you seek correction of the retail sales and use tax assessment issued to ***** (the "'Taxpayer") for the period May 2003 through April 2009. I apologize for the delay in responding to your letter.

FACTS


The Taxpayer is a natural gas production contractor that manages the drilling and operation of natural gas wells. The Department audited the Taxpayer and assessed use tax on various equipment and supplies used in the operation of the business. The Taxpayer disputes the use tax assessed on certain expense and fixed asset purchases that it maintains qualify for the pollution control exemption or the exemption for businesses engaged in the drilling, extraction or processing of natural gas or oil.

DETERMINATION


Pit Liners, Tanks and Silt Fence

The Taxpayer has provided a list of asset and expense purchases that were submitted to the Virginia Department of Mines, Minerals and Energy (DMME) for pollution control certification while the audit was in progress. The items for which the Taxpayer requested certification include pit liners, which are used to control pollution during the drilling of natural gas wells, tanks used to collect fluids created during production activities and silt fence that is used to abate water source pollution.

A representative of the DMME issued a letter to the Taxpayer stating that the items at issue met the minimum construction and installation standards and reflected active permits as required by the DMME. A DMME representative also communicated with members of the Department's staff that the listed equipment was primarily used for the abatement of pollution.

Virginia Code § 58.1-609.3 9 (ii) provides the following exemption from the sales and use tax:
    • Effective retroactive to July 1, 1994, and ending July 1, 2006, certified pollution control equipment and facilities as defined in § 58.1-3660 and which, in accordance with such section, have been certified by the Department of Mines, Minerals and Energy for coal, oil and gas production, including gas, natural gas, and coalbed methane gas. (Emphasis added.)

Virginia Code § 58.1-3660 B defines "[c]ertified pollution control equipment and facilities", in part, as:
    • any property, including real or personal property, equipment, facilities, or devices, used primarily for the purpose of abating or preventing pollution of the atmosphere or waters of the Commonwealth and which the state certifying authority having jurisdiction with respect to such property has certified to the Department of Taxation as having been constructed, reconstructed, erected, or acquired in conformity with the state program or requirements for abatement or control of water or atmospheric pollution or contamination.

Virginia Code § 58.1-3660 B then states that the DMME is the state certifying authority for coal, oil and gas production.

Based on the information provided to the Department by the DMME, the exemption in Va. Code § 58.1-609.3 9 (ii) applies to the Taxpayer's purchases of pit liners, tanks and silt fence that were certified by the DMME. However, this exemption expired July 1, 2006, and the exemption statute has not been amended by the Virginia General Assembly to extend the exemption. Thus, the exemption for pollution control equipment and facilities certified by the DMME applies only to those purchases of qualifying property made by the Taxpayer prior to July 1, 2006.

The audit will be revised and the assessment adjusted to reflect the removal from the audit of the pit liners, tanks and silt fence for the period May 2003 through June 2006. The Taxpayer should note that the items at issue were included in audit samples conducted for calendar year 2007. The sample projections of the taxable measure attributable to these items will be removed from the audit for the period May 2003 through June 2006.

Tracer Wire and Stone

The Department's audit includes the assessment of use tax on purchases of tracer wire and stone. The tracer wire is buried in the ground with gas gathering pipelines. This is a DMME permit requirement and enables the underground pipelines to be located at a later time, if necessary. Stone is used as backfill for the underground installation of the gathering pipelines. The Taxpayer asserts that the tracer wire and stone are used directly in the drilling, extraction, or processing of natural gas and should qualify for the same exemption as the gathering pipelines.

Virginia Code § 58.1-609.3 12 provides the following exemption from the sales and use tax:
    • From July 1, 1994, and ending July 1, 2016, raw materials, fuel, power, energy, supplies, machinery or tools or repair parts therefor or replacements thereof, used directly in the drilling, extraction, or processing of natural gas or oil and the reclamation of the well area. For the purposes of this section, the term "natural gas" shall mean "gas," "natural gas," and "coalbed methane gas" as defined in § 45.1-361.1. For the purposes of this section, "drilling," "extraction," and "processing" shall include production, inspection, testing, dewatering, dehydration, or distillation of raw natural gas into a usable condition consistent with commercial practices, and the gathering and transportation of raw natural gas to a facility wherein the gas is converted into such a usable condition. Machinery, tools and equipment, or repair parts therefor or replacements thereof, shall be exempt if the preponderance of their use is directly in the drilling, extraction, refining, or processing of natural gas or oil for sale or resale, or in well area reclamation activities required by state or federal law.

The exemption set out in Va. Code § 58.1-609.3 12 requires that the property be used directly in the drilling, extraction, or processing of natural gas. Virginia Code § 58.1-602 defines the term "used directly" as "those activities which are an integral part of the production of a product, including all steps of an integrated manufacturing or mining process, but not including ancillary activities such as general maintenance or administration." In Commonwealth of Virginia v. Community Motor Bus Co. 214 Va. 155, 198, S.E.2d 619 (1973), the Virginia Supreme Court held that the use of the word "directly" in a statute was intended to narrow the scope of the exemption. Therefore, the exemption applies only when an item is indispensable to actual production and is primarily used or consumed immediately in the actual production of products.

The standard established by the Virginia Supreme Court is also discussed in the mining regulation, Title 23 of the Virginia Administrative Code 10-210-960 A, which states, in part:
    • The fact that particular property may be considered essential to the conduct of the business of mining or mineral processing because its use is required either by law or practical necessity does not, of itself, mean that the property is used directly in mining or mineral processing operations.

The manner in which the Taxpayer uses the tracer wire and stone is not an integral part of the Taxpayer's mining process. The use of the tracer wire to facilitate the location of underground pipelines is an ancillary mining activity. The same is true for the stone, which is used to support the buried pipelines and prevent the settling of the ground above the pipelines. The use of the tracer wire and stone in the installation of the underground pipelines does not directly affect the mining of natural gas. As noted in Title 23 VAC 10-210-960 A, the fact that an item's use is required by law, by the DMME or by practical necessity does not mean the item is used directly, as the term is defined for sales and use tax purposes. The tracer wire and stone used for the installation of underground pipelines was properly held taxable in the audit.

Stone in Well Site Access Areas

The Taxpayer uses stone in well site access areas during the well drilling phase. The Taxpayer describes these access areas as restricted and gated to limit access to well personnel only. The well site access areas contain the gathering pipelines that are installed from the wells. The well site access areas are permitted by the DMME.

The audit includes multiple invoices for purchases of stone. The stone was used for various purposes including the well site access areas and for road construction and maintenance. The auditor and the Taxpayer agreed to exclude from the audit one-half of the taxable measure for the stone purchases on the basis that the stone used in well site access areas qualified for the mining exemption. The Taxpayer claims that, upon further examination, more of the stone was used in the well site access areas than the 50 percent that was originally estimated. Based on the size of the site access areas and the amount of stone used for the access areas, the Taxpayer contends that it is more appropriate to exempt 75 percent of the stone purchases and to treat 25 percent of the stone purchases as taxable. To support its claim, the Taxpayer has provided sample linear measurements of the gathering pipelines used in some of the well site access areas where the stone was used.

After reviewing this issue and applying the used directly requirement of the mining exemption statute to the Taxpayer's use of the stone, I do not agree that the stone used in the well site access areas qualifies for the mining exemption. Although the well site access areas are permitted by the DMME, the use of the stone in the well site access areas is not an integral part of the actual mining process. Like the stone buried with gathering pipelines, the stone at the well site access areas must be used directly in mining to qualify for the exemption. In the instant case, the stone helps to facilitate access to the sites by mining personnel, machinery, equipment and motor vehicles, but the Taxpayer has not demonstrated that the stone is used directly in the mining process. The Taxpayer may wish to refer to Public Document 02-49 (4/8/02), which explains the Department's position with respect to the use of stone by mining businesses.

Based on the above, there is no basis to remove from the audit additional purchases of stone used in well site access areas. Further, the Taxpayer should begin paying the sales tax or accruing and paying consumer use tax directly to the Department on purchases of stone used in the well site access areas.

CONCLUSION


The assessment is correct with respect to the tracer wire and the stone purchased for use in well site access areas and in gathering pipeline installations. The audit will be recalculated to remove the projected sample measure for purchases of qualified pollution control equipment for the period May 2003 through June 2006. A revised audit report and an updated bill, with interest accrued to date, will be mailed to the Taxpayer. Payment should be made within 30 days from the date of the bill to avoid the accrual of additional interest. Please remit payment to: Virginia Department of Taxation, Main Street Centre, 600 East Main Street, 23rd Floor, Richmond, Virginia 23219, Attention: *****.

If you have any questions concerning payment of the assessment you may contact ***** at *****. Questions concerning this determination should be directed to ***** in the Office of Tax Policy, Appeals and Rulings, at *****.

Sincerely,



                • Craig M. Burns
                  Tax Commissioner
Superseded by PD 13-2


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Rulings of the Tax Commissioner

Last Updated 09/16/2014 12:47