Tax Type
Retail Sales and Use Tax
Description
Mining; Intent of drilling; Extraction
Topic
Exemptions
Taxability of Persons and Transactions
Date Issued
01-04-1989
January 4, 1989
Re: §58.1-1821 Application/ Sales and Use Tax
Dear********************
This will reply to your appeal of a sales and use tax assessment issued to********** (taxpayer), for the audit period July 1984, through July 1987.
FACTS
The taxpayer provides, on a contract basis, gas and water well drilling, drilling of ventilation and boreholes in operating coal mines, and installation of sewage treatment facilities. The taxpayer also rents machinery and equipment to other contractors. The taxpayer was recently audited by the department and assessed sales and use tax on a variety of untaxed purchases of machinery, equipment and repair parts for use in its various drilling businesses and on certain untaxed rentals of equipment to other contractors.
The taxpayer contests the assessment on its gas well drilling business stating that the items were used directly in "mining", an activity which is exempt from the tax under Virginia Code §58.1-608(1). The taxpayer states that the vast majority of gas wells which it drills are not exploratory in nature, but rather are drilled with the intent of extracting merchantable quantities of gas from producing gas fields. Further, the taxpayer contests the assessment on its coal mine ventilation and borehole drilling business, stating that such drilling also constitutes an exempt mining process.
The taxpayer also contests various items which it contends were held taxable in the audit in connection with its construction of a public school's sewage treatment facility.
Furthermore, the taxpayer questions the validity of the netting process used by the auditor in arriving at its liability for untaxed rentals of equipment to other contractors.
The taxpayer also seeks the waiver of all penalties assessed contending that items held taxable in the current audit were not taxed in a prior departmental audit.
DETERMINATION
It is the department's understanding that none of the items used in the taxpayer's installation of a public school sewage facility were held taxable in the audit since the job had pollution control certification from the State Water Control Board. Therefore, I find no basis for correction of the assessment on this issue.
Virginia Code §58.1-608(1) provides an exemption from the sales and use tax for, "machinery or tools or repair parts therefor or replacements thereof, fuel, power, energy, or supplies, used directly in ... mining ... of products for sale or resale.." This Code section provides further that such items will be deemed exempt of the tax "...if the preponderance of their use is used directly in ... mining ... of products for sale or resale." (Emphasis added).
Virginia Retail Sales and Use Tax Regulation 630-10-65.2.E, copy enclosed, extends the mining exemption to "persons engaged in any phase of mining or mineral processing, provided such activities qualify for exemption as set forth in Subsection (A) and (B) of this regulation." For example, the regulation continues, "persons who construct a mine under contract with an industrial mining operation would not be subject to the tax on items used directly in an activity exempt under Subsection (B) of this regulation."
Subsection A of the regulation defines the term "mining" to include, "deep and strip mining, quarrying, gas and oil drilling and other industrial removal of natural resources, minerals, or mineral aggregates from the earth." (Emphasis added).
The above regulation provides further that the extraction process of mining, which encompasses the actual removal of minerals, ores or natural resources from the earth, is an exempt function, and tangible personal property used directly in this function qualifies for exemption from the tax.
Not all functions of the mining industry qualify for exemption from the tax. For example, subsection (A)(3)(a) of the above regulation provides that the exploration process of mining, which involves, "the search for economic deposits of minerals, ore, gas, oil or coal by geological surveys, geophysical processing, boreholes and trial pits,..[is not an exempt function and] ... tangible personal property used in ... exploration ... is subject to the tax, including drilling equipment used to test the earth and surveying equipment."
Notwithstanding the foregoing, almost every gas or oil well drilling project involves some element of exploration. It frequently cannot be determined whether production will be feasible until actual drilling is commenced.
Accordingly, the commencement of drilling in an area known to contain significant deposits of gas, oil or other natural resources, with the intent of extracting merchantable quantities of such resources, is the initial step of the extraction process of mining and qualifies for exemption from the tax under Virginia Code §58.1-608(1), whether or not merchantable quantities of such resources are actually produced. However, no exemption exists for test well and similar drilling which is intended to discover if deposits of gas, oil or other natural resources exist at a potential mine site.
Therefore, the taxpayer's gas well drilling process constitutes exempt "mining" when it commences drilling with the intent that merchantable quantities of gas be extracted. If the drilling equipment, machinery and repair parts held taxable in the audit were used by the taxpayer 50% or more of the time in such drilling, I find basis for correction of the assessment. However, any equipment, machinery, etc., which the taxpayer used more than 50% of the time in non-exempt drilling, such as in water well drilling or test well drilling at potential mine sites will remain fully taxable.
In addition, the taxpayer's coal mine ventilation and borehole drilling business qualifies for tax exemption under subsection E of the enclosed regulation. Therefore, machinery, equipment and repair parts used by the taxpayer 50% or more of the time in such drilling will qualify for the mining exemption.
The taxpayer has presented no information in support of its contention that the netting process used by the department's auditor in computing its liability for untaxed equipment rentals to other contractors was invalid. Therefore, I find no basis f or correction of this portion of the assessment.
However, I do find that sufficient basis exists for the waiver of all penalties assessed in this case. The audit will be adjusted in accord with the foregoing, and a revised Notice of Assessment will be issued to the taxpayer under separate cover.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner