Martens, Todd & Leonard
Texas Sales Tax Update:
Comptroller Reverses Policy to Recognize Nontaxable Treatment of Flowback Services and Water Transfer Services
January 2, 2024
By Gordon Martens and Valentyna Kravchuk
with Martens, Todd & Leonard
On December 13, 2023, the Comptroller issued an interoffice memorandum reversing prior policy and providing the circumstances under which flowback services and water transfer services are not subject to Texas sales. Prior policy treated these services as the taxable rental of the flowback and water transfer equipment. The principal requirement for flowback and water transfer services to receive nontaxable treatment is for the service provider to have on-site personnel who continuously regulate and control the operation of the equipment as needed.
Why the change?
In 2020, the Comptroller issued a memo providing guidance to its Audit Division on the taxability of flowback services. The memo stated that charges for flowback were taxable as the rental of equipment and that sales or use tax was due on the total charge for the rental of the equipment. After an industry round table in August of 2023, the Comptroller decided that flowback and water transfer services are non-taxable, provided that they fit within the description of flowback services in the memo.
What are flowback and water transfer services?
Flowback and water transfer services are provided at oil and gas well sites to support hydraulic fracturing operations. Flowback operations involve the temporary use of oilfield equipment to handle the fluid that flows back from fracking operations. After the injection process in the fracking operation is completed, the internal pressure of the rock formation causes fluid to return to the surface. This flowback fluid contains the frack fluid plus other naturally occurring materials. Well operators hire flowback service providers to handle this fluid.
The flowback service provider designs an equipment package based on various factors. The service provider transports the equipment to the well site and may receive direction from the well operator to determine the temporary location of the equipment. The flowback service provider’s personnel are responsible for set up and installation (“rig up”). Flowback personnel are onsite during the flowback operation and are trained to operate and regulate each piece of equipment. This may include metering equipment the flowback service provider uses to send the well operator measurements of flow rate, fluid properties and composition, pressure, and temperature. While the well operators may ask for a specific flow or choke rate, the well operator does not control or operate the equipment. After its work is complete, the flowback provider removes the equipment (“rig down”) and the well operators separation equipment is installed.
Water transfer service providers move the water needed for the fracking operation to the wellsite. They use water transfer pumps, lay flat hoses, water tanks, filters, and manifolds to provide this service. During the service, they monitor and adjust the flow rate of their equipment under the direction of the well operator.
How are equipment purchases affected?
If a service provider performs a non-taxable flowback or water transfer service, they are required to pay sales tax on all the equipment and materials used to provide that service. Section 151.006(c) of the Texas Tax Code states that the sale-for-resale exemption cannot be applied to nontaxable items or services. Providers of flowback or water transfer services are, therefore, not allowed to use the sale-for-resale exemption because flowback and water transfer services are considered non-taxable services.
What records must an oilfield service provider keep?
Oilfield service providers who provide flowback and water transfer services must maintain adequate records to verify the non-taxability of their service. The records can include contracts, service agreements, invoices, bids, estimates, proposals, rate sheets, job logs, field tickets, monitoring logs, and pressure readings. These records should be able to show that personnel are onsite, identify the equipment used, show the time period during which personnel and equipment are provided, and provide details on the personnel’s job responsibilities and activities that demonstrate operational control over the equipment.
What if fracking and flowback are provided by the same company?
If a company provides both fracking and flowback services at an oil or gas well site, the flowback services are subject to the 2.42 percent oil well servicing tax imposed under Chapter 191. The fracking service provider is also responsible for paying sales tax on the purchase of flowback service equipment and materials used in the flowback service at the time of purchase.
When does the new policy take affect?
The new policy will take effect either the date when the rule change is accepted or March 1, 2024, whichever comes later.
What if you’re under audit or in hearings?
For ongoing audits, the auditors are directed to examine the transactions for the entire audit period. If taxpayers have consistently treated the transactions the same way, there should not be any adjustments for flowback and water transfer transactions. For cases that went to the Administrative Hearings section, and where taxpayers were treating transactions consistently the Comptroller has stated that these cases should be dismissed, and the audits finalized with no assessment on the flowback and water transfer sales.
Who might be eligible for a refund of tax previously paid?
Well operators who have paid sales tax on nontaxable water transfer or flowback services may be eligible for a refund. An oilfield service provider who collected tax in error from its customers would generally not be eligible to receive the refund, although it may be able to do so if it received an assignment from its customer.
What periods might be open for audits and refund claims?
In general, the statute of limitations for filing a refund claim or conducting an audit in Texas is four years from the date on which the tax was due and payable to the Comptroller. The statute of limitations may be extended if an Agreement to Extend Period of Limitation (also known as a “statute waiver”) is signed. Statute waivers are fairly common during audits, but they typically also extend the period during which the taxpayer can request a refund claim. The statute of limitations can also be tolled (the clock stops running) after a refund claim is filed, or while the issues related to a refund claim are pending in an administrative proceeding or in litigation.
The text of the guidance, is available in HTML here: https://star.comptroller.texas.gov/view/202312010L
About Martens, Todd & Leonard
Martens, Todd & Leonard is a trial and appellate law firm headquartered in Austin, Texas. It handles only Texas tax cases, specifically those involving the Texas sales tax and Texas franchise tax. The firm’s attorneys have handled cases all the way through the Texas Supreme Court and U.S. Supreme Court. They speak and write frequently on a variety of Texas sales tax and franchise tax topics and have published articles in publications such as the Journal of State Taxation, the Texas Bar Journal, the Texas Lawyer, and the Texas Tech Administrative Law Journal. For more information, please visit texastaxlaw.com.