Revenue Ruling 19-2002-2

Revenue Ruling

Ruling Number:

19-2002-2

Tax Type:	Kansas Retailers' Sales Tax
Brief Description:	Sales taxation of drilling contractors, well service providers and oil and gas producers.
Keywords:
Approval Date:	10/21/2002

Body:

Office of the Secretary

REVENUE RULING 19-2002-2

Sales taxation of drilling contractors, well
service providers, and oil and gas producers
October 21, 2002

OVERVIEW

The Kansas sales tax act treats businesses that drill for oil and gas or that service oil and gas wells as real property contractors. Like other contractors, drilling contractors and well service providers must pay sales tax when they buy machinery and equipment to use in their work --- in this case, drilling equipment, and machinery and equipment used to service wells. The one exception to the rule for equipment is that drill bits used in oil and gas production and exploration are specifically exempt by statute at K.S.A. 2001 Supp. 79-3606(pp). Drilling companies and well service providers also enjoy exemption for explosives and drilling mud, chemicals, and similar items that are consumed in drilling or well servicing. Taxation of purchases by drilling companies and well service providers is discussed more fully in Section I(A).

As with other contractors, the Kansas sales tax act requires drilling contractors and well service providers to collect sales tax when they bill customers for services, with certain exceptions for original construction. A well, whether an oil, gas, or water well, is defined to be a "facility" for purposes of taxing the labor services performed on it. Including wells in the definition of "facility" exempts labor services performed on new wells. These services are exempt since they are being performed during the "original construction" of a "facility." After a well is completed, the servicing and drilling performed on the well are taxable, except when: (1) drilling is done to extend the bottom of the well into a deeper production zone; or (2) services to the well are done to repair damage caused by a fire, flood, tornado, lightning, explosion or earthquake. Taxable services include work to stimulate production on an existing well, including work done during workovers and recompletions. This taxing scheme means that the same services that are exempt on a new well often are taxable when done to increase the production of an existing well. Taxable services that tax must be collected on are discussed more fully in Section I(B).

To properly apply sales tax to labor services, the activities of drilling and servicing oil and gas wells must be distinguished from the activities of servicing and repairing the processing equipment located at a well site. Processing equipment is used to clean oil and gas after it has been severed from the earth. Severing occurs when the oil or gas reaches the surface and is removed at the well. Once oil and gas has been severed from the earth, it typically is subjected to a series of cleaning and separation operations at the well site. These operations qualify as "processing" operations, which makes the equipment that performs these functions exempt from sales tax under K.S.A. 2001 Supp. 79-3606(kk)(1)(D). This statute exempts purchases of the processing equipment, repair and replacement parts for the equipment, and services to install and repair the equipment. The exemption in (kk) is limited to the permanent well-site equipment used to treat oil and gas that has been severed from the earth. K.S.A. 2001 Supp. 79-3606(kk)(2)(d)(i). The coverage of the processing exemption ends at the point the feeder lines begin. K.S.A. 2001 Supp. 79-3606(kk)(2)(D)(i); K.S.A. 2001 Supp. 79-3606(kk)(5)(C). Feeder lines tie the processing equipment to gathering and distribution lines. The sales of materials that make up any of these lines are taxable. Repair and maintenance to any of the lines are also taxable. How the processing exemption applies to well site equipment is discussed in more depth in Section II.

This revenue ruling is broken down into three sections:

I. Drilling contractors and well bore service providers. Section I(A) discusses the taxes that drilling and service businesses must pay on their purchases. Section I(B) discusses the taxes that these businesses must collect from their customers on charges for drilling and well services.

II. Taxation of pumps and processing equipment located at producing wells. Well operators and owners operate pumping and processing equipment at their well site. Section II discusses taxation of sales of this equipment and services to it.

III. Oil and gas exploration and geological services. Section III discusses sales taxation of geological, surveying services, and related services. These services may be performed to locate oil or gas, on wells being drilled, and on producing wells.

I. DRILLING CONTRACTORS AND WELL SERVICE PROVIDERS.

(A) GENERAL RULE FOR TAXING PURCHASES OF MACHINERY, EQUIPMENT, AND MATERIALS. Drilling contractors and other businesses that service oil and gas wells must pay sales tax to their vendors when they buy or rent machinery and equipment, when they pay for repair and maintenance services, and when they buy cement, casing, and other components of the well. The only equipment that is not taxed are drill bits. Materials that drilling contractors and well service providers may buy exempt include explosives and certain consumables.

(1) Taxation of purchases of drilling equipment and other equipment for use in drilling, well service work, and other down-hole work. (a) Drilling equipment and its maintenance and repair. Drilling contractors must pay sales tax when they buy or rent drilling equipment. The only exception is for drill bits, the sale of which is exempt from tax by statute, as are explosives. Taxable drilling equipment includes, but is not limited to, cable, derricks, including hoisting and lowering equipment and drilling controls, drill pipe, elevators, fishing tools, kellys, portable derricks, pipe racks, plugs, rotary tables, safety wires, scratchers, and turbodrills other than the turbodrill bit. Tax must be paid on these purchases or rentals, whether the drilling contractor uses the equipment to provide taxable or non-taxable services. Sales and rentals of equipment, such as cranes, manlifts, and scissorlifts, for use in setting up or installing derricks or other drilling equipment are also taxable. Rental charges for such equipment are taxable regardless of whether the equipment is being set up for use on a new or existing well, or to install pumping equipment and production equipment at a well site. Tax is due on the sales of such equipment, whether it is new or used.
Drilling contractors must pay sales tax on labor services performed to maintain or repair their equipment. This rule applies regardless of whether the drilling equipment is being used on a new well or an existing well, or is being serviced between jobs. Repair services done to the well structure and equipment that makes up the well, such as well heads or down hole pumping units, are taxable. Services done to the well structure, which includes casing, cement, and well heads, are exempt if done before the well is completed. Charges for refurbishing a drill bit are not subject to sales tax.
(b) Equipment used by well service providers and its maintenance and repair. Businesses that provide specialized well services, such as acidizing, capping, fishing, perforating, plugging, squeeze cementing, and similar services, are required to pay sales tax when they buy or rent equipment. Equipment that is taxable includes all of the equipment that is hauled to the well site and used there for down-hole work. Well service providers must pay sales tax on all maintenance and repair services done to their equipment. There are no exceptions to this rule.
Service providers may not claim exemption as manufacturers who operate an integrated production operation. For example, blenders of acid used to acidize a well are themselves contractors or are selling at retail to contractors and may not claim exemption on purchases of their trucks or blending equipment under K.S.A. 2001 Supp. 79-3606(kk).
(c) Taxing equipment rentals; the need to distinguish between rentals and services. Providing equipment without an operator is treated and taxed as a rental of tangible personal property. When a company rents machinery or equipment, the rental charges are taxable. The rule that rentals are taxable applies whether the rental equipment will be used during the original construction of a well when services are exempt, or during a recompletion of a well when services are taxable.
When equipment is furnished with an operator who controls how the equipment is operated, the transaction is considered to be a contract for labor service and is taxed as such. This distinction between rentals and services can result in what might be perceived as disparate tax treatments. For example, if a contractor drilling a new well hires a company to fish out pipe from the well bore, the service is not subject to tax because it is performed in the well bore during the original construction of the well. However, if the drilling contractor rents fishing equipment and uses its own employees to fish out pipe, the rental charges are taxable even on a new well.

(2) Taxation of purchases of cement, casing, and other materials that make up the well structure.
Materials and other items that form the well structure include cement, casing, centralizers, plugs, well head equipment, and similar equipment. Sales of these items are taxable.

(3) Taxation of purchases of drilling mud, chemicals, and other materials that are used in drilling and servicing wells. (a) While Kansas law treats drilling contractors and well service providers as contractors, the law specifically exempts property consumed in drilling. K.S.A. 2001 Supp. 79-3606(n). This exemption of consumables is unique to drilling contractors and well service providers. The consumed in production exemption does not extend to other contractors who service real property. This unique exemption means that, while drilling contractors and well service providers are required to pay tax on purchases of casing, plugs, cements, well heads, and other materials and equipment that make up a well structure or are used in providing their service, they may claim exemption on their purchases of drilling mud, chemicals, lubricants, electricity, diesel fuels, and similar items that are consumed in the process of drilling and servicing wells.
(b) Items that a drilling contractor may buy exempt include lubricants, coolants, and the energy sources used to power drilling equipment and well servicing equipment. The energy source may be electricity, diesel fuel, gasoline, or gas used to power drilling equipment. Items consumed in drilling include acids, chemicals, drilling mud, reagents, and solvents that are placed in the well bore. Exemption may be claimed on these items whether their intended use is in a new well or in an existing well. Also exempt are water, lubricants, and petroleum products that are placed into the equipment that is used in drilling. In order to purchase these items without tax, the buyer should complete a Form ST-28C, Consumed in Production Exemption Certificate, and provide it to their supplier. Propping agents shall be considered to be a consumable and not as something that makes up the permanent well structure. Propping agents or proppants are granular material, such as sand grains or aluminum pellets, that are carried in suspension by the fracturing fluid that serves to keep the cracks open after a fracture treatment.
(c) Sales of explosives used in petroleum exploration and production are exempt from sales tax by statute. This exemption covers explosives, caps, fuses, and shaped charges. It does not exempt equipment used to detonate explosives. Bullets used in a gun perforator are exempt as consumables. The gun itself is taxable.

(4) Taxation of miscellaneous purchases, including purchases of personal apparel and hand tools. Sales of items of personal apparel are taxable. This includes, but is not limited to, gloves, shoes, glasses, goggles, coveralls, aprons, masks, mask air filters, belts, harnesses, and holsters. Sales of safety equipment and fire fighting equipment are also taxable. Hand tools, such as screwdrivers, wrenches, hammers, and saws, that are sold to drilling contractors and well service providers are taxable even though they are replaced frequently because of loss, breakage, or theft.

(5) Purchases of trucks, trailers, portable buildings, and business equipment used at a drilling site. (a) Sales and rentals of trucks, trailers, and portable buildings for use at a drilling site are taxable, even when the work involves original construction. Similarly, sales of electricity to ventilate, heat, and light the trailers and portable buildings are taxable.
(b) Taxable sales include sales of equipment used in inventory control, production or drilling scheduling, purchasing, receiving, accounting, fiscal management, communications, security, management, and similar non-production activities.

(B) GENERAL RULE FOR COLLECTING SALES TAX ON SERVICE CHARGES. As a general rule, well drilling contractors and service providers must collect sales tax from their customers for services performed on existing wells. For purposes of taxing the servicing of a well, the well shall include the physical changes effected by the work done to the oil or gas producing formation, like that caused by acidizing or fracturing. Taxable services do not include services performed when a new well is being drilled, or when the services otherwise qualify as "original construction."

(1) Collecting tax on services performed to enhance production of new and existing wells. As summarized in the Overview section, labor services are exempt when the services are performed during the first or initial construction of an oil or gas well. This includes services performed to extend an existing well to reach deeper production zones. Except for the extending of a well to reach a new production zone, services are taxable when performed to an existing well to increase production. This means that taxable services include work performed during workovers, recompletions, and at other times to stimulate production. Services performed by using the equipment must be distinguished from the repair and maintenance services done to the equipment. Charges for repairing and maintaining equipment owned by drilling contractors and well service providers are taxable.

The following services are exempt when performed on a new well. They are taxable when done on an existing well, except when the well is being extended to reach a new production zone. This list is representative, and not all inclusive, of the services that are performed in a well bore:

(a)

Acidizing

The treatment of formations with a solution of hydrochloric acid and other chemicals to increase production. The acid is pumped under pressure into the formation where it enlarges the pore space in the hydrocarbon-bearing rocks, thus increasing the hydrocarbon flow. The acid may be held under pressure for an extended period of time before the well is put back in production. Chemical inhibitors are combined with the acid to prevent corrosion of the pipe.

(b) Casing installation. Casing is steel pipe threaded together and cemented into a well as drilling progresses to prevent the wall of the hole from caving in during drilling and to provide the means to sever hydrocarbons if the well is productive.

(c) Cementing or pipe setting. A process whereby cement is pumped into the space between the casing and the walls of the bore hole. Upon hardening, the cement holds the pipe in place and prevents fluid movement in the hole.

(d) Drilling out a plug. The removal by drilling of the cement set as a plug in the well bore.

(e) Fishing. When drill pipe, casing, or other objects are lost in the well bore, they must be removed before drilling or other work on the well can continue. The term encompasses both the special equipment and special procedures that are required to remove the objects from the well bore.

(f) Fracturing or frac job. Work performed on a well using high pressure pumps to stimulate production by increasing the permeability of the producing formation. Under extremely high hydraulic pressure a fluid (water, oil, alcohol, hydrochloric acid, liquefied petroleum gas, foam) is pumped down through the tubing and forced through perforations in the casing. The fluid enters the producing formation and parts or fractures it. Sand, aluminum pellets, glass beads, or similar materials are carried in suspension into the fractures. These are propping agents. When pressure is released at the surface the frac fluid returns to the well bore and the fractures partially close on the proppants leaving channels for oil or gas to flow through to the well bore. The well is then ready to complete or put back into production.

(g) Gravel packing. The installation of a screen to prevent the intrusion of formation sand into the well bore.

(h) Jetting. Introduction of nitrogen or other inert gases into the well bore to enhance production or recovery.

(i) Killing a well. The act of bringing a well under control which has blown out or is threatening to blow out. This is considered to be servicing the well.

(j) Perforating. A special service done by lowering a perforating gun into the well. The gun, which is controlled from the surface, fires electrically detonated bullets or shaped charges that pierce the casing and cement to provide holes through which hydrocarbons may enter. Perforations permit production from a formation that has been cased off.

(k) Pulling or resetting casing liner. A liner is any string of casing whose top is located below the surface. Liners are set for the purpose of allowing production from the bottom of the well. Pulling or resetting a liner involves moving this casing up or down the hole or pulling it out of the well.

(l) Putting in artificial lift. If a well will not produce by natural pressure, different means are used to lift the oil to the surface. Artificial lift systems include rod pumping, gas lifting, hydraulic pumping, and centrifugal pumping.

(m) Squeeze cement. Cement trucks with high pressure pumps force cement slurry to a specified point in the well to cause seals at the points of squeeze. It is a secondary cementing method that is used to isolate a producing formation or to seal off water.

(n) Swabbing. Operating a rubber faced cylinder up and down on a wireline to bring fluids to the surface when the well will not flow naturally. If an oil well does not flow after being swabbed, an artificial lift is installed.

(o) Whipstock placement. A long steel wedge used to deflect the bit from the original borehole at a slight angle for controlled directional drilling, for straightening crooked holes, to sidetrack, or to bypass an unretrieved fish.

(2) When is a new well considered to have been completed? The first or initial construction of a new oil or gas well is completed when a permanent wellhead is installed to allow the production of oil or gas. Original construction of a dry hole ends when the decision is made to discontinue attempts to produce oil or gas in commercial amounts. As has been discussed, labor services performed during the first or initial construction of a well are exempt. Labor services performed after the initial or original construction is completed are taxable.

(3) Collecting tax on services done to enhance the production of existing wells. Servicing a well structure is considered to be maintaining or servicing a "facility," as that term is used in K.S.A. 79-3603(p). The well structure includes the physical changes effected by the work done on the oil or gas producing formation, such as is caused by acidizing or fracturing. Services performed to enhance production of an existing well are taxable, except for extending a well to reach new production zones. These taxable activities are often performed during what are termed "recompletions" or "workovers."

As discussed in Section I(B)(1), the act of bringing a new well into production requires numerous services to be performed in the well bore. These services include, but are not limited to, running casing, cementing, perforating, fracturing, acidizing, swabing, and other special services depending on the nature of the formation. These services are exempt when done to a new well but are taxable when done to enhance the production of an existing well.

The following definitions supplement the list set out above in Section I(B)(1) with additional activities and services that are taxable when performed to an existing well:

(a)

Hot oil or water treatment of casing.

This involves the treatment of a producing well with heated oil or water to melt accumulated paraffin. Special truck-mounted units heat the oil or water and pump it down the well.

(b) Plug back. A workover operation placing cement in the bottom of a well for the purpose of excluding bottom water, sidetracking or producing from a formation that is already drilled through.

(d) Recompletion. When an existing well is re-worked for the purpose of developing new zones after its initial completion.

(e) Rodtubing jobs. This involves pulling the sucker rods, or both sucker rods and tubing out of a well and running it back into the well.

(f) Workover. Work performed when a formation has declined in production or ceased to produce, with the hope of restoring or increasing production. Workover operations can include plugging back.

(4) Collecting sales tax on services to cap or plug a well; work on abandoned wells. Charges for services to cap and plug a well are taxable. This includes work performed to a well that is capped because of low prices or low production. It also includes work performed to plug a dry hole. Work performed to remove casing from a well that is being plugged and abandoned is taxable since these services are done to alter the existing structure of the well. Plugging a dry hole is taxable since construction of a new well ceases when the decision is made to end all efforts to produce oil or gas in commercial amounts.

(5) Tax base for taxable services. (a) Every business that performs a taxable service incurs business expenses that the business must recover through the charge for its services. These expenses can include meals and lodging for employees, mileage, insurance, permits, equipment rental, and supplies that are used in providing the service. For taxable services, the term "selling price" includes the charges made to recover these overhead expenses. These charges are part of the selling price for the services and are taxable even when the charges are itemized on the billing or when these overhead items bore retail sales tax at the time of purchase.
(b) The tax base for taxable services provided by drilling contractors and service providers is the difference between the total amount charged to the customer and the cost of materials, supplies, and subcontractor payments, on which sales tax has been paid. For example, when charges are made for installing new casing in an existing well, tax should be collected on the difference between the total contract amount and the charges for the casing, cement, and drilling fluids, including sales tax on the casing and cement.
(c) Charges for mileage and per diem expense are part of the total cost to the consumer for the service. When the service is taxable, the mileage and per diem for the laborer are also taxable. When the service is not taxable, the cost of the service which includes the mileage and per diem charges also is not taxable.
(d) Service providers sometimes charge customers for items that are lost or damaged during the providing of their services. Billing the customer for lost or damaged items is not a sale but is a reimbursement of cost by the customer. These transactions should not be labeled as "sales" on the invoice. The company may be reimbursed for the sales or use tax that the company paid by including the sales or use tax on the invoice to the customer as part of the charge for such item. Since the reimbursement is for the service providers cost, the billing should lump the item's selling price and sales tax together. The charge for the reimbursement should not state the selling price and tax as separate line items. The reimbursement charge is not taxable to the customer.

II. TAXATION OF PUMPS AND PROCESSING EQUIPMENT LOCATED AT PRODUCING WELLS.

(A) GENERAL RULE. As a general rule, well operators must pay sales tax on pumping equipment, compressors, and on repair parts and services for the pumping equipment and compressors. However, well operators enjoy a broad sales tax exemption for processing equipment that is used to clean oil and gas at the well site after severance but before shipment or delivery into a feeder line.

(1) Taxation of sales of pumping equipment and compressors used for severing oil and gas. (a) Sales of pumping and well head equipment are taxable. This equipment includes, but is not limited to, walking beam pumps and associated equipment, such as electric motors, belts, gear boxes, bearings, pressure gauges, polished rods, down-hole sucker rods, underground pumps, leak sensors, leak catchers, rod lubricators, stuffing boxes, well heads or "christmas trees," and production blowout preventers. Services to repair and maintain pumping equipment are also taxable.
(b) Sales and rentals of gas compressors used on gas wells are taxable, just like sales of pumping equipment for oil wells. Compressors are used because, over the life of a gas well, the reservoir pressure diminishes as gas reserves are severed from the earth. When the reservoir pressure becomes less than the pipeline pressure, a compressor is needed to produce gas. As with oil pumping equipment, natural gas compressors used to help sever gas are taxable. Such compressors, when used on a gas distribution line or gathering system, are taxable as part of the distribution system. See K.S.A. 2001 Supp. 79-3606(kk)(5)(A). Services to repair and maintain compressor equipment are also taxable.
(c) Sales of electricity and natural gas, that is delivered through a main, line, or pipe and used to power an oil pumping unit or gas compressor used at the well head, are exempt from sales tax. To claim exemption, the consumer should complete a Form ST-28 and furnish it to its utility provider.

(2) Taxation of sales of processing equipment installed at a well site. (a) Oil wells. Processing equipment installed at an oil well site includes machinery and equipment that is used to treat the crude oil after it has been severed from the ground but before it is placed into feeder lines or loaded on trucks to be hauled to a refinery. This equipment typically separates the crude oil from water, sand, and other contaminants. It may include, but is not limited to, separators, heater treaters, storage tanks, in-tank monitors and detectors, free water knock out vessels, desalters, demulsifiers, gun barrels, and produced water treatment systems. This equipment is exempt from sales tax as integrated production equipment, as are repairs to the equipment, and repair and replacement parts for it. When buying this type of equipment, the buyer should complete an Integrated Production Machinery and Equipment Certificate, Form ST-201, and furnish it to their supplier.
(b) Gas wells. Processing equipment installed at a gas well includes machinery and equipment that is used to treat the gas after it has been severed but before it is placed into feeder lines. It includes equipment used to remove liquefiable hydrocarbons from wetgas or casinghead gas, equipment used to remove undesirable gaseous and particulate matter from natural gas, and equipment used to remove water or moisture from the gas stream. Sales of this equipment are exempt from sales tax as integrated production equipment, as are repairs to the equipment, and repair and replacement parts for it. When buying exempt processing equipment, the buyer should complete an Integrated Production Machinery and Equipment Certificate, Form ST-201, and furnish it to the supplier. Sales of the same equipment are taxable when used in a pipeline system instead of at a well site. Sales of compressors that are used to server gas from the earth are taxable even though compression is a necessary step in cleaning and processing the gas.
(c) The exemption for processing equipment extends only to equipment that is intended to remain at the oil or gas site or facility indefinitely and treat oil or gas for as long as the well is producing. The exemption does not cover equipment that is rented or purchased to service or repair processing equipment.

(3) Taxation of feeder lines, gathering systems, and pipelines. (a) Sales of pipe and other material that make up a feeder line are taxable. Feeder lines connect the processing equipment to gathering lines. Feeder lines are operated for the purpose of conveying or assisting in the conveyance of natural gas or oil. As such, feeder lines, gathering systems, and pipelines all are taxable. K.S.A. 2001 Supp. 79-3606(kk)(2)(C). Repair and maintenance services done to feeder lines, gathering systems, and pipelines also are taxable.
(b) Sales of equipment used on gathering systems and pipelines do not qualify for the integrated plant exemption. K.S.A. 2001 Supp. 79-3606(kk)(5)(c). Only processing equipment used at the well site are exempt. This statutory rule means that the same type of equipment that may be exempt when used at a well site is taxable when it is installed on a pipeline or gathering system. See K.S.A. 2001 Supp. 79-3606(kk)(5)(c).

(4) Taxation of portable buildings, and business equipment used at a well site. (a) The purchase and rental of trailers and portable buildings for use at a well site are taxable. Similarly, sales of electricity or gas to ventilate, heat, cool, and light the trailers and portable buildings are taxable. Sales of water for use by personnel at the well site are also taxable.
(b) Equipment used in inventory control, production or drilling scheduling, purchasing, receiving, accounting, fiscal management, communications, security, management, and similar non-production activities at the well site, is taxable.

(5) Taxation of apparel, tools, and other miscellaneous items. These purchases for use on processing equipment are taxable to the same extent as discussed for drillers and well service providers in Section I(A)(4).

(6) Distinguishing between rentals and services. Labor services to processing equipment and the rental of equipment for use in servicing processing equipment are taxed in the same manner as discussed in Section I(A)(1)(c).

(7) Taxation of general maintenance around a well site. (a) Sales of materials and other items for use around a well site are taxable. This includes fences, gates, cattle guards, building materials, cement for footings and post holes, gravel, wire and other materials. Installation services are not taxable when done in connection with the initial construction of a well. Site work performed around a new well will be presumed to be original construction when the work is performed within six months of the installation of the first well head on a well.
(b) General dirt work is not subject to sales tax. This includes dirt moving services to construct pits, trenches, disposal ponds, firewalls, ditches, lease roads, or other earthen structures by scraping and bulldozing. It also includes bulldozing services to level ground for drilling rigs, pumps, and tank batteries. It should be noted that application services are taxable. Application services typically involve spreading or spraying materials. Thus, if a business contracts with a well owner to bulldoze a new road and spread gravel on it, the entire amount is taxable unless the earthmoving services are separately stated on the bill.
(c) Grass mowing and trash pick-up services performed around a well site are not taxable.
(d) Transportation charges are not taxable unless they are billed to the customer as part of a retail sale. Charges for hauling the property of another are not taxable. This rule means that when a company is hired to haul casing that is owned by a well owner from one well site to another, the hauling charges are not subject to sales tax. However, when a drilling contractor contracts to buy casing and have the retailer deliver it, the retailer must collect sales tax on the entire charge to the drilling contractor, including the delivery charges.

(8) Inspection work. Inspection work is taxable when done in connection with taxable services or sales. For example, maintenance and servicing of a well pump is taxable. Any separately stated inspection work done on the well pump that results in the maintenance or servicing of the pump by the same party that performed the inspection should be included in the tax base since it is integral part of the charge for maintenance and servicing. When inspection work is performed by someone who does not service or repair the equipment being inspected, the inspection work is not subject to sales tax.

(9) Cathodic protection equipment. Sales of cathodic protection equipment are taxable. Such equipment is not production equipment and is not exempt from tax. Charges for services to install cathodic protection systems on well equipment are exempt when they are performed in connection with the original construction of the well. This work will be presumed to be original construction when the work is performed within six months of the installation of the first well head on a well. Thereafter, charges for repair and installation of such equipment is taxable. Sales of electricity to power cathodic protection equipment are taxable.

III. OIL EXPLORATION AND GEOLOGICAL SERVICES.

(A) GENERAL RULE. (1) Services are exempt. Oil field exploration services, which include services such as seismic studies, surveying, and well logging, are not taxed by the Kansas retailers' sales tax act. These include charges for measurements taken based on the electrical, magnetic, acoustical, or gravitational properties of subsurface formations. Charges made by geologists, surveyors, and engineers for their oil field exploration services also are not subject to sales tax.

(2) Purchases are taxable. Because they furnish nontaxable services, oil exploration service providers, including geologists, surveyors, and engineers, must pay sales tax on all of their purchases, except for their purchases of drill bits and explosives that are actually utilized in the exploration of oil or gas. Taxable equipment purchases include, but are not limited to, purchases of gravity meters, magnetometers, seismographic equipment, surveying equipment, pressure bombs, and cable. These businesses also must pay sales tax on all maintenance and repair services done to their equipment. There are no exceptions to this rule. They must also pay tax on miscellaneous purchases, such as apparel and hand tools, and on trucks, trailers, portable buildings, and business equipment, as was discussed in Sections (I)(A)(4) and (I)(A)(5).

This notice replaces and supercedes all prior notices and rulings that have been issued regarding the taxability of sales of services and tangible property to the oil and gas industry.

Stephen S. Richards
Secretary of Revenue

Date Composed: 10/22/2002 Date Modified: 10/22/2002

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