(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.
(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:
(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.
(c) Pump change. Replacing a bottom hole pump.
(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.
(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