Questions and Answers

Identifying Information:Drilling contractors, well service providers, and oil and gas producers.
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 Policy & Research


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

1. Q. When are sales of drilling equipment taxable?

A. Sales of new and used drilling equipment are always taxable, with the exception of drill bits. Taxable sales of drilling equipment include, but are not limited to, sales of derricks, including hoisting and lowering equipment and drilling controls, drill pipe, elevators, fishing tools, cable, kellys, portable derricks, pipe racks, plugs, rotary tables, safety wires, and turbodrills other than the turbodrill bit. Maintenance and repairs done to this equipment are also taxable. While explosives are not "equipment," sales of explosives for use in drilling and in oil and gas exploration are exempt.

2. Q. What sales of materials that make up the well and that are placed in the well are subject to sales tax?

A. Taxable sales include sales of casing, plugs, cements, well heads, and other materials and equipment that make up a well structure. Items exempt because they are considered to be consumed in drilling include drilling mud, chemicals, fracing materials, proppants, and similar items.

3. Q. Are sales of pumping equipment and compressors used for severing oil and gas subject to sales tax?

A. Yes. 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 this equipment are also taxable. Sales of compressors used in severing gas are subject to sales tax, as are repair and maintenance services for such compressors.

4. Q. Are sales to drilling contractors of personal apparel and hand tools subject to sales tax?

A. Yes. The sale of items of personal apparel are taxable. This includes, but is not limited to, aprons, belts, coveralls, glasses, gloves, goggles, harnesses, holsters, masks, mask air filters, and shoes. Sales of safety equipment and fire fighting equipment are also taxable. The sale of hand tools, such as screwdrivers, wrenches, hammers, and saws, that are sold to drilling contractors and well service providers for their use are taxable even though they may be replaced often because of loss, breakage, or theft.

5. Q. Is well servicing and well maintenance done on producing wells subject to sales tax?

A. Yes. Kansas law taxes labor services performed to maintain and service a well. See K.S.A. 2001 Supp. 79-3603(q). Servicing a well structure is considered to be maintaining or servicing a "facility," as that term is used in K.S.A. 2001 Supp. 79-3603(p). The well structure includes the physical changes effected by the work done to the oil or gas producing formation, such as that caused by acidizing or fracturing.

6. Q. Does sales tax apply to operations done to stimulate or maximize production in an oil or gas well?

A. These services are performed to both new wells and existing wells. These services are taxable when performed on an existing well, but are exempt when performed during the first or initial construction ("original construction") of a new well.

7. Q. Are the services of cementing, acidizing, or fracturing an oil or gas well subject to sales tax?

A. These services are taxable when performed on an existing well, but are exempt when performed during the first or initial construction ("original construction") of a new well.

8. Q. Is the service of heating water with a hot oiler or other equipment to clean or remove paraffin in the well bore subject to sales tax?

A. Yes. Services performed to increase production of an existing well are taxable. This includes maintaining and servicing a well by removing paraffin deposits from the well bore or from the oil or gas producing formation.

9. Q. Is the service of replacing faulty equipment in an oil well subject to sales tax?

A. This service is taxable when performed on an existing well, but is exempt when performed during the first or initial construction ("original construction") of a new well.

10. Q. Is the service of pulling casing from wells subject to sales tax?

A. Yes. This service alters a "facility" and is being done to an existing well. It should be noted that original construction of a dry hole ends when the decision is made to discontinue attempts to produce oil or gas in commercial amounts. Thus, pulling casing from a dry hole is subject to sales tax.

11. Q. After the tubing or casing has been pulled from a well, a machine is used to test the amount of pressure the tubing or casing can withstand. Is this service taxable?

A. No. Testing services are not taxable unless they result in the performance of repair services by the same party that performed the testing.

12. Q. Is a contract that calls for the testing of gas and oil pipelines for leaks and repairing any leaks that are found a taxable service? A. Yes. Contracts that call for both testing and repair are maintenance contracts that are fully taxable.

13. Q. Is well servicing performed during the completion of a new well a taxable service?

A. No. If the service is rendered during the original construction of a well it would not be taxable under K.S.A. 2001 Supp. 79-3603(p). A well is considered to have been completed when a permanent wellhead is installed to allow production of oil or gas. As noted in Question 10, original construction of a dry hole ends when the decision is made to discontinue attempts to produce oil or gas in commercial amounts.

14. Q. Is the operation of bringing a low producing or non-productive well back into profitability subject to sales tax?

A. Yes. This operation is taxable. Services done on an existing well to rework the well to increase production are taxable. This includes work done to exploit shallower production zones in the well. However, it should be noted that drilling deeper or extending an existing well to reach a new, deeper production zone is considered to be "original construction" and is exempt.

15. Q. Is the process of killing oil well pressure subject to sales tax?

A. This is a well service. The process of killing oil well pressure during the original construction of an oil well is not subject to the sales tax. If the same process is performed after an oil well has been completed, it is subject to sales tax pursuant to K.S.A. 2001 Supp. 79-3603(q).

16. Q. Is the service of putting out fires for oil companies taxable?

A. No. This is not a taxable service under the retailers' sales tax act. It should be noted that service charges for repairing damage caused by a fire to a facility are not taxable. This is because these services are included in the statutory definition of "original construction." See K.S.A. 2001 Supp. 79-3603(p)(1). However, while these services are exempt, any repair and replacement parts are taxable.

17. Q. Is the sale and installation of a cathodic protection system taxable? Is electricity used to power the system taxable?

A. Yes. Cathodic protection equipment is not processing equipment. Sales of cathodic protection equipment are taxable. Services performed to install cathodic protection equipment on production or processing equipment during the original construction of a well are not subject to the sales tax. Installation services performed to install such equipment on an existing well are taxable. Any electricity consumed to provide cathodic protection is taxable since cathodic protection is not a processing, mining, drilling, or a refining process. The sale, installation, and operation of cathodic protection equipment on pipelines are always subject to sales tax.

18. Q. Are materials such as sand, gelling agents, chemicals, and acids, that are injected into an oil or gas well to stimulate oil or gas production, subject to sales tax?

A. No. The sales of these materials that are injected into an oil or gas well are exempt as consumed in drilling. However, the services to inject them are taxable when performed on an existing well, but exempt when performed during the first or initial construction of a new well.

19. Q. Does this mean that services are sometimes taxable while the materials being used are exempt, and that at other times, the services are exempt but the materials used in performing the services are taxable?

A. Yes. This is the result of the sales tax act exempting labor services done during original construction and exempting items consumed in drilling.

20. Q. Are sales of casing, cement, and plugs taxable?

A. Yes. Materials and other items that make up the permanent well structure are taxable.

21. Q. Is the off-site blending of chemicals for use in treating formations or chemical treatment for corrosion subject to sales tax?

A. These services are normally performed by the retailer of the chemicals and are an integral part of the retail sale of the chemicals. When the chemicals are used in the well, the sale of the chemicals is not taxable because they are consumed in drilling. Hence, the services done to the chemicals off-site would not be taxable. As discussed in Question 18, services to inject these chemicals into the well may be taxable depending on whether it is a new well or an existing well. These services to the well structure would not include off-site blending services since these services are considered to be an integral part of the retail sale of the property.

22. Q. Are sales of water to an oil and gas operator to use in the drilling or processing operations subject to sales tax? This includes water for waterflooding operations.

A. No. Water used in drilling operations is considered to be exempt as consumed in drilling. Water used in the processing equipment is considered to be consumed in production.

23. Q. Are purchases of drilling mud subject to sales tax?

A. No. The sale of drilling mud is exempt because it is consumed in drilling. Other items that are placed down the bore hole and are considered to be exempt as consumed in production include: acids, surfactants, corrosion inhibitors, guar, crosslinkers, and proppants. "Guar" is a material made up of ground guar beans that is used to enhance the viscosity of fluids that carry proppants. "Proppants" or "propping agents" 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.

24. Q. Is the casing of producing wells subject to sales tax?

A. Yes. Sales of casing are sales of tangible personal property that are subject to sales tax. The service of installing casing is taxable when installed on an existing well and exempt when performed during the first or initial construction ("original construction") of a well.

25. Q. Are labor services charges and mileage charges for the taxable repair of a broken pump and motor located at the oil well subject to sales tax?

A. Yes. As discussed in Question 3, sales of and services to pumping equipment are taxable. The full amount charged to the customer for the taxable repair is subject to sales tax. This includes mileage charges and other charges that are billed to the customer.

26. Q. Is the charge for frac tank rental subject to sales tax?

A. Most rentals of tangible personal property are subject to sales tax. A rental involves the transfer of property to someone else for that person's use and operation. One important exception to this rule is for rental of processing equipment that is located at a well site. This exemption is discussed in more depth in Question 37. A frac tank is generally a portable holding tank that has a variety of uses. When a tank is used in place of a permanent waste water tank, the rental of a tank is exempt since waste water tanks are considered to be processing equipment, and sales of processing equipment are exempt. When a tank is used during drilling operations, the rental of the tank is taxable since sales of equipment used during drilling operations is subject to sales tax.

27. Q. Are the services of electrical logging, geological studies, engineering studies, and geophysical studies taxable services as contemplated by K.S.A. 2001 Supp. 79-3603, et seq?

A. No. These services are not subject to Kansas sales tax.

28. Q. Are transportation services subject to sales tax?

A. Transportation per se is not a taxable service. However, when delivery charges are billed to a customer for the sale and delivery of a taxable item, the charges are part of the selling price and are subject to sales tax. Absent being part of a taxable sale, hauling someone else's property from one site to another is not taxable. For example, when casing is sold and hauled to the well site by the seller or his agent, the selling price of the casing includes the delivery charge. The selling price is the tax base or amount that is taxed. When a well owner hires someone to haul the owner's casing from a well site, no sale is taking place and the hauling is not taxable. Transportation charges that make up part of a service provider's overhead are included in the tax base for services and are taxed when the service is taxed. For example, a drilling contractor may impose a surcharge for hauling special equipment to a drilling site. This fee is part of the "total cost to the consumer" for the service, and is subject to sales tax on a job where services are taxable even when the fee separately stated. See K.S.A. 2001 Supp. 79-3602(g).

29. Q. Is the hauling of fresh or salt water for drilling purposes, or the hauling of oil to be mixed with drilling mud, subject to sales tax?

A. As discussed in Question 28, hauling charges are taxable when the charges are billed as part of a taxable retail sale, such as the sale of casing or drilling pipe. When the retail sale is not taxed, any shipping or hauling charges should not be taxed. Here, the retail sale of water or oil is exempt because the water or oil is consumed in drilling. Consequently, the hauling charge is not taxed because the retail sale is not taxed.

30. Q. Is the service of emptying workover pits from drilling and lease operations subject to sales tax?

A. No. This service is rendered to real property and is not subject to sales tax.

31. Q. Is the service of skimming oil from salt water tanks taxable?

A. No. This service is not taxable since it is performed to processing equipment.

32. Q. Are services performed to clean-up: (1) spills from line breaks; (2) spills from line repairs; and, (3) fluids from wet string, subject to sales tax?

A. No. Since these services are not considered to be repairing, servicing, altering, or maintaining tangible personal property or property that was once tangible personal property pursuant to K.S.A. 2001 Supp. 79-3603(q), they are not subject to sales tax.

33. Q. Is the service of emptying salt water tanks and hauling the water to a salt water disposal system subject to sales tax?

A. No. This is not a service that is subject to sales tax under K.S.A. 2001 Supp. 79-3603(q). As has been discussed, shipping, transportation, and hauling services are not taxable, unless they are provided as part of the taxable sale of tangible personal property or part of the overhead cost for a service.

34. Q. Is the service of flushing and cleaning salt water lines a service subject to sales tax?

35. Q. Is the service of cleaning tanks, tubing, flow lines, and other processing equipment by use of portable steam units or other kinds of cleaning equipment subject to sales tax? A. These appear to be maintenance services performed on processing equipment located at a well site. Maintenance services are exempt from sales tax when done to processing equipment. Services to feeder lines, gathering systems, and pipelines are taxable. Services to lines from the well head to the processing equipment are taxable, as are services to lines from the processing equipment to a gathering systems or similar system. 36. Q. Is the service of pumping scraper pigs and rubber balls through lines to clean out scale deposits subject to sales tax? A. As has been discussed, maintenance of processing equipment located at a well site is exempt from tax. When these services are done to maintain lines that connect pieces of processing equipment to each other, the services are exempt. If the scraper pigs and rubber balls are pumped through feeder lines or other lines that deliver gas or oil from the well site, this is a taxable maintenance service. Feeder lines, gather systems, and pipelines are not part of the processing equipment and services to them are taxable. Similarly, the lines from the well head to the processing equipment and from the processing equipment to a gathering system or similar system are not part of the processing equipment and services to them are taxable.

37. Q. Is equipment that is permanently located at a well site and used to treat oil in a tank or a battery of tanks subject to sales tax?

A. No, if it is used to process the oil or gas after it has been severed from a well. This equipment is considered to be processing equipment. The sale of processing equipment and services to it are not subject to sales tax. Common processing equipment includes: gun barrels, heat treaters, separators, free water knockouts, scrubbers, dehydrators, water tanks, stock tanks, gas production units, and salt pots. Items that are not exempt include compressors and chemical feeders. Chemical feeders are used to inject chemicals down the well bore. Frac tank rentals are exempt when the tank is used in place of permanent waste water tanks. Frac tank rentals are taxable when the tank is used during well drilling. It should be noted that the sale or rental of equipment that is used to do repair and maintenance work on exempt processing equipment is taxable.

38. Q. Is cleaning a saltwater disposal pit or tank, by removing sand, dirt, and other drilling by-products, subject to sales tax?

A. No. When a service only involves the removal of sand and dirt from a pit or tank, the service is not taxable.

39. Q. Is the service of cleaning tanks, gun barrels, and other processing equipment and hauling away the heavy sediment, sand, gravel, and other contaminants, subject to sales tax?

A. No. These maintenance services are being done to processing equipment. Maintaining processing equipment is not subject to sales tax.

40. Q. When can services to real property be subject to sales tax?

A. Separately stated charges for dirt work are not subject to sales tax. Services to real property can be taxable when: (a) the services are done to real property that consists of what was once tangible personal property, such are fences, roads, buildings, tanks, and similar structures; (2) the work involves application or installation, such as applying gravel to a road, and (3) charges for excavation or other dirt work are not separately stated on the customer billing.

41. Q. Are services performed to real property, such as mowing, digging pits at well sites, excavation, or backhoeing, subject to the sales tax?

A. No, if charges for the services are separately stated on the customer billing. Separately stated charges for dirt moving services are not subject to sales tax. Grass mowing services are also not subject to sales tax.

42. Q. Are services performed by a contractor who uses his winch truck subject to sales tax? What if I rent the winch and operate it myself?

A. When a business provides a piece of equipment with an operator, the transaction is presumed to be the providing of labor services. The transaction is taxed according to whether the service is taxable or exempt. When a business rents a piece of equipment for use by the person who rents the equipment, the transaction is a rental of tangible personal property and is taxable even when the equipment is for use during the original construction of the well.

43. Q. Is the lease operation overhead, which is charged to the joint interest partners, subject to sales tax?

A. "Lease operation overhead" is normally a charge made to recover the indirect costs of running an office, hiring a bookkeeper and engineer, and so forth. Reimbursement of these overhead costs is not subject to sales tax when charges for taxable services are not involved. However, an operator may bill his partners for services that the operator performs on the well. When these services are taxable, sales tax should be billed to the partners. When charges for these services are made, they normally include a number of indirect costs, including overhead, that are taxed as part of the service. An operator may also seek reimbursement for purchases of tangible personal property. Sales tax is due when the operator purchases taxable items from the vendor. These charges should not be billed to partners as a sale since the operator is simply being reimbursed the cost of materials and taxes that he or she paid on the purchase.

44. Q. Is the servicing of storage tanks for a refinery subject to sales tax?

A. This Q & A is intended to apply only to drilling and well sites. Therefore, it does not apply to pipelines or to refineries, unless they are specifically discussed. These businesses are treated under different part of the sales tax act. Many of the statements in this Q & A have no application to refineries. With these statements in mind, the answer to this question is "No." These services appear to be done to integrated processing equipment.




Date Composed: 10/22/2002 Date Modified: 03/16/2005