Sales Tax Audits in the Oil and Gas Industry: Nexus and Exemptions

Companies involved in Texas’ oil and gas industry must strictly comply with the state’s sales tax laws. Sales tax is among the state’s most important sources of revenue, and with the size of Texas’ oil and gas industry, tax collection within the industry is a priority for the Texas Comptroller’s Office.

While companies across all segments of Texas’ oil and gas industry need to prioritize sales tax compliance, they must also have a clear understanding of when paying or collecting sales tax is not required. Various exemptions apply, and relying on them can be critical to avoiding unwarranted liability during a Texas sales tax audit.

Texas Sales Tax Nexus: Implications for the Oil and Gas Industry

Due to the nature of Texas’ sales tax nexus rules, essentially all companies involved in Texas’ oil and gas industry will be subject to state sales tax compliance. Companies with in-state oil and gas operations will necessarily have physical nexus with the state, while out-of-state companies will have economic nexus in most circumstances:

• Physical Nexus – Physical nexus is based on having a physical presence in, or physical contacts with, the state. This includes not only drilling, processing, and storage operations, but also sales, management, and other corporate activities.
• Economic Nexus – Economic nexus is based on having “total Texas revenue” of $500,000 or more annually. If a business has economic nexus based on its sales volume to Texas oil and gas businesses, no physical contacts with the state are required.

As a result, not only can in-state oil and gas companies face Texas sales tax liability, but out-of-state equipment suppliers can face Texas sales tax liability as well. If a company is required to collect and remit sales tax, its failure to do so can trigger a high-risk audit, and delinquent sales tax liability is subject to both interest and penalties.

Texas Sales Tax (and Related Tax) Exemptions in the Oil and Gas Industry

Under Texas law, products and services can both be subject to state sales tax (or a related tax, such as the state’s oil and gas well servicing tax). For example, along with taxable products like storage tanks, pump jacks, flow lines and compressors, the following services are also generally subject to tax under Texas law (these services are subject to the state’s oil and gas well servicing tax instead of its standard sales tax):

• Acidizing
• Cementing
• Fracturing
• Shooting
• Surveying and testing

However, other products and services are exempt. For example, processing equipment generally is not subject to Texas sales tax. This includes separators, scrubbers, and other pieces of processing equipment, as well as replacement parts for these items. As a result, even if a company has a physical or economic nexus with the state, it is not required to collect and remit sales tax if it sells these products to in-state companies.

Responding to a Texas Sales Tax Audit Involving Crude Oil or Natural Gas Operations in Texas

The tax laws that apply to Texas’ oil and gas industry are complex, making compliance a challenge. However, this is not an excuse for noncompliance. As a result, all companies involved in the oil and gas industry must be prepared for the possibility of facing scrutiny from the Texas Comptroller’s Office; and, when facing Texas sales tax audits, companies must be prepared to both: (i) demonstrate what they have paid; and (ii) demonstrate when payment is not required.

To ensure that they are prepared to respond effectively to sales tax audits, companies involved in Texas’ oil and gas industry should:

Ensure a Clear and Comprehensive Understanding of Their Compliance Obligations

Companies involved in Texas’ oil and gas industry should not assume that auditors will have an accurate understanding of the law or apply the law correctly under the circumstances at hand. Instead, they should ensure they have a clear and comprehensive understanding of their compliance obligations and be prepared to respond effectively to any unwarranted allegations of noncompliance.

Document Any Grounds for Nonpayment of Texas Sales Tax (or Related Tax)

For companies that are not required to pay Texas sales tax (or a related tax, such as Texas’s oil and gas well-servicing tax), documenting their grounds for nonpayment will also be important for successfully defending against a Texas sales tax audit. For out-of-state equipment suppliers, this may include: (i) demonstrating that their “total Texas revenue” falls below the $500,000 economic nexus threshold; and/or (ii) demonstrating that some or all of their products are eligible for Texas’s oil and gas processing equipment sales tax exemption.

Document Their Texas Sales Tax Compliance Efforts

In addition to documenting when compliance is not required, companies should document their Texas sales tax compliance efforts. When facing a Texas sales tax audit, being able to affirmatively demonstrate good-faith adherence to the state’s tax laws can be critical to avoiding unwarranted liability (including interest and penalties).

Know What to Expect and Have an Audit Response Plan

Texas sales tax audits follow standardized procedures; and, as a result, companies can—and should—plan ahead. Given the relatively high risk of scrutiny from the Texas Comptroller’s Office, companies in Texas’ oil and gas industry should have documented audit response plans they can execute when necessary.

Engage Experienced Local Tax Counsel Promptly

Due to the complexity of Texas’ sales tax laws and the unique requirements and exemptions that apply within the oil and gas industry, engaging experienced local tax counsel is essential. When facing scrutiny from the Texas Comptroller’s Office, both in-state and out-of-state companies should promptly engage an experienced Texas sales tax lawyer who can use his or her experience to communicate effectively with the Texas Comptroller’s Office on their behalf.

Schedule a Call with a Texas Sales Tax Lawyer at Brown PC

Our firm has extensive experience representing clients in Texas sales tax audits and related state tax enforcement proceedings. To speak with an experienced Texas sales tax lawyer at Brown PC in confidence, please call 888-870-0025 or inquire online today.