By Charles Capouet and Todd Lard

The Supreme Court of Texas held that an oil and gas exploration and production company’s purchases of casing, tubing, other well equipment, and associated services were not exempt from sales tax under various processing exemptions. Texas provides multiple exemptions from sales tax for certain tangible personal property related to the “actual manufacturing, processing, or fabrication of tangible personal property.” The court held that “processing” meant “the application of materials and labor necessary to modify or change characteristics of tangible personal property.” The taxpayer’s equipment was used in the process of extracting hydrocarbons from underground mineral reservoirs, separating the hydrocarbons into their component substances, and bringing them to the surface. However, there was “no evidence that the equipment acted upon the hydrocarbons to modify or change their characteristics.” Because the changes in the hydrocarbons were instead caused by the natural pressure and temperature changes occurring as the hydrocarbons traveled from the reservoir to the surface, the court held that the taxpayer was not entitled to the processing exemptions from sales tax on its purchases of the equipment. Southwest Royalties, Inc. v. Hegar, No. 14-0743 (Tex. June 17, 2016).