Judge Reverses His Recent Texas District Court Ruling, Says Collecting Sales Tax on Oil and Gas Equipment Is Proper

Travis County District Judge John Dietz reversed his recent ruling in Southwest Royalties, Inc. v. Combs (D-1-GN-09-004284) and issued a final order stating that sales tax does apply to the sale of machinery and equipment used to extract oil and gas.

The original ruling he made in early April would have made the state liable for billions in tax refunds and face future losses of annual tax revenue of $500 million. The reversal has relieved state budget writers and state legislators, while some in the oil and gas industry are disappointed that sales tax refunds will not be forthcoming.

The plaintiffs claimed that the equipment used to extract oil and gas directly caused a physical change in the oil and gas, and thus exempted the equipment from sales tax under exemptions for manufacturing found in Section 151.318, Texas Tax Code.

Dietz disagreed with the exemption the second time and wrote:

[T]he change of pressure and temperature "intervene…to raise the changes to marketable" oil and gas and that Plaintiff's equipment that brings it to the surface "is merely an indirect cause of the changes."

It is unknown at this time if Southwest Royalties will appeal the decision.

Southwest Royalties is one of three similar oil and gas industry cases focusing on the sales tax exemption for manufacturing. The first case also was decided in favor of the state. The last case against the Comptroller of Public Accounts is expected to be heard in September.

With all of the attention placed on the sales tax exemption, some in Austin are predicting that next year the Texas Legislature may modify the statute in an attempt to obtain greater clarity.

When such tax statutes are amended, industries that could be impacted — via intended or unintended consequences — should closely monitor such legislative activity. Some entities may use the opportunity to seek minor changes in the statutes to benefit their interests. Others may attempt to exclude themselves from new tax liability.

Gardere's Government Affairs, Tax and Energy Practice Groups are closely monitoring the developments in Southwest Royalties, other similar cases, and the actions of the Texas Legislature.

Austin Partner Mark Vane ([email protected] or 512.542.7077), Dallas Partner Michael J. Donohue ([email protected] or 214.999.4231), and Houston partner N.L. "Larry" Stevens ([email protected] or 713.276.5774) are available to discuss any questions you might have about the content of this alert, as well as Houston Of Counsel Allen B. Craig III ([email protected] 713.276.5570).