West Virginia: Oil and gas producer qualifies for “direct use” exemption

Recently, the West Virginia Supreme Court addressed whether a taxpayer engaged in the exploration, development, and acquisition of oil and gas properties was entitled to a sales tax exemption on certain of its purchases. Following an audit, the State Tax Department assessed the taxpayer on three categories of purchases and rentals used in its horizontal drilling operations in West Virginia: (1) crew quarters and related equipment to make the quarters usable; (2) portable toilets, sewage systems, related water systems, and septic cleaning charges, and (3) trash trailers and waste receptacles. The taxpayer appealed the assessment, and the case eventually came before the West Virginia Supreme Court of Appeals, where the taxpayer argued that the purchases and rentals qualified for the state’s “direct use” exemption because they were integral and essential to the oil and gas production activities.  Under the direct use exemption, sales of services, machinery, supplies, and materials directly used or consumed in the production of natural resources (and other specified activities) are exempt from sales and use tax. “Directly used or consumed” means that the purchases must constitute an integral and essential part of the production of natural resources, as contrasted with purchases that are simply incidental, convenient, or remote to production.  With regard to the crew quarters and related equipment, the taxpayer argued that these purchases were directly used in production because the crew quarters were necessary to allow individuals who are essential to the drilling operations to remain on-site around the clock. The Department argued that these purchases were merely provided for the personal comfort of the individuals, and therefore were incidental or convenient to the production of natural gas. The court disagreed with the Department, noting that although the West Virginia tax code provides thirteen specific categories of expenses that qualify for the direct use exemption, there is also a “catch-all” category that applied to the crew quarters and related equipment.. In the court’s view, the crew quarters were necessary to allow the drillers to remain on-site to perform ongoing work related to the operation and monitoring of the drilling operations. Similarly, the portable toilets, sewage and water systems, and septic cleaning charges were not merely for the personal comfort of the taxpayer’s personnel. The court concluded that considering the remote setting of the drilling operations these purchases were integral and essential to the mining operations, which could likely not proceed without such facilities. Finally, the court addressed whether purchases of trash trailers and waste receptacles qualified for the exemption. West Virginia law provides that the direct use exemption is available to equipment and services necessary to store, remove, or transport “waste resulting from the production of natural resources.” The court was not convinced that the taxpayer’s primary use of this equipment was “directly” related to waste resulting from production, rather than a more general purpose. Therefore, the court reversed the taxpayer’s assessment in part, and affirmed the part of the assessment related to the trash trailers and waste receptacles. Please contact Mark Balistrieri at 412-232-1556 with questions on Antero Resources Corp. v. Steager.