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Texas Court Case Update

by DMA Staff | Jun 20, 2016
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DuCharme, McMillen & Associates, Inc. (DMA) provides this Update to inform its clients of today’s Texas Supreme Court opinion in Southwest Royalties, Inc. v. Hegar, relating to the manufacturing exemption from Texas sales and use tax.

The issue concerning whether tangible personal property placed inside a well (i.e., “downhole”) qualifies for the manufacturing exemption has been pending in the Texas court system for several years. In Southwest Royalties, the trial court ruled in favor of the Comptroller on April 30, 2012, and the Third Court of Appeals issued an opinion on August 13, 2014, affirming the trial court’s judgment. The Texas Supreme Court granted Southwest Royalties’ Petition for Review in January of this year, heard oral arguments on March 8, 2016, and today issued its opinion, affirming the judgment of the lower courts for the Comptroller.

Texas exempts a taxable item purchased by a manufacturer if the purchase falls within one of the specific exemption provisions provided by Texas Tax Code §151.318. This manufacturing exemption statute, as administered by the Comptroller, is not limited to taxpayers that are classified within the manufacturing sectors of industry. The Comptroller has permitted mining and oil/gas companies to claim the manufacturing exemption for qualifying activities performed after the extraction phase because they are manufacturing, processing, or fabricating tangible personal property for ultimate sale. Past tax issues have involved questions of when the manufacturing process begins and what items that are used during the manufacturing process qualify for the manufacturing exemption. The Comptroller has rejected attempts by taxpayers to extend the manufacturing exemption to items used to lift and extract minerals (including oil and gas) from realty and to transport product. The Comptroller’s distinction between the extraction stage and the surface stage for purposes of the manufacturing exemption was the subject matter ofSouthwest Royalties, Inc. v. Hegar

The Texas Supreme Court ruled that the manufacturing exemption statute is not ambiguous and that the statute exempts equipment that directly causes a physical change to the product. The court held that Southwest Royalties failed to establish its eligibility of the manufacturing exemption to downhole equipment because the facts in the record demonstrated that changes in the substances were caused “by the natural pressure and temperature changes that occurred as the hydrocarbons traveled from the reservoir through the casing and tubing to the surface.” Not directly causing the physical change, the downhole equipment was held not to be exempt.

The only remedy left for Southwest Royalties before the Texas Supreme Court is the filing of a motion for rehearing. The court’s opinion today was unanimous; therefore, it is unlikely that the court would consider the matter again. If a motion were to be filed and denied, Southwest Royalties could file a Petition for Writ of Certiorari with the Unites States Supreme Court; however, this is a state statutory law case and the high court does not intervene in these type cases absent some constitutional question that would necessarily have to be of real importance to the jurisprudence of the Nation as a whole. Nothing of that nature has thus far been raised by the litigants in Southwest Royalties.

Please do not hesitate to contact one of our DMA professionals below should you have specific questions about this particular subject matter. We will respond as promptly as possible.

Please do not hesitate to contact your local DMA office should you have specific questions or requests.