Can a manufacturer claim a 100%-exempt sales tax refund on steam purchases by citing the "predominant use" test that applies to natural gas and electricity?

Plain-English summary

A steam seller ("Water Company") asked the Comptroller to review a customer's ("Company A") request for a sales tax refund on its steam purchases. Company A's exemption certificate claimed the refund based on "predominant use" under Rule 3.295, and it submitted electricity utility studies to support the claim.

The Comptroller rejected the theory, though not necessarily the outcome entirely:

Predominant use doesn't apply to steam. The predominant-use test (Tex. Tax Code § 151.317(e), Rule 3.295) is specific to natural gas and electricity metered through a single meter serving both exempt and taxable purposes -- letting a taxpayer claim exemption on the whole meter based on which use predominates. It's not a general tool for any utility-like purchase. The letter cites two prior Comptroller hearings confirming this limit: in Hearing 20,901 (STAR 8801H0876G09), an ALJ denied a 100%-exempt predominant-use claim for nitrogen, holding predominant use doesn't apply outside natural gas/electricity and instead applying the divergent-use statute (§ 151.154(a)) to tax the actual non-exempt-use percentage (there, 30%); in Hearing 28,827 (STAR 9210484H), an ALJ likewise rejected a predominant-use claim for manufacturing equipment, since a specific statutory exemption (§ 151.318) already governs that instead.

The right, narrower theory for steam: Steam applied directly to tangible personal property to cause a chemical or physical change to a product being manufactured for sale qualifies for exemption under § 151.318(a)(2) -- but only for the steam actually used that way, not automatically for 100% of purchases based on a predominant-use showing. (Separately, § 151.318(a)(4) exempts equipment used to produce steam for sale -- a different exemption for a different party in the supply chain.)

Bottom line for this transaction: because the exemption certificate's stated basis (predominant use) is invalid, the Water Company may not accept it and may not issue the refund as requested. Company A could potentially still qualify under the narrower § 151.318(a)(2) manufacturing exemption if it can show the steam is applied directly to the manufactured product.

What this means for you

Manufacturers buying steam, compressed gases, or similar utility-like inputs

Don't assume the natural gas/electricity "predominant use" shortcut applies to other inputs like steam or nitrogen -- per this letter and the hearings it cites, it doesn't. You'll need the specific exemption that actually covers your input (here, § 151.318(a)(2) for steam applied directly to the manufactured product), and you may need to substantiate actual usage rather than relying on a single-meter predominant-use study.

Sellers receiving exemption certificates

If a customer's exemption certificate cites the wrong legal basis (like predominant use for a non-electricity/gas utility), you're right to decline it and withhold any refund until a valid basis is documented -- this letter confirms the seller shouldn't accept an invalid certificate.

Accountants and tax professionals

This is a useful, citation-rich example of the natural gas/electricity predominant-use test's boundary, cross-referencing two administrative hearings (20,901 and 28,827) that each rejected attempts to extend it to other purchased inputs.

Common questions

Q: Can I use the "predominant use" test for steam, compressed gas, or other utility-like purchases?
A: No -- per this letter, predominant use under Rule 3.295/§ 151.317(e) is limited to natural gas and electricity metered through a single meter. Other purchases are instead subject to the divergent-use rule (§ 151.154(a)) or a specific exemption statute, if one exists.

Q: Is steam ever exempt from Texas sales tax?
A: Yes, when it's applied directly to tangible personal property to cause a chemical or physical change to a product being manufactured for sale, under § 151.318(a)(2).

Q: What if only part of the steam is used exempt and part isn't?
A: Based on the divergent-use principle applied to other inputs (nitrogen) in the cited hearings, only the portion of steam actually used in a qualifying manufacturing manner would be exempt -- not a 100% claim based on predominant use.

Q: Does this letter bind the Comptroller for my company?
A: No -- this is an informal 2001 letter addressing one taxpayer's specific refund request, not a modern Private Letter Ruling or General Information Letter, and it cannot be relied on by anyone else.

Citations and references

Statutes:

• Tex. Tax Code § 151.318(a)(2) (exemption for items causing a chemical/physical change to a manufactured product)
• Tex. Tax Code § 151.318(a)(4) (exemption for equipment producing steam for sale)
• Tex. Tax Code § 151.317(e) (predominant use test, natural gas and electricity)
• Tex. Tax Code § 151.154(a) (divergent use of tax-free purchased property)

Rules:

• 34 Tex. Admin. Code Rule 3.295 (natural gas and electricity)

Prior hearings cited:

• Comptroller's Hearing No. 20,901 (STAR document 8801H0876G09) -- predominant use denied for nitrogen; divergent-use tax applied to the 30% non-exempt portion
• Comptroller's Hearing No. 28,827 (STAR document 9210484H) -- predominant use denied for manufacturing equipment in favor of the specific § 151.318 exemption

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200110730L

Original ruling text

October 1, 2001

Dear **:

Thank you for your letter concerning the exemption and refund request submitted
by your customer, COMPANY A on its purchases of steam.

COMPANY A is requesting a $** sales tax refund on its purchases of
steam from the WATER COMPANY. The basis for this claim is predominant use as
defined in Rule 3.295 concerning natural gas and electricity.

You asked that we review the refund request and electricity utility studies
sent to you by COMPANY A.

The steam that is applied directly to tangible personal property to make a
chemical or physical change to the tangible personal property being
manufactured for sale as tangible personal property qualifies for exemption
under Texas Tax Code Section 151.318(a)(2). The purchases of steam are exempt
if used directly on the product as described in the preceding sentence;
however, the reason for claiming exemption that is stated on the exemption
certificate is invalid. Texas Tax Code Section 151.317(e) allows a predominant
use test for natural gas and electricity measured through a single meter that
is used for exempt and taxable purposes.

In Hearing 20,901 (STAR 8801H0876G09) the administrative law judge (ALJ) denied
the taxpayer's claim that 100% of its use of nitrogen was exempt based on
predominant use. The comptroller's auditor determined from the taxpayer's
records that 70% of the nitrogen was used in an exempt manner. The ALJ went on
to state that predominant use test used for natural gas and electricity did not
apply to the taxpayer's uses of nitrogen. The ALJ reasoned that the statute
[Texas Tax Code Section 151.154(a)] specifically addresses the divergent use of
nitrogen and other tangible personal property (other than natural gas and
electricity) purchased tax free under an exemption certificate. The taxpayer
was required to pay sales tax on 30% of the nitrogen used in non-manufacturing
activities. Also see Hearing 28,827 (STAR 9210484H), in which the ALJ denied a
taxpayer's request to claim an exemption on manufacturing equipment based on
predominant use as opposed to the specific exemption provided under Texas Tax
Code Section 151.318.

COMPANY A may issue a valid exemption certificate claiming exemption based on
Texas Tax Code Section 151.318(a)(2) if the steam is applied directly to the
product being manufactured. The exemption under Texas Tax Code Section
151.318(a)(4) applies to the equipment used to produce steam for sale.

WATER COMPANY may not accept the exemption certificate and may not refund the
sales tax.

You may view or down load the sales tax law by clicking on the following URL
and then click on the following:

1. Texas Taxes
2. Tax Code under Texas Laws and Rules
3. Tax Code
4. Scroll down to referenced statutory cite

You may view or download the referenced STAR documents at:
, then click on:

1. simple search (under document collection)
2. type in the STAR document number and enter
3. open the document

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

You may call me toll free 1-800-531-5441, extension 3-4683, if you have any
questions or need more information. My email address is
. You may write to Tax Policy Division,
Comptroller of Public Accounts, P.O. Box 13528, Austin, Texas 78711-3825.

Sincerely,

Eddie C. Washington
Tax Policy Division

c: **