An oil and gas well operator places its own compressors at well sites to boost gas pressure for working interest owners, billing them monthly under line items historically called 'compressor rental' (recently relabeled 'compressor services'). The operator's compressors were later sold to a commonly-owned affiliate, which now leases them back to the operator. Are the operator's compression services to working interest owners taxable rentals of tangible personal property, or nontaxable services — and does the billing label, or the separate affiliate lease-back arrangement, change that answer?

Plain-English summary

This is a detailed, multi-part ruling for an oil and gas well operator working through a voluntary disclosure process with the Comptroller's Revenue Opportunity Group. The operator places compressors (mounted on skids) at or near well locations to boost gas pressure to gathering-system/pipeline levels for the working interest owners whose properties it operates. The compressors run largely unattended by an on-site operator but need periodic maintenance, setting changes, and repairs, and the operator shifts them between wells as pressurization needs change over time. In a 1991 corporate reorganization, the operator sold all its compressor assets to a newly formed, commonly-owned "Affiliate," which now leases the compressors back to the operator — but the operator's monthly billing to working interest owners (originally labeled "compressor rental," later relabeled "compressor services" in 1997) never changed in substance. Critically, the working interest owners never get any right to physically possess, control, operate, maintain, or repair the compressors — they're entitled only to receive the compression itself; the operator (and now the Affiliate) retains sole control over placement, operation, and maintenance throughout.

The Comptroller confirmed the core legal test up front: under Rule 3.294(a)(2), a taxable "lease" or "rental" requires an actual TRANSFER OF POSSESSION of tangible personal property — not merely a transaction called a lease or rental "by whatever name." Reviewing a line of prior Comptroller decisions on compressor arrangements, the pattern was consistent: where the customer never gets any right to control, operate, maintain, or repair the equipment (as in Taxability Response 8903L0942C14), the arrangement is a nontaxable SERVICE; but where the customer IS allowed or required to exercise some incident of control or ownership over the equipment (as in Hearings 9918/9647 and TR 8711T0847F01), the arrangement is a taxable RENTAL, because possession has genuinely transferred.

Applying that test here, the Comptroller agreed with the operator's own analysis: because working interest owners have zero possessory rights over the compressors, the operator is using the equipment to provide a NONTAXABLE compression SERVICE to them — regardless of what the billing line items are called ("compressor rental" vs. "compressor services" makes no legal difference), and regardless of the SEPARATE transaction where the Affiliate leases the same compressors TO the operator (which the Comptroller confirmed IS a taxable rental in its own right, since that transfer of possession genuinely happens between the Affiliate and the operator).

What this means for you

Oil and gas operators providing compression, or similar equipment-based services, to working interest owners

The taxability of your arrangement doesn't turn on what you call it in your invoices or operating agreement — it turns on whether the customer actually gets any right to possess, control, operate, maintain, or repair the equipment. If you retain full control and the customer is entitled only to the SERVICE the equipment produces (compression, in this case), your charges are a nontaxable service regardless of historical billing terminology like "rental."

Businesses with related-party equipment ownership structures (operator/affiliate arrangements)

A separate, genuine transfer-of-possession transaction between you and a related affiliate (like an equipment lease-back) can be independently taxable even while your downstream service to your ultimate customers stays nontaxable — these are two distinct transactions analyzed separately under the same possession-transfer test.

Accountants and tax professionals evaluating lease-vs-service questions generally

This letter is a comprehensive, citation-rich walkthrough of the possession-transfer test under Rule 3.294(a)(2), tracing multiple prior Comptroller decisions (TR 8903L0942C14, Hearings 9918/9647, TR 8711T0847F01, Hearing 22,583) to show how the same underlying legal principle — does the customer get possessory control? — produces different taxable/nontaxable outcomes depending on the actual facts, regardless of contractual labels.

Common questions

Q: Is providing compression services to working interest owners a taxable rental or a nontaxable service?
A: Nontaxable service — because the working interest owners never get any right of physical possession, control, operation, maintenance, or repair over the compressors; they're entitled only to the resulting compression.

Q: Does it matter that the billing line item was historically called "compressor rental"?
A: No — the label doesn't determine taxability. Under Rule 3.294(a)(2), what matters is whether possession of the equipment actually transferred, not what the parties call the transaction.

Q: Does the separate lease between the operator and its affiliate change the analysis of the operator's service to working interest owners?
A: No — that's treated as a separate, independently taxable transaction (a genuine transfer of possession from the affiliate to the operator), distinct from the operator's nontaxable service to the working interest owners.

Q: What's the core legal test the Comptroller applies to distinguish a taxable rental from a nontaxable service involving equipment?
A: Whether there's an actual transfer of POSSESSION of the tangible personal property, per Rule 3.294(a)(2) — not the transaction's name, and not merely whether the customer benefits from the equipment's use.

Q: Can I rely on this letter for my own equipment-service arrangement?
A: No. It's based on the facts presented, and the letter notes the opinion may change on additional or different facts.

Citations and references

• Tex. Tax Code § 151.051, § 151.101 (imposition of sales and use tax)
• Tex. Tax Code § 151.010 (definition of taxable items)
• 34 Tex. Admin. Code Rule 3.294(a)(2) (lease/rental defined as transfer of possession, not title, "by whatever name called")
• Taxability Response ("TR") 8903L0942C14 (March 9, 1989) — compression service found nontaxable where customer had no control rights
• Comptroller's Decision Hearings No. 9918 & 9647 (March 10, 1978) — taxable rental where customer had full control and supplied consumables
• TR 8711T0847F01 (Nov. 17, 1987) — taxable rental where customer regulated compressor use
• Comptroller's Decision Hearing No. 22,583 (April 28, 1988) — taxable rental between related parties despite ultimate nontaxable end-use

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9803354L

Original ruling text

March 12, 1998

Dear Mr. **:

Thank you for visiting with ** and me regarding an issue involving
your firms' clients. You have also discussed the issues with Sergio Carrera of
our Revenue Opportunity Program.

The situation we discussed involves an anonymous taxpayer ("Taxpayer" or
"Operator") who wishes to resolve issues regarding its tax liability and tax
collection responsibility.

1. During the early to mid-1980s, Taxpayer purchased compressors from various
   third-party vendors for use in its capacity as operator of oil and gas
   properties. Taxpayer paid Texas sales tax to vendors when it acquired the
   compressors.

2. As Operator of oil and gas leases, Taxpayer places compressors mounted on
   skids, at or near well locations. The compressors are used to increase the
   pressure of gas to equal that of a gathering system or pipeline (referred to
   herein as the "Compression Services"). The compressors typically rent without
   an operator present, although the compressors frequently require maintenance,
   repairs, or changes to their operating settings.

3. In some case, a compressor is placed at the location of, and provides
   compression for, a single well. In other cases, two or more wells may jointly
   use a "compressor facility," which could include several compressors.

4. Different compressors achieve different levels of pressurization, and the
   wellhead pressure of gas at particular wells fluctuates over time, requiring
   differing levels of compression at different well locations over time.
   Consequently, Taxpayer shifts compressors among wells that it operates in order
   to match the compressors various pressurization capabilities with the wells'
   changing pressurization requirements.

5. In most if not all cases, Taxpayer (1) does not own a working interest in
   the oil and gas properties for which it serves as operator, but (2) does own an
   overriding royalty interest in properties for which it serves as operator.
   [FOOTNOTE: Overriding royalty interest generally represent a right to a portion
   of production, without offset or reduction for the costs of production.
   However, royalty interests are burdened with a pro rata portion of a well's
   "marketing cost," which includes all the charges for the Compression Services.
   Thus, Taxpayer must charge to its own account a portion of the total fee for
   the Compression Services.]

6. Prior to May of 1990, third-party vendors performed necessary maintenance
   services on the compressors, while Taxpayer's employees changed the setting of
   the compressors as necessary and periodically inspected the compressors.
   Beginning in May of 1990, Operator's employees (rather than third-party
   vendors) have performed scheduled maintenance to the compressors. During all
   periods when taxpayer used third-party vendors, such vendors have remained
   under Taxpayer's direction and control with respect to the timing, nature, and
   extent of work performed on the compressors.

7. In early 1991, the shareholders of Operator formed a new corporation
   ("Affiliate"), the ownership of which is identical to that of Operator. In
   April 1991, Operator sold all its compressor assets to Affiliate for fair
   market value (significantly in excess of its federal income tax basis), but did
   not collect Texas sales tax on the purchase price. Prior to such sale,
   Operator's books and records separately recorded the income and expenses
   related to the compressor business segment. Operator calculated and recorded
   on its books a gain from the sale of the compressors, and Affiliate and began
   depreciating the compressors on its books at the stepped-up value.

8. The compressors continue to be used to provide compression solely at
   properties operated by Taxpayer.

9. Taxpayer's monthly billings to working interest owners consist of a variety
   of specific line-item charges. With respect to the Compression Services, the
   monthly billings include (i) for properties served by a single, on site
   compressor, a line-item charge for "compressor rental," (ii) for properties
   served by a compressor facility, a charge for a allocable portion of all costs
   of the facility, and (iii) chargeouts of overhead allocations, one component of
   which (for properties served by a single compressor) is "compressor
   maintenance."

10. In the fall of 1997, Taxpayer changed the designated charges used in its
    monthly billings from "compressor rental" to more accurately read "compressor
    services." [FOOTNOTE: The decision to use the label "compressor rental" stems
    from the fact that, prior to Taxpayer's acquisition of the compressors in the
    early 1980s, Taxpayer leased compressors from unrelated third parties to
    provide the Compression Services. At that time, the accounting system was set
    up to reflect a pass-through of the "compressor rental" as part of the fee for
    providing the service. This accounting description remained in place after
    Taxpayer acquired compressors to provide the service.]

Prospectively, Taxpayer is contemplating consolidating all compressor-related
charges into a single charge to each working interest owner for "compressor
service." This single charge would encompass all amounts previously designated
as either a "compressor rental," "compressor maintenance," or an allocation of
compressor facility costs.

11. Taxpayer's monthly billings for each operated property are made pursuant
    to an operating agreement between Taxpayer and the working interest owners.
    Taxpayer's Operating Agreements are based on the American Association of
    Petroleum Landmen (A.A.P.L.) Model Form 610-1982 Operating Agreement (the
    "Operating Agreement"), typically with only minor changes to the form document.

12. The Operating Agreement does not specifically address Taxpayer's right or
    duty to provide Compression Services. Instead, Article V, section A of the
    Operating Agreement contains a broad provision stating that Taxpayer "shall be
    the Operator of the Contract Area, and shall conduct and direct and have full
    control of all operations on the Contract Area as permitted and required by,
    and within the limits of this Agreement." Pursuant to industry usage and
    interpretation, an operator's general duties require the provision of
    compression services, as necessary.

13. Taxpayer's monthly billings are governed by Exhibit C, Accounting
    Procedure, of the Operating Agreement. In turn, the various line-item charges
    for the Compression Services are authorized and governed by Section II(8),
    Exhibit C of the Operating Agreement, relating to "Direct Charges" and reading
    as follows:

A. Operator shall charge the Joint Account for use of Operator owned equipment
at rates commensurate with costs of ownership and operation. Such rates shall
include cost of maintenance, repairs, and other operating expense, insurance,
taxes, depreciation, and interest on gross investment less accumulated
depreciation not to exceed _____ percent (%) per annum. Such rates shall not
exceed average commercial rates currently prevailing in the immediate area of
the Joint Property.

B. In lieu of charges in paragraph 8A above, Operator may elect to use average
commercial rates prevailing in the immediate area of the Joint Property less
20%. For automotive equipment, Operator may elect to use rates published by
the Petroleum Motor Transport Association.

14. Although the compressors are located on oil and gas properties owned by
    the working interest owners, the working interest owners have no right of
    custody or control of the compressors under the Form Agreement. Instead,
    Operator and/or Affiliate have the sole right to place the compressors at the
    well sites; to operate, adjust, maintain and repair the compressors; and to
    remove or replace the compressors. Operator is unaware of an instance in which
    a working interest owner exercised an incident of possession or control over
    the compressors.

15. The form of Operator's billings to working interest owners has not changed
    because of the transfer of the compressors in April 1991; thus, as
    consideration for the Compression Services, Operator has continued to collect
    monthly charges from the working interest owners for the specific line items
    described above.

16. Each month, Operator records in an intercompany account with Affiliate
    offsetting entries for the income associated with the compressors (e.g.,
    "compressor rental" and "compressor maintenance" charges) and the expenses
    associated with the compressors (e.g., a charge-back for services performed by
    Operator's employees, amounts paid to third-party vendors). In most months,
    the income has exceeded the expenses. At the end of the month, if income has
    exceeded expenses, Operator writes a check to Affiliate for the net amount. If
    expenses have exceeded income, Affiliate writes Operator a check for the net
    amount.

17. Operator and Affiliate have not entered a written agreement regarding
    their respective rights and obligations with regard to the compressors.

Procedural Matters

1. Taxpayer does not hold a Texas sales and use tax permit. Taxpayer
   currently has pending before the Revenue Opportunity Group of the Office of the
   Comptroller of Public Accounts of the State of Texas a proposal to enter into a
   voluntary disclosure agreement (the "VDA") I settlement of Texas sales and use
   tax liability for prior periods. The proposed terms of the VDA do not include
   a payment of Texas sales tax by Taxpayer with respect to the Compression
   Services.

2. The Affiliate currently is the subject of a Texas sales and use tax audit.
   The auditor's preliminary schedules have proposed the imposition of Texas sales
   tax on the Affiliate, in its capacity as collection agent for the State of
   Texas, for the rental of compressors to Taxpayer.

II. Issues Presented

For purposes of this letter, we are making the assumption that the charges
between Affiliate and Operator constitute taxable rentals for the Compressors.
We are making the further assumption that Affiliate should collect and remit
sales tax on such charges. If you disagree with our assumptions and underlying
conclusions stated immediately above, please let us know. Based on these
assumptions and underlying conclusions stated immediately above, please let us
know. Based on these assumptions, the discussion below focuses solely on the
transaction between Operator and working interest owners.

Taxpayer requests a ruling on the following issue:

Are the Compression Services provided by Operator to the oil and gas properties
nontaxable services or taxable rentals of tangible personal property?

III. Discussion

A. Authorities

Section 151.051 and 151.101 of the Texas Tax Code Ann. (Vernon 1992) (the "Tax
Code") impose Texas sales and use tax, respectively, on sales, storage, use or
other consumption of "taxable items" in the State of Texas. "Taxable items"
comprise tangible personal property and certain services defined as "taxable
services." Tax Code ¤ 151.010. Neither the operation of an oil and gas well
nor compression services are defined as taxable services.

34 T.A.C. section 3.294(a)(2) defines a "lease" or "rental" as "[a]
transaction, by whatever name called, in which possession but not title to
tangible personal property is transferred for a consideration."

B. Administrative Interpretations

Taxability Response ("TR") 8903L0942C14 (March 9, 1989, a copy of which is
attached for your convenience) considered the Texas sales tax consequences of a
gas compression agreement. Those facts can be summarized as follows: (i) the
seller was responsible for installation, daily operations, repairs and starting
and stopping of the compression equipment; (ii) the customer did not provide
employees for the operation of the equipment; (iii) the customer had no right
or duty to control the equipment used in providing the service. Under these
facts, the TR concluded that "the essence of this transaction was to provide a
compression service for a fee," and therefore the compression services were not
taxable.

Earlier authorities had concluded that compressors provided to customers under
other circumstances were taxable rental of tangible personal property. For
example, Comptrollers Decision Hearings No. 9918 & 9647 (March 10, 1978) found
that compressor transactions were rentals rather than services where the
provider of the compressors reserved to the customer "full control over the
manner in which the equipment is operated" and required the customer to furnish
"all fuel, lubricant, filters, and other expendable items." Similarly, TR
8711T0847F01 (Nov. 17, 1987) found that compressor transactions were taxable
rental of tangible personal property where the vendor provided routine
maintenance and repair, while the customer regulated the use of the compressor.

Comptroller's Decision Hearing No. 22,583 (April 28, 1988) concerned a taxpayer
who "owned gas compression equipment which was managed by another corporation
[the "customer"] in providing contract compression of natural gas." The
taxpayer gave possession and management of the compression equipment to the
customer, a related party, who used it to provide contract compression
services. In exchange, the customer "would periodically transfer to taxpayer
amounts equal to the gross receipts from the compression services provided by
the taxpayer's equipment less expenses incurred by [the customer] in
maintaining and repairing the equipment." The auditor treated these receipts
as consideration for the rental of tangible personal property. The Hearing
concluded that the transactions at issue were taxable rentals. The
administrative law judge recognized that the ultimate use of the compressors
was to render nontaxable compression services, but concluded that the specific
transactions between the taxpayer and the customer were transfers of possession
of tangible personal property for consideration.

C. Analysis.

By definition, a taxable rental personal occurs only if there is a transfer of
possession of tangible personal property. See 34 T.A.C. ¤ 3.294(a)(2). This
fundamental principal reconciles and explains the prior authorities that
previously have considered the taxability of compressor transactions. Thus, in
TR 8903L0942C14, compressors were used to provide a nontaxable service because
the customer had no right or duty to control the equipment. In Hearings no.
9918 & 9647 and TR 8711T0847F01, taxable rentals existed because the customer
was allowed or required to exercise incidents of control or ownership over the
compression equipment, thereby establishing the transfer of possessory rights.

Applying this standard to the Compression Services establishes that they are
nontaxable services. The working interest owners have no right of physical
possession, control, operation, maintenance, repair, or any other exercise of
possessory rights. Rather, the working interest owners are entitled solely to
compression of their gas production. Consequently, Operator is using the
compressor equipment to render a nontaxable service to the working interest
owners.

This conclusion is not affected either by the method by which Operator bills
the working interest owners or by the compressor transactions between Operator
and Affiliate. [FOOTNOTE: We do not, however, request a ruling as to the
character or the taxability of the transactions between Affiliate and Taxpayer,
and Taxpayer does not hereby concede that such transactions are properly
characterized as taxable rentals.]

Response: I agree with your conclusions. In 1991, Affiliate acquired
compressors in a tax-free occasional sale transaction. Affiliate is now
renting or leasing compressors to Taxpayer/Operator. The lease of the
compressors to Taxpayer/Operator is a taxable transaction. Taxpayer/Operator
is using the compressors to provide nontaxable compression services to other
parties. The nature of the transactions and the services provided by taxpayer
has not changed. The fact that before the fall of 1997, the service agreements
were termed "compressor rental" did not change the nature of the transactions
from "service" to "rental." Similarly, styling a rental agreement as a
"compression agreement" would not cause the transaction to become none taxable.
Rule 3.394 specifies that a transaction, "by whatever name called," is a lease
if a transfer of possession occurs. On the surface, an agreement called a
lease or rental may appear to be lease. However, If it can be determined that
no transfer of possession occurs, then the transaction is something else. In
this case it is a non-taxable gas compression service agreement

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

You also may write to Tax Administration Division, Comptroller
of Public Accounts. My internet address is .

Sincerely,

Tom Soto
Tax Policy Division