Is sales tax due on drilling rigs docked in Texas, and on repairs/maintenance performed on them, while they wait for offshore oil-and-gas contracts?

Plain-English summary

A Louisiana-based company that rents drilling rigs and equipment (with full operating crews) to oil companies had to dock its idle rigs in Texas during an industry downturn while waiting for offshore contracts. It asked the Comptroller how Texas sales tax would apply to (1) renting the rigs out, and (2) the purchase and repair costs it would incur while the rigs sat in Texas.

Renting the rigs with crew is a nontaxable service. If a rig is rented out with an operator for a single charge, that's treated as the performance of a service, not a taxable rental of tangible personal property — no tax is due from the customer on that charge. (Rule 3.294(c)(2)(A) sets out the criteria for what counts as a taxable lease versus a service.)

Purchase and repair of the rigs themselves depends on two possible exemptions. Absent an exemption, sales tax is due on buying the rigs and on labor/materials to repair or maintain them. But two paths can make that exempt:

• Built for exclusive offshore use: if the rigs are built for exclusive use outside Texas's territorial waters (three marine leagues from the coast) under § 151.324(b), the purchase is exempt, and repair/maintenance labor and materials are also exempt under § 151.3111, which exempts services performed on property that would itself be exempt because of its nature/use.
• Vessel status: separately, Rule 3.297(b) exempts repair labor on vessels, or machinery/equipment/component parts of vessels over eight tons displacement used exclusively for commercial purposes — regardless of whether the vessel was purchased by the original builder or a later owner/operator. If the rigs qualify as vessels under this rule, their repair labor and materials are exempt on that separate basis, even if they don't meet the "built for exclusive offshore use" test.

The letter notes the taxpayer's own uncertainty about whether these particular rigs qualify as "vessels," and points to two Comptroller administrative hearing decisions (Nos. 8,864 and 9,034) and one other administrative ruling (TR0794) that addressed similar rigs' qualification as vessels, available on STAR under specific accession numbers.

What this means for you

Oil-field service and drilling-rig companies

Whether your idle rig sitting in a Texas dockyard triggers Texas sales tax on its purchase and on repair/maintenance work depends on facts specific to the rig — was it built exclusively for offshore use outside Texas waters, and/or does it meet the "vessel over eight tons, exclusively commercial" test in Rule 3.297(b)? Get a rig-specific determination (the two Comptroller administrative hearings cited here are a good starting point for precedent) rather than assuming a blanket answer for your whole fleet.

Companies renting rigs with an operating crew

Renting a rig out complete with crew, for a single charge, is treated as a nontaxable service rather than a taxable equipment rental — a useful distinction if you're structuring rig-leasing contracts.

Accountants and tax professionals

This letter is a good roadmap of the overlapping exemptions in this space: § 151.324(a)/(b) (built/used exclusively offshore), § 151.3111 (repair services follow the exempt status of the underlying property), and Rule 3.297(b) (vessel repair labor, independent of the offshore-use test). They can each independently support an exemption, so check all of them before concluding a rig purchase or repair is taxable.

Common questions

Q: Is renting a drilling rig with a full crew taxable in Texas?
A: If it's rented for a single charge with an operator, it's treated as a nontaxable service rather than a taxable lease of tangible personal property.

Q: Is buying or repairing a drilling rig automatically taxable while it's docked in Texas?
A: Not automatically exempt, but not automatically taxable either — it depends on whether the rig was built for exclusive use outside Texas's territorial waters, or otherwise qualifies as a vessel over eight tons used exclusively for commercial purposes.

Q: Where can I find prior Comptroller rulings on whether a rig counts as a "vessel"?
A: The letter cites Comptroller administrative hearing decisions Nos. 8,864 and 9,034, and ruling TR0794, all addressing various rigs' qualification as vessels, accessible on the STAR system.

Q: Can another drilling company rely on this letter?
A: Only the company that requested it can use this letter as the basis of a detrimental-reliance claim, and the Comptroller notes the answer is based on the facts presented — a rig-specific vessel determination may be needed for other companies' rigs.

Citations and references

Statutes:

• Tex. Tax Code § 151.324(b) — drilling equipment built for exclusive use outside Texas
• Tex. Tax Code § 151.324(a)(1), (2), (c), (d) — offshore exploration/production exemption for pipe and other exclusively-offshore-use tangible personal property
• Tex. Tax Code § 151.3111 — services on certain exempted personal property

Rules:

• 34 Tex. Admin. Code Rule 3.294(c)(2)(A) — rental and lease of tangible personal property (criteria for a taxable lease vs. a service)
• 34 Tex. Admin. Code Rule 3.332(a), (b) — drilling equipment exemption
• 34 Tex. Admin. Code Rule 3.297(b) — carriers; repair labor on vessels/component parts over eight tons, exclusively commercial use

Related Comptroller decisions cited (not hyperlinked in the original; referenced by accession number on STAR):

• Administrative Hearing Decisions Nos. 8,864 and 9,034, and Ruling TR0794 (accession numbers 8007H0432D05 and 8306T0515A13)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9911864L

Original ruling text

November 5, 1999

Subject: Texas Sales Tax Law

Dear **:

This is in response to your request for a ruling on the following fact
situation and questions:

We are in the business of renting drilling rigs and associated equipment
complete with full operating crews to Oil Companies. In the past all of our
operations were in Louisiana. Therefore, my sales tax knowledge is in LA. law
not Texas law.

As a result of the downturn in the oil industry, we have had to find a place to
dock our rigs that no longer have contracts. We have chosen to dock our idle
rigs in Texas. I need direction on the role sales tax will play in this
matter.

I don't think these drilling rigs qualify as vessels. We will keep them at a
dock where we will have a skeleton crew of employee's having repairs and
maintenance performed on these rigs and getting them ready to go offshore as
contracts become available. We don't know how long it will take before these
rigs get jobs.

Since any revenue we derive from these rigs will be offshore in the Gulf of
Mexico, all revenues will be Tax Exempt. However, I need to know if purchase &
repair expenses we incur will be taxable and if so under what circumstances.

I have been informed that since these rigs are rental items, purchases should
be exempt under the RESALE rule. I don't know if this is correct. Also, What
about repairs? I have also been informed that repairs to the hull are exempt
because it becomes a component part of the rig.

I have some requisitions coming in and I don't know if they are taxable to
Texas. Listed below are the requisitions. for Texas. Please help me
understand the law as it relates to them.

1.) New Valves purchased to meet coast guard inspection.
2.) Repairs to the Hull .
3.) Repairs ( Material, Labor, Mileage ) to Gas Detectors on Rig.
4.) Shipyard repairs ( Labor & Material ). This will be significant and I
need to understand what will be subject to sales or use tax.

Please note: We will soon be working on MAJOR PROJECTS on these stacked rigs
in Texas. There will be a lot of money involved and I need to write a company
policy on Texas Sales Tax Law. I have attended a Texas Sales Tax seminar and
have spoken with both the Comptroller's office and numerous vendors in Texas.
I am now more confused than ever. I would be willing to fly to Texas to meet
with someone in your office if that is possible. I would like help in drafting
the company policy. We want to follow proper procedures and eliminate any
exposure we may incur due to ignorance of the law.

Response: If the rigs are rented with an operator to a customer for a single
charge this is presumed to be the performance of a service and no tax may be
charged to the customer. Unless otherwise exempted, sales tax is due on the
purchase of the rigs and on the purchase of labor and materials to repair or
maintain the rigs. See subsection (c)(2)(A) of 3.294 - Rental and Lease of
Tangible Personal Property, for criteria which would establish a lease of
tangible personal property.

Subsection (a) and (b) of Rule 3.332 - Drilling Equipment, provides an
exemption from sales tax of the following:

(a) Drilling equipment built for exclusive use outside Texas. TEX. TAX CODE
ANN. sec. 151.324(b) exempts the receipts from a sale, lease, or rental of, or
the storage, use, or other consumption in this state of drilling equipment used
in the exploration for or production of oil, gas, sulfur, or other minerals
when such equipment is built for exclusive use outside the boundaries of the
State of Texas and is removed forthwith from the state upon completion.

(b) Offshore exploration or production. TEX. TAX CODE ANN. sec. 151.324(a)(1)
exempts the receipts from a sale, lease, or rental in this state of casing,
drill pipe, tubing, and other pipe to be used in exploration for or production
of oil, gas, sulfur, and other minerals offshore outside the territorial limits
of the state from the tax. TEX. TAX CODE ANN. sec. 151.324(a)(2), (c), and (d)
extends the above exemption to all tangible personal property which is to be
used exclusively in the exploration for or production of oil, gas, sulfur, or
other minerals offshore and outside the territorial limits of the state. Such
tangible personal property may be delivered to the purchaser or lessee in this
state for removal by his own facilities or by any other means beyond the
territorial limits of the state, or may be shipped to any place in the state
for further assembly or fabrication, and the receipts from a sale, lease, or
rental of such property made upon completion of the assembly or fabrication are
exempt if the property is forthwith removed beyond the territorial limits of
the state.

Therefore, if these rigs are built for exclusive use outside the territorial
waters of Texas, which extend to three marine leagues from the coast, then the
purchase of the rigs is exempt from tax. Labor and materials to repair or
maintain these rigs would also be exempt under subsection (a) of Texas Tax Code
section 151.3111 - Services on Certain Exempted Personal Property, which
provides that:

A service that is performed on tangible personal property that, if sold,
leased, or rented, at the time of the performance of the service, would be
exempted under this chapter because of the nature of the property, its use, or
a combination of its nature and use, is exempted from this chapter.

Alternatively, subsection (b) of Rule 3.297 - Carriers, provides that sales
or use tax is not due on labor to repair vessels, or machinery, equipment, or
component parts of vessels in excess of eight tons displacement that are used
exclusively for commercial purposes whether purchased by the builder or by a
subsequent owner or operator. If your rigs meet this criteria, labor and
materials to repair or maintain these rigs would also be exempt.
Administrative hearings #8,864 and 9,034 and TR0794 addressed various rigs and
their qualifications as vessels. These documents may be accessed on our STAR
system under accession number 8007H0432D05 and 8306T0515A13.

I would be happy to meet or speak with you concerning your company policy on
sales tax responsibilities for these rigs.

Sales tax rules can be accessed on the Internet at:
http://www.window.state.tx.us/taxinfo/rulendx/ruleindex.html

The Texas Tax Code can be accessed at:
http://capitol.tlc.state.tx.us/statutes/codes/TX000023.html

The State Tax Automated Research (STAR) system may be accessed on the Internet
at:

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, please call me toll-free at 1-800-531-5441, extension 3-4502. The
direct line is 512/463-4502. You may also write to Tax Policy Division,
Comptroller of Public Accounts. You may also e-mail our tax help section at:

Gilbert Zamora

Tax Policy