Drilling for Dollars: File Your Pa. Marcellus Shale Refund Claim Now

Pennsylvania's mining exemption from sales and use tax has been used and expanded by coal mining and oil and gas companies for as long as the exemption has existed.  The mining exemption clearly applies to equipment purchased by companies that mine for natural gas in Pennsylvania's Marcellus Shale region.  These companies, and many of their subcontractors, are entitled to purchase the equipment used in these mining activities free of Pennsylvania sales tax. 

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Unfortunately, the Pennsylvania Department of Revenue recently issued guidance--in the context of equipment purchased for use in mining for natural gas in Pennsylvania's Marcellus Shale region--that interprets the mining exemption in a manner that is much more limited than existing law would require.[1]

This article briefly discusses the breadth of the mining exemption, summarizes the Department's ruling and why it is inappropriate, and what companies should do next.

Pennsylvania's Mining Exemption

The language of Pennsylvania's mining exemption is quite broad and applies to all purchases of equipment used directly in mining.[2]  The Department of Revenue's regulations specifically provide that the purchase or use of tangible personal property, or services performed on tangible personal property, by a person engaged in the business of mining is exempt from tax if the property is predominantly used directly by the person in mining operations.[3]

Whether property is directly used in mining is determined by the following factors:  (1) physical proximity of the property to the mining process; (2) proximity of time of use to the mining processes that precede and follow its use; and (3) the active and causal relationship between the use in question and the production of the mined product.[4]  A purchase is deemed to be predominantly used in mining if it is used more than 50 percent of the time in mining operations.[5]

Pennsylvania Supreme Court.jpg
Pennsylvania Supreme Court

The Pennsylvania Supreme Court has interpreted the mining exemption broadly.  In R.G. Johnson v. Commonwealth,[6] the court held that the mining exemption applied to purchases by a taxpayer who was in the business of sinking mine shafts and driving slopes, even though the taxpayer did not do the actual mining.  The court determined that it was the nature of the work and not the identity of the individual who performed the work that controlled the applicability of the exemption.  Relying on the court's decision in R.G. Johnson, the Department has opined that a subcontractor's activity fell "under the mining exclusion even though the subcontractor was not mining or extracting anything because the actual drilling for and extraction of oil or gas is dependent upon the machinery and equipment" the subcontractor employs.  The Department derived this "dependent upon" standard directly from the Pennsylvania Supreme Court's language in the R.G. Johnson opinion.[7]

hydraulic fracturing

Hydraulic fracturing (or fracking) is a mining process by which pressurized fluid is injected into a shale formation causing small fractures in the rock.  After the fractures are induced, trapped natural gas is released and can be extracted.  So it stands to reason that, because of the unique nature of the fracking process, and the specialized equipment and process necessary to accomplish that process, nearly all equipment purchased by a company conducting mining operations in Pennsylvania's Marcellus Shale region (including purchases by subcontractors) should easily satisfy the "dependent upon" standard set forth in R.G. Johnson.

The Department's 2010 Ruling Contradicts the Pennsylvania Supreme Court's Interpretation of the Exemption

Despite the fact that the "dependent upon" standard set forth in R.G. Johnson is now the law in Pennsylvania, the Pennsylvania Department of Revenue recently published guidance in the form of a letter ruling that applies the mining exemption in a much more limited manner than allowed by R.G. Johnson.  Many of the items the Department treats as taxable in the ruling clearly would not have been treated as taxable if the proper "dependent upon" standard had been applied.  Consider the following examples:

  • Frac Pump (exempt in letter ruling) vs. Hydration unit (taxable in the letter ruling)- The Frac Pump injects fluid into a shale formation and the Hydration unit mixes and retains the fluids on the surface at the well site.  Both pieces of equipment are used at the well site to facilitate the extraction of natural gas.  Thus, the extraction process is dependent upon both the Frac Pump and Hydration unit.  In the letter ruling, the Department summarily opined that only the purchase of the Frac Pump is covered by the mining exemption.

  • Twin Cement Unit(exempt in the letter ruling) vs. Sand Conveyor and Sand Storage Bins (taxable in the letter ruling) - The sand conveyor transports sand from the storage bins to the cement unit, and the cement unit mixes cement.  This cement is then used to bond casing or piping to the wall of the bore hole.  All of this equipment is located and used at the well site, and the success of the extraction process is dependent upon the proper operation of both the cement units and the conveyor.  Nonetheless, in the letter ruling, the Department opined that only the cement unit qualifies for the mining exemption.

Thus, the Department's recent letter ruling is not consistent in its application of the "dependent upon" standard to all purchases of fracking-related equipment.  However, notwithstanding the inconsistent treatment of these purchases in the Department's letter ruling, when the proper "dependent upon" standard is applied, nearly all equipment purchased by a natural gas extraction company (or any equipment purchased by subcontractors) for use in Pennsylvania's Marcellus Shale region should be exempt from Pennsylvania sales tax.  The law on this issue is clear, longstanding, and contradicts the Department's limited view of the exemption.

What Do I Do Now?

To the extent your company paid any Pennsylvania sales tax on its purchases of mining equipment related to its Marcellus Shale operations, you should contact your state tax consultants and discuss filing refund claims for the tax paid before the refund deadline passes.

[1] See Pennsylvania Letter Ruling SUT 10-003

[2] 72 P.S. § 7201(c)(3).

[3] 61 Pa. Code § 32.35(a).

[4] 61 Pa. Code § 32.35(a)(1).

[5] 61 Pa. Code § 32.35(a)(2).

[6] Commonwealth of Pennsylvania v. R.G. Johnson, 433 A.2d 465 (1981).

[7]Id (emphasis supplied).

(Daniel M. Dixon is an Associate and Stephen J. Blazick is Counsel with the Reed Smith LLP law firm's State Tax Group. Both are based in Philadelphia, Pa.)


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