Many thanks to Kevin Scott for his assistance in preparing this post.
On June 14, 2018, Governor Kasich signed into law H.B. 430 which will go into effect in September of 2018. The bill clarifies the language covering sales and use tax exemptions for certain oil and gas industry participants. Specifically, the new law modifies the existing statute governing the sales and use tax exemption for property used directly in producing oil or gas. Following recent actions by the Ohio Department of Taxation, H.B. 430 can help to ensure predictability and stability by reaffirming the sales tax exemptions received by Ohio oil and gas operators and service providers.
Prior to the passage of H.B. 430, Ohio law required purchased goods and services to be used “directly in the production of crude oil or natural gas” in order for that purchase to be exempt from sales and use taxes. However, the Ohio Department of Taxation recently narrowed its interpretation of which purchases qualify for the “direct” use tax exemption. For example, concrete used to backfill a “mouse hole” and other equipment purchased by a well services company were not exempt from taxation as used “directly in the exploration for, and production of, crude oil and natural gas.” In the Commissioner’s view, “exploration” did not expand the exemption to site preparation activities. Rather, “[t]he line is drawn at the actual drilling of the well[.]” As a consequence of this narrowed interpretation, if a purchase was not directly used for drilling, then that purchase would be subject to sales tax.
What H.B. 430 Changes
While the new law retains the current requirement that goods and services be used “directly in the production of crude oil or natural gas,” H.B. 430 clarifies which purchases can qualify for the sales and use tax exemption. Specifically, H.B. 430 expands the term “production” to include operations and tangible personal property directly used to:
- Expose and evaluate an underground reservoir that may contain oil or gas
- Prepare the wellbore for production
- Lift and control all substances brought to the surface.
Accordingly, purchases directly used in these types of operations are exempt from sales and use taxation. Further, the new law clarifies that providing production services to others also qualifies as “production” and exempts sales where the purchased service or item is intended be used directly in the expanded definition of “production” of oil or natural gas. Formerly codified in R.C. 5739.02(B)(42)(a), the new sales and use tax exemptions are now found in R.C. 5739.02(B)(42)(q) which includes several examples of goods and services that are exempt from tax.
Although the key take-away from H.B. 430 is the expanded definition of “production” that includes purchases that are not directly used in drilling activities, there are several additional aspects of the new law to keep in mind. Particularly, the changes to the sales and use tax exemption are intended to be “remedial.” As such, the modifications will apply both prospectively to any future cases and to any cases or audits pending on or after May 18, 2018.