Texas Flowback Services are Taxed as Equipment Rentals, Not Services

“Flowback services” used to transition an oil and gas well to production after hydraulic fracturing are taxable as equipment rentals under the Texas Administrative Code. In Private Letter Ruling 202009002L, issued on September 21, 2020, the Texas Comptroller clarified the tax treatment of flowback services in a policy statement that applies to all periods open within the statute of limitations and supersedes four STAR documents (Accession Nos. 200208347L, 200811221L, 9705464H, 200804075H).

Flowback Services

Flowback occurs when frac fluid combined with oil, gas, and saltwater from the producing formation flow up the wellbore after the high pressure created during the frac job is released. Companies that provide flowback services generally provide equipment used to manage flowback pressure and the removal of frac fluids and proppants from the wellbore prior to transitioning the well to production. They also provide employees who install, operate, and remove the equipment. These employees also supervise and adjust the equipment while it is in use under the direction of the well operator. In the private letter ruling, the Texas Comptroller clarified that payments for flowback services are taxed under the rule as an equipment rental or sale.

Rental or Sales Transaction

Rule 3.324(b)(5) states that “[a]ny machinery or equipment transferred to the customer will be taxable to the customer if sold or rented without an operator.” Under Rule 3.324(c)(1), if a company “merely provides equipment and a supervisor, the presumption will be that the company is not providing services but selling or renting equipment.”

The Comptroller reasoned that companies that provide “flowback services” are providing equipment rentals based on the following:

• the customer has operational control of the flowback equipment by determining the location and operational rate;
• the flowback equipment works automatically, needing only minor adjustments;
• the customer may operate the equipment to perform testing;
• the flowback personnel do not “actively guide, drive, pilot, or steer the equipment” and are therefore not “operators” of the equipment for sales and use tax purposes as defined under Rule 3.294(a)(3).

Sales or use tax is due on the total charge for the rental of the flowback equipment, including charges for transportation, installation, removal, and accompanying personnel. This treatment applies regardless of how the charges for equipment and personnel are billed. Flowback service providers can purchase equipment tax-free for resale when tax is collected on the total rental charge of the equipment. Tax would be due on any divergent use of the equipment other than equipment rental.

Flowback Services by Fracking Service Provider

The Comptroller also clarified that flowback services are subject to the 2.42 percent oil well service tax instead of sales or use tax if the company providing the flowback services is also the provider of the fracking service. The fracking service provider in this instance owes sales tax on the purchase of the flowback service equipment and materials used in the flowback service at the time of purchase under Rule 3.324(b)(3). If the service provider is not providing frac service, the flowback service is not subject to 2.42 percent tax.

Manufacturing Exemption

The Comptroller noted that neither the companies providing flowback equipment nor the customers renting the equipment can claim the manufacturing exemption under Rule 3.300(a)(9) when used during the flowback process because the flowback process occurs prior to completion of the well.

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