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Texas Court of Appeals Clarifies Sales Tax Exemption for Equipment Used in Processing

Tax Development Oct 14, 2021

Texas Court of Appeals Clarifies Sales Tax Exemption for Equipment Used in Processing

In Hegar v. Texas Westmoreland Coal Co., the Texas Third Court of Appeals (“Court”) ruled in favor of a coal company that mined and processed coal for sale and allowed a refund of sales taxes paid on equipment used in processing the coal for sale.

Texas Westmoreland Coal Co. (“Westmoreland”) operated a coal mine and produced pea-sized to soccer-ball-sized coal for sale to a customer who required that the coal be no larger than a soccer ball. The process began with the removal of the overburden, which exposed the coal. Then, Westmoreland  used excavators to crack, break, or rip apart the coal. When the excavator buckets were full, the coal was dropped into trucks from 10 to 12 feet, further breaking apart the coal as required by the customer. 

Westmoreland paid sales tax on the lease of the excavators and on parts for the excavators and requested a refund of the tax based on Tex. Tax Code Sec. 151.318(a)(2), which provides an exemption for tangible personal property (including equipment) “directly used or consumed in or during the actual manufacturing, processing, or fabrication of tangible personal property for ultimate sale if the use or consumption of the property is necessary or essential to the manufacturing, processing, or fabrication operation and directly makes or causes a chemical or physical change to [: (A)] the product being manufactured, processed, or fabricated for ultimate sale[;].” The Comptroller denied the refund and Westmoreland’s motion for rehearing, and Westmoreland filed suit.

The Comptroller argued that the exemption in Tax Code Sec. 151.318(a)(2) did not apply because the coal was real property and not personal property when the excavators dug into the formation and that processing does not include mining. The Court did not agree. The exemption in Tax Code Sec. 151.318 does not require that the components or raw materials be personal property. The Court noted that the “Comptroller’s reading does not comport with the statute’s (1) grammatical structure and prepositional phrase—the ‘manufacturing, processing, or fabrication of tangible personal property for ultimate sale’; (2) repeated use of the phrase ‘for ultimate sale’; and (3) grouping together of manufacturing, processing, and fabrication.” The Court explained that “the only reasonable reading of the preposition ‘of’ in the phrase ‘manufacturing, processing, or fabrication of tangible personal property for ultimate sale’ is that the preposition is used to indicate the end product of a production process, not the inputs or the process itself.”

To support its position that processing does not include mining, the Comptroller cited the Texas Supreme Court’s decision in Southwest Royalties, Inc. v. Hegar, 500 S.W.3d 400, 404 (Tex. 2016) in which the Supreme Court found that casing and tubing used in oil and gas production did not qualify for the exemption in Tax Code Sec. 151.318(a)(2) because the casing and tubing did not directly cause a change  to the products produced. Instead, any changes to the products were the result of pressure changes as the products were brought to the surface.

The Court noted that in the  Southwest Royalties decision, the Supreme Court focused on whether the casing and tubing caused a physical change to the product, and the Supreme Court did not address the Comptroller’s argument that Southwest Royalties did not qualify for exemption because it was processing real property, not personal property. In fact, the Court found support for its decision in Southwest Royalties as the Supreme Court favorably cited three previous Comptroller decisions allowing manufacturing or processing exemptions for equipment and explosives used in a manner similar to Westmoreland’s excavators (i.e., to break up limestone formations for sale as cement and to blast rock and sandstone formations to be sold as gravel or sand).


Kelly Butler

Chuck Rice

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