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Stingray Pressure Pumping LLC v. McClain

Court of Appeals of Ohio, Tenth District

December 17, 2019

Stingray Pressure Pumping LLC, Appellant-Appellant,
[Jeffrey A. McClain], Tax Commissioner of Ohio, Appellee-Appellee.

          APPEALS from the Ohio Board of Tax Appeals, Nos. 2015-1465 & 2015-1823

         On brief:

          Baker & Hosteller LLP, and Edward J. Bernert, for appellant.

          [Dave Yost], Attorney General, and Daniel G. Kim, for appellee.


          Edward J. Bernert.

          Daniel G. Kim.


          KLATT, P.J.

         {¶ 1} Stingray Pressure Pumping LLC ("Stingray"), appeals from the decision of the Ohio Board of Tax Appeals ("the BTA") entered on January 17, 2018. The BTAs decision affirmed two final determinations of the Tax Commissioner of Ohio ("tax commissioner") that assessed tax liability related to Stingray's purchases of certain equipment it uses in its hydraulic fracturing operations. Because subsequent to the BTAs decision an amendment to R.C. 5739.02(B)(42) became effective that retroactively applies to the tax exemption at issue here, and because the BTA abused its discretion in refusing to abate penalties for tax assessments that were later canceled, we reverse the BTAs decision and remand for further consideration.


         {¶ 2} The central issue in this appeal is whether an exemption to the excise ("sales") tax applies to certain pieces of equipment purchased and used by Stingray in the production of crude oil and natural gas by a process known as hydraulic fracturing. To understand the context in which this issue arises, we start with a general description of hydraulic fracturing. Hydraulic fracturing is the process of inserting water, chemicals, and sand under high pressure through perforations in a casing that lines a well hole, to create fractures or cracks in shale formations to allow the extraction of oil and gas held in the formation. The size of the fractures is increased by the force of the hydraulic mixture delivered under pressure. The hydraulic mixture contains water, chemicals, cross link fluid (slick water with some friction reducer) and sand, called proppant, which holds the fractures open to allow the oil and gas to flow through them.

         {¶ 3} The appropriate amount of pressure and the mixture of water, sand, and chemicals is highly dependent on the geological conditions in the well. In some cases, the well will not accommodate the pressure necessary to deliver the large quantities of necessary sand. Gel made from guar and other materials is added when necessary to increase viscosity for pumping when a lower pressure is required. Guar acts as a suspending agent that holds the sand in place in the fractures. The decisions regarding what additives, and in what quantities, to mix into the fracturing fluid are made quickly while preparing the fluid and injecting it into the well.

         {¶ 4} Stingray is engaged in the production of crude oil and natural gas from shale formations by hydraulic fracturing. Stingray begins its hydraulic fracturing process after a separate company digs a well and inserts a metal casing. The casing is cemented in place in the well to ensure that it is held in place. A perforating company shoots holes in the casing and creates a connection with the shale formation. These holes are similar to doors that permit hydraulic fluid to flow. Only after the well is drilled, the casing is inserted and cemented, and the production casing is perforated, does Stingray begin its hydraulic fracturing production process.

         {¶ 5} The hydraulic fracturing production process involves numerous pieces of equipment. Stingray purchased data van command posts, pumps, high pressure manifolds, blenders, sand kings and sand silos, t-belts, hydration units, and related equipment for its hydraulic fracturing operation. Each piece of equipment is permanently mounted on a trailer and must be titled as a motor vehicle. Stingray believed that these equipment purchases were not subject to sales tax under an exemption contained in former R.C. 5739.02(B)(42)(a). Stingray paid no sales tax at the time of the motor vehicle transfers but supplied instead exemption certificates claiming "direct use - oil and gas." (Commissioner Final Determination July 17, 2015 at 2.)[1]

         {¶ 6} The tax commissioner initially issued 60 assessments for sales tax liability against Stingray. Each assessment corresponded to a piece of equipment Stingray purchased for its hydraulic fracturing operation that the tax commissioner deemed subject to the sales tax. Stingray disputed the assessments and filed petitions for reassessments with the tax commissioner. Stingray argued that the equipment at issue was exempt under former R.C. 5739.02(B)(42)(a) because the equipment was used directly in the production of crude oil and natural gas. The tax commissioner decided Stingray's requests for reassessments in two final determinations dated July 17 and August 24, 2015.[2] The tax commissioner canceled 33 assessments based on his determination that certain pieces of equipment qualified for an exemption under former R.C. 5739.02(B)(42)(a). However, the tax commissioner left intact the monetary penalties associated with the initial assessments. The tax commissioner affirmed the remaining 23 tax assessments based on his determination that they related to equipment not directly used in the production of crude oil and natural gas, and therefore, did not qualify for the exemption under former R.C. 5739.02(B)(42)(a).[3]

         {¶ 7} The tax commissioner's decisions were based on former R.C. 5739.02(B)(42)(a), which provided:

For the purpose of providing revenue with which to meet the needs of the state, for the use of the general revenue fund of the state, for the purpose of securing a thorough and efficient system of common schools throughout the state, for the purpose of affording revenues, in addition to those from general property taxes, permitted under constitutional limitations, and from other sources, for the support of local governmental functions, and for the purpose of reimbursing the state for the expense of administering this chapter, an excise tax is hereby levied on each retail sale made in this state.
(B) The tax does not apply to the following:
(42) Sales where the purpose of the purchaser is to do any of the following:
(a) To incorporate the thing transferred as a material or part into tangible personal property to be produced for sale by manufacturing, assembling, processing, or refining; or to use or consume the thing transferred directly in producing tangible personal property for sale by mining, including without limitation, the extraction from the earth of all substances that are classed geologically as minerals, production of crude oil and natural gas, or directly in the rendition of a public utility service, except that the sales tax levied by this section shall be collected upon all meals, drinks, and food for human consumption sold when transporting persons. Persons engaged in rendering services in the exploration for, and production of, crude oil and natural gas for others are deemed engaged directly in the exploration for and production of, crude oil and natural gas. This paragraph does not exempt from "retail sale" or "sales at retail" the sale of tangible personal property that is to be incorporated into a structure or improvement to real property.

(Emphasis added.)

         {¶ 8} Stingray appealed the tax commissioner's final determinations to the BTA arguing that the 23 pieces of equipment deemed by the tax commissioner to be taxable "work together in unison to [produce oil and gas] and cannot be separated from the production process," and therefore, should be exempt. (Feb. 14, 2018 Stingray's 2015-1465 Notice of Appeal at 4.) Stingray also appealed the penalties associated with the assessments that were canceled along with the 23 assessments that remained in place. The BTA consolidated the appeals for hearing and decision purposes.

         {¶ 9} On April 3, 2017, the BTA's attorney examiner conducted a combined hearing on both final determinations. Based upon the record of that hearing, the BTA issued its decision and order affirming the tax commissioner's final determinations (BTA Case Nos. 2015-1465 and 2015-1823 entered January 17, 2018). The BTA found that the contested pieces of equipment used to blend the hydraulic fluid and control the overall process are not exempt from sales tax because these pieces of equipment are not used directly in the production of crude oil and natural gas. The BTA based its decision on its interpretation of the exemption language contained in former R.C. 5739.02(B)(42)(a) ("to use * * * the thing transferred directly in producing tangible personal property for sale by mining, including without limitation * * * production of crude oil and natural gas") and on case law interpreting the scope of that exemption. The BTA principally relied on its prior decision in Indep. Frac Serv. v. Limbach, No. 1989-J-863 (June 28, 1991) and on Lyons v. Limbach, 40 Ohio St.3d 92 (1988) (tax assessments upheld for land reclamation equipment and "frac tanks" that store water at the well site because they were not used directly in the exploration for, or production of, crude oil and natural gas) and Kilbarger Constr., Inc. v. Limbach, 37 Ohio St.3d 234 (1988) (tax assessments upheld for equipment used to prepare a site for drilling oil and gas wells because they were not used directly in exploration for or production of oil and gas). The BTA stated:

We find our decision in Independent Frac Service dispositive as to the blenders and the equipment which feeds material to it, i.e., the sand kings/silos and t-belts, chemical add, and hydration unit. Stingray fails to demonstrate how the facts of the process used in these matters are distinguishable from the process at issue in Independent Frac Service. Stingray argues that, because the well had not yet been drilled in Independent Frac Service, this board's conclusion was foregone under the case law holding that the actual drilling of the well is the first point at which the mining equipment could possibly be exempt. See Kilbarger, supra. However, we reject such conclusion and agree with the Tax Commissioner that [the] focus of the inquiry is the actual usage of the equipment and not merely the sequence of events. 2016-1465 S.T. at 4. We further agree with the commissioner's conclusion that, just as with the blenders in Independent Frac Service, the equipment at issue in these matters are adjuncts to the drilling process. See Lyons, supra. In doing so, we reject Stingray's contention that these matters should be analyzed in a matter more similar to the analysis used in applying the manufacturing exemption. See id. at 95.

(BTA Decision and Order at 3.)

         {¶ 10} The BTA also denied Stingray's request that the assessed penalties be abated, stating:

Finally, we find that Stingray has failed to meet its burden with regard to abatement of the assessed penalties. Although it requested abatement in its notices of appeal, it has presented no further argument in support. In consideration of whether the assessed penalties should have been abated, we look to the Supreme Court's decision in Jennings & Churella Constr. Co. v. Lindley, 10 Ohio St.3d 67 (1984), where it held that "[r]emission of the penalty is discretionary. * * * Appellate review of this discretionary power is limited to a determination of whether an abuse has occurred." Id. at 70. Further, in Huffman v. Hair Surgeon, Inc., 19 Ohio St.3d 83 (1985), the court held"' "In order to have an 'abuse' in reaching such determination, the result must be so palpably and grossly violative of fact and logic that it evidences not the exercise of will but perversity of will, not the exercise of judgment but defiance thereof, not the exercise of reason but rather of passion or bias. * * *"' State v. Jenkins (1984), 15 Ohio St.3d 1674, 222." Id. at 87. See also J.M. Smucker, L.L.C. v. Levin, 113 Ohio St.3d 337, 2007-Ohio-2073, ¶ 16. Here, upon review of the record, we conclude there is no evidence that the commissioner abused his discretion with regard to the amount of the penalties assessed.

Id. at 3-4.

         {¶ 11} Stingray appeals the decision of the BTA affirming the tax commissioner's final determinations. However, subsequent to the filing of this appeal, the General Assembly amended R.C. 5739.02(B)(42), expressly as a remedial measure, to clarify the tax exemption at issue here. Because this amendment did not become effective until after the BTA issued its decision and order, the BTA did not apply the amended statute in rendering its determinations.


         {¶ 12} Stingray presents two assignments of ...

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