Reed Smith Client Alert

Authors: Lee A. Zoeller Stephen J. Blazick

Type: Client Alerts

Using subcontractors does not 'fracture' your exemption from Pennsylvania sales tax

The Pennsylvania Department of Revenue has taken the position that certain equipment used in Pennsylvania fracking operations is subject to sales tax when that equipment is used by someone other than the owner (i.e., a subcontractor). That position is contrary to existing case law, which provides that all equipment used in mining (which includes fracking) is exempt from Pennsylvania sales tax, regardless of who uses it.

Pennsylvania’s mining exemption from sales and use tax is quite broad and applies to all purchases of equipment used directly in mining.1 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.2 Of course, this exemption is of paramount importance for all companies that have operations in the Pennsylvania portion of the Marcellus Shale Natural Gas Field Formation. This is because companies that extract natural gas from the Marcellus Shale clearly qualify for the mining exemption, and should not pay sales or use tax on any of their equipment purchases used in their Pennsylvania fracking operations.

The current state of the law is that it is the nature of the work and not the identity of the person who performed the work that controls the applicability of the mining exemption. Relying on the court’s decision in Commonwealth v. R.G. Johnson,3 the Department, in private guidance, has previously opined that a subcontractor's activity fell under the mining exemption, even though the subcontractor itself was not mining or extracting anything, because the actual mining activities were dependent upon the machinery and equipment the subcontractor employed.

Many natural-gas-extraction companies use subcontractors to assist in, or entirely conduct, their mining operations in Pennsylvania. According to R.G. Johnson, all of the equipment that these companies use in mining is exempt from sales and use tax, even if the subcontractor does not own or purchase the equipment itself. Consider the following example: Natural Gas Co. purchases fracking equipment and hires Subcontractor Co. to operate the fracking equipment. In this example, neither Natural Gas Co. nor Subcontractor Co. should pay sales or use tax on the equipment because the fracking equipment is used in mining operations. Who purchases the equipment or who has ownership of it is completely irrelevant. It is the use of the equipment that controls the exemption. In this example, fracking clearly constitutes mining operations, and the purchase and use of the equipment is exempt from Pennsylvania sales and use tax.

Unfortunately for Pennsylvania taxpayers, the Pennsylvania Department of Revenue has issued guidance that contradicts its prior interpretation of the exemption, and contradicts also the Pennsylvania Supreme Court’s holding in R.G. Johnson. Specifically, in a December 2011/ January 2012 Tax Update, the Department stated that "otherwise tax-exempt drilling equipment would be taxable if purchased by a party who then gives the equipment to a business engaged in the extraction of natural gas." Under current Pennsylvania law, this is not accurate. As we mention above, as long as the equipment is used in mining, it is exempt from sales and use tax (regardless of who actually uses the equipment) because it is the nature of the work that controls the exemption.

The Department has been issuing assessments to taxpayers based on the position taken in the Tax Update. In addition, we suspect that many taxpayers have been following the Department’s new position, as expressed in the Tax Update, and have been paying sales or use tax on purchases of equipment that fall within the mining exemption. Reed Smith State Tax Lawyers have been successful in defeating these assessments, and have also obtained tax refunds for taxpayers who paid tax based on the Department’s new position. If your company has received an assessment on these grounds, or has errantly paid tax based on the Department’s new, narrow, interpretation of the mining exemption, you should contact one of the authors of this alert, or the Reed Smith lawyer with whom you usually work, to discuss your appeal/refund rights.


1. 72 P.S. § 7201(c)(3).
2. 61 Pa. Code § 32.35(a). A purchase is deemed to be predominantly used in mining if it is used more than 50 percent of the time in mining operations. 61 Pa. Code § 32.35(a)(2).
3. Commonwealth of Pennsylvania v. R.G. Johnson Co., 433 A.2d 465 (1981).