MEMORANDUM. To: National Ground Water Association Members. From: The National Ground Water Association. Date: July 20, 2011

Transcription

1 MEMORANDUM To: National Ground Water Association Members From: The National Ground Water Association Date: July 20, 2011 Re: Applicability of Federal Retail Sale Excise Tax The following Memorandum analyzes the applicability of the retail sale excise tax on the sale of heavy trucks under 4051 of the Internal Revenue Code to portable drilling rigs manufactured, sold, or used by the members of the National Ground Water Association. Keep in mind that the tax is currently set to expire at the close of September 30, 2011, but Congress is anticipated to extend the tax. The analysis that follows serves only as a guide as to the current status of the law, the arguments made by drilling rig manufacturers and the IRS, and the varying successes the parties have had. The ultimate treatment of a particular portable drilling rig will depend heavily on the drilling rig s individual specifications. Accordingly, the National Ground Water Association strongly recommends that each Member rely on its and its attorney s own examination of each portable drilling rig in question. Nothing in the contents of this Memorandum, nor any prior or subsequent communication between the National Ground Water Association and its Members, shall constitute legal, tax, or financial advice. THE NATIONAL GROUND WATER ASSOCIATION STRONGLY RECOMMENDS THAT EACH MEMBER SHOULD CONSULT WITH HIS OR HER OWN ADVISORS AS TO LEGAL, TAX, FINANCIAL AND RELATED MATTERS CONCERNING THE APPLICABILITY OF A FEDERAL EXCISE TAX TO A PORTABLE DRILLING RIG. I. The Portable Drilling Rig - General Specifications and Usage A portable drilling rig is a piece of construction equipment used to drill water wells. Portable drilling rigs feature a large drill welded to a heavily modified truck chassis. The drill, when in use, is oriented vertically, allowing for the drill to enter squarely with the ground. When not in use, the drill is moved to a horizontal position above the vehicles chassis. Portable drilling rigs are not available off the shelf from truck manufacturers that produce highway vehicles. The type of chassis used in a portable drilling rig is available only from certain truck manufacturers and only through a special order to the factory. Many of the specified components of the portable drilling rigs are far more expensive than those which would be used in the construction of an over-the-highway truck, resulting in a truck which is more expensive than a more typical over-the-highway truck would be. Other components, such as the cab, are less expensive than an over-the-highway cab because so little time is spent in the cab of a portable drilling rig. 1

2 Although the exact characteristics vary by portable drilling rig model and manufacturer, the heavy duty chassis used as components of portable drilling rigs have the characteristics listed below. They are not standard options and are not typically found on most highway trucks. The chassis of a portable drilling rig generally has a double frame in which the standard frame is reinforced by welding a second frame within the standard frame. This is necessary to permit the chassis to withstand the extra weight of the drilling apparatus and related equipment. The double frame also provides much better rigidity to withstand the twisting caused by the operation of the drilling rig. The double frame is approximately twice as heavy as a standard frame. That extra weight significantly reduces a drilling rig s fuel mileage, and it makes the rigs much harder to drive on a highway. The double frame often extends forward of the truck s front grille to allow for attachment of the outrigger jacks, which are described below. Such an extended frame is seldom a feature associated with a truck that is suitable for highway use. Portable drilling rigs must be capable of operating in difficult off-road conditions. They must operate in mud, in soft ground, in sand, over uneven terrain, up hills, and on mountains. They must creep over gullies and ditches. Therefore, they have extra-low creeper gears and locking rears to make this possible. At the same time, the trucks do not have the gears and shifting mechanisms necessary for economically efficient highway travel. The trucks generally have a maximum speed of fifty to fifty-five miles per hour on a level highway. Because the gears on these trucks are limited, the trucks cannot maintain their speed on uphill grades or shift gears easily in order to operate effectively on the highways. To enable off-highway transportation of the drilling rig, and to provide the rigidity needed for drilling, the suspension must be very stiff. Off-highway suspensions of the type used in these trucks do not perform well on highways and would not be tolerated for highway use. Frequently, the trucks are ordered with rubber block suspensions, which contain no springs at all. Alternatively, where springs are used, they are very heavy-duty springs which do not ease the ride of the truck at all and, in fact, the portable drilling rig manufacturer typically eliminates the range of motion of the springs. This adaptation is necessary to provide greater stability for the drilling function. To support the weight of the portable drilling apparatus, the axles used in the chassis are much heavier than those that would be used in typical highway trucks. For example, a standard truck s front axle might be rated for a 12,000 pound load. A portable drilling rig would typically need a front axle that is rated for an 18,000 pound load. Some of the portable drilling rigs are powered by the truck engine, which is termed a power take off. This requires a larger engine and an expensive drive train not found in a highway truck. The portable drilling rig manufacturer must then make substantial modifications to the drive line. Other portable drilling rigs use a separate engine to power the drilling apparatus. In that case, the truck engine is much less powerful than a highway truck s engine because the drilling rig is used so rarely over the highways that it is not worth spending any real money on this feature. In addition, manufacturers make their drilling rigs as compact as possible for easier maneuvering at the job site. Truck chassis are purchased with extremely small fuel 2

3 tanks to make the portable drilling rig more compact. These tanks are too small for normal highway driving. After receiving the customized truck chassis from the general truck manufacturer, portable drilling rig manufacturers make additional modifications to the trucks prior to attaching the drill rig machinery. The frame often needs additional strengthening and the suspension typically needs to be further enhanced. Sometimes, an extra detachable axle must be added. This axle is used only on the highways and is detached for off-road use. The portable drilling rig manufacturer normally adds several outrigger jacks, which are bolted and welded to the front and rear of chassis. At a job site, the outrigger jacks are lowered and all of the weight rests on these jacks (in other words, the tires do not touch the ground). These heavy duty jacks are suited solely for non-highway use. The drill rig machinery is both bolted and welded to the truck chassis. On a typical rig, there are ten or more spots where the drilling rig is welded to the chassis. Once the drill rig machinery is attached, there no room or weight capacity for carrying any additional loads. Portable drilling rig manufacturers attempt to design the portable drilling rigs to be legal vehicles to go over the highway in most states. However, the portable drilling rigs may need special signs mounted on them to specify that they are over-height or over-width, and sometimes a special escort is required when driving the portable rigs on the highways. Additionally, special mirrors or other equipment may be required to travel on the highways. Typically, over 95% of a portable drilling rig s life is spent as a stationary drill at a job site. In one example, a manufacturer accepted a 1985 model drilling rig in trade, and the vehicle had less than 110,000 driving miles in over 17 years of usage. The engine for the drilling apparatus had been used for over 55,000 hours. II. Legal Analysis. A. Section 4051 and the Highway Vehicle. As stated in 4051(a)(1) of the Internal Revenue Code ( I.R.C. ): There is hereby imposed on the first retail sale of the following articles (including in each case parts or accessories sold on or in connection therewith or with the sale thereof) a tax of 12 percent of the amount for which the article is so sold: (A) (B) (C) (D) Automobile truck chassis. Automobile truck bodies. Truck trailer and semitrailer chassis Truck trailer and semitrailer bodies. 3

4 (E) Tractors of the kind chiefly used for highway transportation in combination with a trailer or semitrailer. However, the regulations clarify that this section applies to certain chassis and bodies only if such chassis or body is sold for use as a component part of a highway vehicle. Reg (a)(2). Thus, the first step in analyzing whether portable drilling rigs are subject to the excise tax under I.R.C is to determine if the drilling rigs are highway vehicles. The regulations define highway vehicle to mean any self-propelled vehicle, or any trailer or semi-trailer, designed for transporting a load over public highways, whether or not it is also designed to perform other functions. Reg (a)-1(d)(1). It is also immaterial as to specially designed machinery or equipment that such machinery or equipment is permanently mounted on the vehicle. Id. The term transport as used in Reg (a)-1(d)(1) includes the term tow and the term public highway includes any road (whether a federal highway, state highway, city street, or otherwise) in the U.S. that is not a private roadway. The term highway vehicle is intentionally defined broadly. For instance, a tanker which was used to deliver liquid asphalt to a job-site, even though it also was used to apply the asphalt to a roof, was deemed to be a highway vehicle. Liquid Asphalt Systems Inc. v. U.S., 52 AFTR 2d Another example of a highway vehicle is a piece of mobile machinery designed to remove traffic lines from pavement by grinding them off. IRS Letter Ruling In contrast, examples of non-highway vehicles include industrial tractors used to carry loads at railroad stations and in warehouses, and diesel-powered vehicles operated in mine pits, even if capable of occasional emergency use on the highways. See Rev. Rul ; Rev. Rul Based on the express language of the regulations, portable drilling rigs would qualify as highway vehicles, and thus are subject (absent an applicable exemption) to the retail sales tax imposed under B. Exceptions to Excise Tax As noted above, there are certain exceptions to the broad definition of highway vehicle as well as express statutory exemptions under the I.R.C. The two primary exceptions discussed herein are the Off-Highway Transportation Vehicle exception and the Mobile Machinery Exception. i). Off-Highway Transportation Vehicle. Under I.R.C. Section 7701(a)(48)(A)(i), a vehicle will not be treated as a highway vehicle for purposes of the retail sale excise tax if the vehicle is (a) specially designed for the primary function of transporting a particular type of load other than over the public highway and (b) because of this special design the vehicle s capability to transport a load over the public highway is substantially limited or impaired. Therefore, to qualify under the off-highway vehicle exception, the vehicle must be primarily designed to drive over non-public roads. The off-highway vehicle exception has usually applied to vehicles designed to transport a load whose special design features make them unsuitable for transporting their load over the 4

5 public highway. P.L.R Typically, vehicles qualifying under the off-highway vehicle exception transport removable loads (as opposed to machinery fixed to the chassis), but transport such removable loads off the highway - such as mines or quarries. Id. However, just because a vehicle is capable of transporting a load on the public highways does not preclude application of the off-highway vehicle exception - as long as the vehicles (a) primary design is for transporting a load off-highway and (b) such design limits its ability to transport its load over the public highways, the exception will apply For purposes of the off-highway vehicle exception, a vehicle s design is determined solely on the basis of its physical characteristics. I.R.C. 7701(a)(48)(A)(ii). The physical characteristics of a portable drilling rig indicate that they are primarily designed to carry the drilling rig itself. All the structural modifications to the springs, axles, suspension, etc. are made in order to (1) carry the drill on both public and non-public roads and (2) effectively operate the drill on site. Of course, the physical design characteristics of a portable drilling rig also allow it to transport the drill itself off of public roads. However, simply because a portable drilling rig is capable of operating off road does not mean this was its primary design. For instance, in Schlumberger Technology Corp. v. U.S., 91 AFTR (55 Fed. Cl. 2003), the court determined that a sand dump truck and conical cement transport trucks did not qualify as offhighway vehicles on the basis that the trucks in question logged 80% of their mileage over public highways. Therefore, the trucks cannot be said to have been specially designed for the extremes of off-highway use; instead, they were specially designed to carry a load over several different types of terrain. Id. That is not to say, however, that an argument could not be made that portable drilling rigs qualify as off-highway vehicles. See e.g., Gateway Equipment Corp. v. U.S., 247 F.Supp. 2d 299 (W.D. N.Y. 2003) (finding that a vehicle that delivers hot mix asphalt to highway construction sites qualifies under the off-highway vehicle exception because, in part, the vehicle spends percent of its time off the public highway). Arguments to the IRS under the off-highway vehicle exception should focus on an attempt to establish that the particular portable drilling rig in question was designed primarily for off-road transportation usage. Members should keep in mind that some portable drilling rigs are frequently designed with the intention of being used on the public roads as a transportation for the drill. Other drilling rigs that do away with any attempt at being street legal may be better candidates to fit under this exception. Moreover, the actual percentage of time spent by the drilling rig on public highways will undoubtedly affect whether the vehicle will qualify for the exception. ii). Mobile Machinery Exception. Section 4053 of the I.R.C. provides: No tax shall be imposed by section 4051 on any of the following articles: (8) Mobile Machinery. Any vehicle which consists of a chassis - 5

6 (A) to which there has been permanently mounted (by welding, bolting, riveting, or other means) machinery or equipment to perform a construction, manufacturing, processing, farming, mining, drilling, timbering, or similar operation if the operation of the machinery is unrelated to transportation on or off public highways, (B) which has been specially designed to serve only as a mobile carriage and mount (and a power source, where applicable) for the particular machinery or equipment involved, whether or not such machinery or equipment is in operation, and (C) which, by reason of such special design, could not, without substantial structural modification, be used as a component of a vehicle designed to perform a function of transporting any load other than that particular machinery or equipment or similar machinery or equipment requiring such specially designed chassis. Thus, the mobile machinery exception assumes that a vehicle is roadworthy and instead focuses on whether the design of the chassis is solely limited to the transportation of particular job-site equipment. Part (A) of the mobile machinery exception is met if the equipment at issue is (1) permanently mounted on the chassis of the vehicle and (2) if its operation is unrelated to transportation. See Schlumberger Technology Corp. v. U.S., 91 AFTR 2d (55 Fed. Cl. 2003). Although some variation could exist depending on an individual portable drilling rig s characteristics, most portable drilling rigs will satisfy Part (A). The drilling rig itself is welded in several spots to the truck s chassis, and thus is certainly permanently mounted. It seems equally clear that the operation of the drilling rig is unrelated to transportation. It would strain credulity to suggest that drilling a water well somehow involves transportation. Members attempting to fit their portable drilling rigs under the mobile machinery exception should give greater thought to Part (B). In order to meet Part (B), the vehicle s chassis must be designed only as a mobile carriage for the job-site equipment. Several court cases have discussed this standard and wrestled with whether Part (B) permits the chassis to perform other minor purposes. For instance, in Florida Power & Light Company, 375 F.3d 1119 (Fed. Cir. 2004), Florida Power & Light, a utility company, sought to recover excise taxes paid on the use of various types of specially designed trucks used on the operation and maintenance of the company s power distribution system. Like portable drilling rigs, these trucks included a variety of non-standard features, such as reinforced frames, modification of the chassis, etc. However, each vehicle also was equipped with a pintle hook which created towing capacities of 6,000 to 20,000 pounds. The Federal Circuit concluded that, even though the addition of the pintle hook was a minor modification not central to the vehicles primary purpose, the chassis has been modified to serve also as a towing device. As such, the chassis has not been specially designed 6

7 to serve only as a mobile carriage and mount Id. at 1123 (emphasis included); see also, Schlumberger, 91 AFTR 2d ( only means only. ). Thus, any other design feature to the chassis other than those geared towards transporting the drilling rig will fail Part (B). Furthermore, Courts have acknowledged that the only requirement will be strictly enforced, even though businesses will have to use two trucks to do the same job for which they now use one. Florida Power, 375 F.3d at On the other hand, it seems that only may be qualified by some sort of materiality threshold. As at least one court has noted, it is not necessary that designers eliminate any nooks and crannies where some cargo could conceivably be stashed. It is not necessary, for example, that there be no place for tools, clothing and safety equipment. The court believes that vehicles which carry the foregoing and similar items as incidental cargo may nevertheless be deemed to qualify under part (B) of the exception. Schlumberger, 91 AFTR 2d The analysis of whether the requirements of part (B) are met will be driven entirely by the specific features and specifications of the particular vehicle in question. Although a typical portable drilling rig s design process contemplates only the transportation of the drilling rig itself, Members and their counsel are advised to do a thorough examination of their own particular portable drilling rigs under Part (B) of the test. Unfortunately, the analysis under Part (C) of the test is equally as fact intensive as that in Part (B). However, there are court cases and revenue rulings holding certain vehicles analogous to portable drilling rigs to satisfy Part (C). Under Part (C), a vehicle s special design must be of a nature that would prevent the vehicle to perform another function without substantial structural modification. Courts have applied Part (C) of the test to Digger Derrick vehicles, which have modifications that are somewhat analagous to those on a drilling rig. Utilicorp United v. U.S., 66 AFTR 2d The Digger Derrick models in Utilicorp were self-propelled medium duty trucks with gross vehicle weight ratings in the range of 24,000 to 27,500 pounds. The vehicle consisted primarily of a hydraulically-powered boom, mounted to the right-rear of the chassis, which had several implements attached which assisted in the placement and maintenance of power utility poles. Like a portable drilling rig, the boom is placed in a vertical fashion while in use, but then retracted back into a horizontal storage position. The IRS conceded that parts (A) and (B) were met by the Digger Derrick. Thus, the only requirement at issue was that in Part (C). The Court first noted that the focus must be on the chassis immediately prior to the installation of the equipment. Id. citing Halliburton Co. v. U.S. 611 F.Supp. 1118, 1128 (N.D. Tex. 1985). Therefore, in order to determine whether the vehicle was suitable for other functions, the inquiry would be with respect to the chassis immediately prior to the digger derrick equipment being mounted. Id. The Court, also citing Halliburton, noted that in the context of Part (C), substantial meant important or essential. Id. Ultimately, the Court concluded that the Digger Derricks qualified for the special mobile exception. In particular, the Court relied on certain modifications to the chassis that made it unsuitable for transporting a load without substantial structural modification. First, the Court 7

8 noted that additional fishplating adds considerable weight to the chassis and keeps the frame from twisting when the digger derrick equipment is used it is clear that extra weight does tend to limit the alternate uses for which the vehicle may be used. Furthermore, if one were to remove the welded fishplating, it would be a substantial and structural modification. Id. The Court also determined that a potential removal of the Digger Derrick s significant right rear springs would meet the mobile machinery exception: All 51 vehicles in issue have a skewed rear end configuration to accommodate the digger derrick equipment which if not removed would cause the vehicle to pull severely to the left when driven, thus posing a threat to highway safety. In performing its analysis on both the fishplating and right rear springs (as well as the other structural modifications designed to carry the Digger Derrick equipment), the Court employed a reasonable or economic feasibility test: Id. In the final analysis, this Court must rely on the rule of reason. In the abstract, it is quite clear that virtually any vehicle can be modified so as to make it useful for another purpose. The question that must be answered, however, is, in the real world, would these vehicles be modified to perform another over-the-road use? The very words used in the regulations in part C without substantial structural modification connote an economic feasibility or reasonability test. Is it economically feasible to modify those vehicles back from the special design part B of the regulations to convert the vehicles to a over-the-road use? In the judgment of the Court, the answer is no! Unfortunately, not all the courts have concurred with this description of the test under Part (C). In Schlumberger Technology, the plaintiff made similar arguments in regards to certain tractors - that a reasonable businessman would have to remove and alter significant aspects of the tractor before it could be economically used as a component of a highway vehicle. The Court rejected the plaintiff s argument, stating that: [P]laintiff does not point to text in the regulation which allows an exception for structural modifications required for the unit to serve economically as a highway vehicle.while all modifications enumerated by plaintiff may well be required for the tractor to serve economically as a highway vehicle, none is needed for the tractors to be used as a component of a vehicle designed to perform a function of transportation. Schlumberger Technology, 91 AFTR 2d The different approach taken by Utilicorp and Schlumberger make it difficult to predict with certainty how a court would analyze the portable drilling rigs. If a court were to adopt the approach taken in Utilicorp and Halliburton, it would be more likely that portable drilling rigs would satisfy Part (C). Almost universally, portable drilling rigs have variety of features that would need to be altered or removed for it to carry another load in an economically feasible 8

9 manner. Material added to reinforce the chassis would have to be removed to increase gas mileage. The gearing would have to be changed to increase the vehicles speed. The gas tank would need to be replaced with a larger version. As the Utilicorp court stated, [i]t is clearly unrealistic and impractical to believe that a purchaser would buy a chassis with expensive equipment that is not needed and then pay more money to have the equipment removed. Utilicorp, 66 AFTR 2d The analysis under Schlumberger is more problematic, as (apparently) these real world economic considerations do not matter. The question is narrower under Schlumberger can the portable drilling rig physically carry a load without a structural modification? Although not before the Schlumberger court, presumably the right rear spring in the Digger Derricks would meet this test. Failure to remove the right rear spring would cause a safety hazard, as the vehicle s natural tendency would be to drift off the road. It would seem that a vehicle unable to climb steep roads without alteration of the gearing and removal of weight would meet the Schlumberger test. Any fact that points to a portable drilling rigs chassis being unable to otherwise carry a load without structural modification increases the likelihood that Part (C) under Schlumberger is met. The IRS has not adopted either test. However, the test employed by Utilicorp is both logically more sound and has been adopted by a larger number of courts. E.g., Custom Bodies, Inc. v. U.S., 56 AFTR 2d ; see also, Gateway Equipment Corp. v. U.S., 247 F.Supp.2d 299, 312 (W.D. N.Y. 2003) (analyzing the economic feasibility test under the off-highway vehicle exception). However, Utilicorp, Halliburton, and Custom Bodies are not binding upon the courts, and therefore it is uncertain how any particular court would analyze any particular portable drilling rig. III. Conclusion. Of course, no universal answer exists for the question of whether portable drilling rigs fit within an exception to the retail sale excise tax. Instead, each Member confronted with a claim by the IRS that the tax applies must conduct its own analysis as to each portable drilling rig in question. With the retail sale excise tax set to expire later in the year, remember to check with your counsel or tax advisor to see if the anticipated extension changes the way the retail sale excise tax impacts your business. 9