Texas Comptroller of Public Accounts    STAR System


200802434L



AP 116

Date: February 4, 2008
To: All Audit Managers
From: Tony Luna Manager-Audit Division
Subject: Natural Gas Tax-Audit Policy on Marketing Costs

Attached is the Audit Policy on Marketing Costs, a comprehensive report on 
allowable and non-allowable items for marketing cost deductions in the natural 
gas severance tax. 

The purpose of this AP memo is to provide detailed guidelines on the marketing 
cost issue and make clear our position on allowable and non-allowable items so 
that policies can be applied consistently.   While the list is certainly not 
inclusive of every type of cost that an auditor may encounter, the logic 
provided should serve as a basis for making decisions on any other type of 
cost.

Please provide this report to all auditors working with the Crude Oil and 
Natural Gas taxes. 

If there are any questions on this report, they should be directed to Audit 
Headquarters subject matter expert or the Tax Policy subject matter expert.

AP 116
NATURAL GAS SEVERANCE TAXES AUDIT POLICY ON MARKETING COSTS

Section 201.101 of the Tax Code states “The market value of gas is its value at 
the mouth of the well from which it is produced.” Rule 3.15, Gas Marketing 
Costs, states “The ‘market value at the mouth of the well’ shall be determined 
by ascertaining the producer’s actual marketing costs and subtracting those 
costs from the producer’s gross cash receipts from the sale of the gas.” Market 
value has been further discussed in the court case Mobil v. Calvert, 451 SW 2d 
889 (Tex 1970).

The purpose of the marketing cost deduction is not to cause the taxable value 
to be a “net income” tax. It simply equalizes the tax burden for those selling 
at or near the point of production with those who have to treat the gas and 
send it further away to market. Where there is no compression, sweetening, 
dehydration or transportation to the market, there will be no marketing costs. 
(The one exception is for costs on the sales meter or a necessary allocation 
meter. See “Meters” for more information on this subject.)

If a marketing facility is being used for gas lift, pressure maintenance or 
handling gas for outside parties, those volumes must also be included to 
calculate a “per mcf” value for the marketing cost deduction. The volumes for 
gas that qualify for one of the exemptions from tax (i.e., high cost gas) must 
also be used in the calculation of a “per mcf” cost.

Marketing costs may not reduce the taxable value of gas below zero. Marketing 
costs may not be carried forward from one month to another.

Three general rules:

(1)  Marketing costs do not include any costs associated with producing natural 
gas or with the separation of natural gas from oil, condensate and water.
(2)  The cost must be necessary and essential to marketing the gas.
(3)  The cost should be directly related to the physical handling of the gas.

General Concepts:

(1)  Only the lease operator can take marketing cost deductions.

(a)  What if other interest owners have paid their own share of the taxes? Can 
they then take their own share of the costs?

No, but the operator taking the costs should reimburse the other interest 
owners for their share of the costs. Exception: If the producer puts in writing 
that they will tell the other parties the amount of the costs, and agree to 
make supporting records available, the non-operator can take marketing cost 
deductions. Also, a non-operating, tax-paying interest owner may file for a 
refund of marketing costs if the operator provides supporting documentation and 
if the operator has not already deducted those same costs or received a refund 
for those costs. 

Note: each non-operator has their own statute of limitations for the purposes 
of filing refunds.

(b)  What if the gas purchaser is paying the tax? Can the producer tell the 
purchaser how much the costs were so that the purchaser can enter them on the 
tax return? 

No. The purchaser can only take costs that are built into the contract.

(c)  What if the gas purchaser has paid the tax? Can the producer and/or 
operator get an assignment letter from the purchaser and file for a refund on 
their costs?

Yes. They may file the costs on a schedule rather than on amended returns since 
they have zero reported value.

(2)  Amended returns need to be filed for all refund requests. Amended returns 
are required to provide a good audit trail for costs taken. If additional costs 
are submitted as part of a refund request and are to be incorporated in an 
audit and/or filed on a schedule, the taxpayer must first obtain approval from 
Account Maintenance Division and from Audit Division.

(3)  Taxpayers can compute costs on an annual basis and use a rate per MCF for 
reporting, then go back at the end of the year and compute the actual costs and 
rate. Then if the rate used was too high or too low, the rate for the next year 
must be adjusted accordingly. Actual costs must be used for audits and refund 
requests.

(4)  A reasonable amount is allowed for overhead, at a rate of 6% of the 
appropriate accounts. The “overhead” accounts from which the 6% is taken are to 
be marketing related overhead accounts. Joint interest billings can be used to 
determine the accounts if necessary, but joint interest billings or amounts 
billed as “COPAS” overhead can NOT be used directly as the overhead amount.

(5)  Costs can be allocated between sales and gas lift systems by using a ratio 
of gas sales to the total gas produced or compressed.

(6)  Costs can be allocated between gas and condensate systems by:
(a)  hydrocarbon liquids to gas method
(b)  gas to hydrocarbon liquids method

(7)  Typical depreciation and return on investment calculation:
Purchase price = $100,000
Salvage value = $ 10,000
Useful life = 10 years

Depreciation per year = $100,000 - $10,000 = $90,000/10 yrs = $9,000 per yr

Return on investment:
Undepreciated balance at beginning of year = $100,000
Undepreciated balance at end of year = $91,000
Subtotal = $191,000
Divided by 2 = $95,500
Less: salvage value = -10,000
Average undepreciated balance = $85,500
Multiplied by 6 percent rate = .06
Return on Investment per year = $5,130

Notes:

(a)  Useful life and depreciation rate: Ten years useful life and a 
depreciation rate of 10% per year is normally used for field equipment. Twenty 
years useful life or more is normally used for plants. However, a different 
term can be used if the situation calls for it, based upon documentation in the 
taxpayer’s records. Useful life must be the lesser of the expected life of the 
equipment or the life of the field. Straight-line depreciation is the preferred 
and recommended depreciation method. 

(b)  If another method is used, the taxpayer should be ready to support why 
that particular method is appropriate for the situation. Useful life should be 
adjusted for major capital improvements. Useful life for marketing cost 
purposes should match the depreciation on the financial books.

(c)  In cases where one company acquires another, it is best to use the value 
placed on the new owner’s books. If the new owners place no value on the 
equipment, valuing only the reserves, the company should not be allowed to 
depreciate the equipment.

(d)If equipment that has been fully depreciated is sold for more than the 
salvage value, the additional “profit” is subject to severance tax. If 
equipment that is not yet fully depreciated is sold for more than book value, 
the excess depreciation taken can be recouped. In either case, tax is due, and 
auditors should assess this in audits.

(e)  If fully depreciated equipment continues in use by the taxpayer, they can 
continue to deduct the return on investment amount on the salvage value.

(8)Lease schematics appropriate to the relevant time period and signed by a 
company engineer should be provided for all audits or refund requests. If not 
available, a written description, including a listing of equipment, signed by a 
company engineer, may be provided.

The following lists present various costs by category as “Allowable” or 
“Disallowed” as marketing costs. The exact answer as to whether the cost is 
deductible or not often depends upon exactly how the item is used. Also, if the 
cost is deductible, it must be determined whether the item should be expensed 
or depreciated.

Wellhead and Downhole Equipment/Operations

Comments: These items all relate to either the drilling of the well or well 
servicing activities. None are deductible as marketing costs.

Item: Acidizing
Allowable:
Disallowed: x
Comments:

Item: Casing
Allowable:
Disallowed: x
Comments:

Item: Cementing
Allowable:
Disallowed: x
Comments:

Item: Drill Pipe
Allowable:
Disallowed: x
Comments:

Item: Fishing/fishing tools
Allowable:
Disallowed: x
Comments:

Item: Fracturing
Allowable:
Disallowed: x
Comments:

Item: Hot oiling/hot oil treatment
Allowable: x
Disallowed: x
Comments: Allowable if used in flow lines on a percentage basis.  Downhole uses 
are not allowed.

Item: Injecting baroid
Allowable:
Disallowed: x
Comments:

Item: Logging
Allowable:
Disallowed: x
Comments:

Item: Packers/setting packers 
Allowable:
Disallowed: x
Comments:

Item: Paraffin removal
Allowable:
Disallowed: x
Comments:

Item: Perforating
Allowable:
Disallowed: x
Comments:

Item: Swabbing
Allowable:
Disallowed: x
Comments:

Item: Tubing
Allowable:
Disallowed: x
Comments:

Item: Well Service
Allowable:
Disallowed: x
Comments:

Item: Wire line service
Allowable:
Disallowed: x
Comments:

Production equipment/operations

Comments: These items are all involved with the production of oil and gas, not 
marketing the gas. Therefore, none is allowable as marketing costs.

Item: Christmas tree
Allowable:
Disallowed: x
Comments:

Item: Compressors: wellhead/suction/vacuum
Allowable:
Disallowed: x
Comments: This type of compressor is used to create a vacuum or suction 
pressure to help produce oil and gas.  Our policy is that if a well has a 
flowing pressure greater than the atmospheric pressure (14.65 psi), the oil and 
gas will flow to the surface in a natural state without the aid of a 
compressor.  Therefore, the compressor is allowable as marketing cost.  If the 
flowing pressure is less than the atmospheric pressure, the well will not 
produce without the compressor.  Consequently, the compressor relates to 
production, and its cost are not deductible as a marketing expense. 

Item: Corrosion inhibiting chemicals
Allowable:*
Disallowed: x
Comments: Most of these chemicals are used downhole and are not allowable.  If 
the chemical is used in pipelines that are part of the marketing function, that 
portion may  be allowed

Item: Downhole separation
Allowable:
Disallowed: x
Comments:

Item: Electricity to run pumping unit
Allowable:
Disallowed: x
Comments:

Item: Lease use gas to run pumping unit
Allowable:
Disallowed: x
Comments: Gas used to run a pumping unit is taxable as lease use gas, and there 
is not a corresponding marketing deduction for this gas value since pumping 
units are used to produce oil and gas.

Item: Pumping unit
Allowable:
Disallowed: x
Comments:

Item: Replacement valves/parts for Christmas tree
Allowable:
Disallowed: x
Comments:

Item: Rods/pulling rods
Allowable:
Disallowed: x
Comments:

Item: Submersible pumps
Allowable:
Disallowed: x
Comments:

Item: Tanks
Allowable:
Disallowed: x
Comments:

Item: Tank and Vessel
Allowable:
Disallowed: x
Comments:

Item: Automatic Shut-Down Devices (ASDs)
Allowable:
Disallowed: x
Comments: The devices will automatically shut-down the operations of all lease 
equipment in the event there is a problem with the wellhead or within the lease 
operations.

Lease Equipment After the Wellhead

Item: Air compressors used to start lease equipment 
Allowable: 
Disallowed: x
Comments: Not allowable unless used to start equipment that otherwise qualifies 
as marketing equipment. 

Item: Cathodic protection
Allowable: x
Disallowed: x
Comments: These are rods used to prevent corrosion of pipes and vessels.  They 
are allowed if used on the marketing gathering lines or if used on any allowed 
marketing equipment but not allowed if used downhole.  

Item: Chrome/stainless steel piping for handling gas with high H2S content
Allowable: x*
Disallowed:
Comments: *Depends on if the piping qualifies as allowable, based on location 
of the piping and its function.  The “chrome/stainless steel” element is 
irrelevant.

Item: Cranes for compressor building
Allowable: x
Disallowed:
Comments: Used to lift and move the compressor.  Sometimes referred to by just 
the cranes’s brand name such as “Coffing”

Item: Compressor installation charges
Allowable: x
Disallowed:
Comments: If the compressor is owned and used in a manner related to gas 
marketing, the installation costs may be included in depreciable base. 

Item: Compressors/parts and service for compressors gas lift systems 
Allowable: 
Disallowed x:
Comments:

Item: Compressors/parts and service for compressors to return gas to leases 
Allowable:
Disallowed: x
Comments:

Item: Compressors/parts and service for compressors to get gas up to required 
sales pressure. Compressors owned rather than rented. 
Allowable: x
Disallowed:
Comments: If compressors perform a dual purpose, the costs can be allocated 
between allowable and not allowable marketing costs.  Must be depreciated over 
useful life, and return on investment may be calculated.

Item: Compressors - rented sales compressors 
Allowable: x
Disallowed:
Comments: Deducted as a monthly expense.

Item: Compressors – at central facility (compressor stations)
Allowable: x
Disallowed:
Comments: Same as above for all compressors

Item: Compressors – transmission line
Allowable: 
Disallowed: x
Comments: Not allowable unless it occurs before the sale has been made. 

Item: Compression charge on settlement statement
Allowable: x*
Disallowed:
Comments: *Allowable if not already deducted from the reported gas sales price.

Item: Compressor fuel for gas lift compressors
Allowable:
Disallowed: x
Comments:

Item: Concrete slab for compressor
Allowable: x
Disallowed:
Comments: If compressor is owned, cost of slab may be included in depreciable 
base. 

Item: Concrete pad around compressor to collect oil and drainage, to reduce 
environmental cleanup in the future 
Allowable:
Disallowed: x
Comments: Environmental related costs are not allowed.  These pads are not 
necessary and essential to market the gas and they do not physically handle the 
gas. 

Item: Cost reimbursement from gas purchaser for compression
Allowable:
Disallowed: x
Comments: Should be included in gross taxable value, and actual marketing costs 
deducted by the producer.

Item: Dehydrators
Allowable: x
Disallowed:
Comments: Takes the water content out of the gas stream.

Item: Demulsification chemicals
Allowable: 
Disallowed: x
Comments: Used to break down oil emulsions, usually in a heater treater.

Item: Fence around compressor
Allowable:
Disallowed: x
Comments: 

Item: Filters
Allowable: x*
Disallowed:
Comments: *Allowable if used on a piece of equipment that qualifies as a 
marketing cost deduction.

Item: Fin Fans
Allowable: x
Disallowed:
Comments: Used to cool the gas after it has been compressed.

Item: Flow lines from separator to purchaser’s transmission line
Allowable: x
Disallowed:
Comments:

Item: Glycol for use in dehydrators
Allowable: x
Disallowed:
Comments: See “dehydrators”

Item: Heater treater
Allowable:
Disallowed: x
Comments: Used to treat oil, not gas.

Item: Hydrogen sulfide (H2S) scavengers
Allowable: x
Disallowed:
Comments:

Item: Hydrogen sulfide monitoring
Allowable:
Disallowed: x
Comments:

Item: Insurance on compressor
Allowable:
Disallowed: x
Comments:

Item: LACT Units
Allowable:
Disallowed: x
Comments: These measure crude oil being sold. 

Item: Lease chiller
Allowable: x*
Disallowed:
Comments: *Cost of the chiller are allowable if tax is paid on the products 
obtained at 7.5 percent tax rate.  If the taxpayer defines the liquids obtained 
as condensate and pays tax at 4.6 percent tax rate, no marketing costs are 
allowed.

Item: Lease separators
Allowable:
Disallowed: x
Comments: By law, the costs of separation are not allowable.

Item: Line heaters
Allowable: x*
Disallowed:
Comments: *Allowable if the heater is located after the first separator.  If 
located before the first separator, the cost may be allocated based on the 
liquids to gas ratio. 

Item: LTX Unit
Allowable: x*
Disallowed:
Comments: *Allowable if the producer is paying gas tax on the liquids that are 
obtained from the unit.  

Item: Methanol for gas line
Allowable: x
Disallowed:
Comments: Used in preventing freeze-ups.

Item:  Oil/condensate storage tanks
Allowable:
Disallowed: x
Comments: 

Item: Painting dehydrator and sales compressor building
Allowable: x
Disallowed:
Comments:

Item: Painting separators
Allowable:
Disallowed: x
Comments:

Item: Paint storage tanks to prevent rusting
Allowable:
Disallowed: x
Comments:

Item: Pig socks used around oil storage tanks & compressor
Allowable:
Disallowed: x
Comments: Used to clean oil spills

Item: Pigs and pigging equipment
Allowable: *
Disallowed: x
Comments: *Allowed if used on gathering lines prior to the sales point.  
However, most pigs are used on gas transmission lines after the lease sale, in 
which case they are not allowed as a marketing cost. 

Item: Pipeline between wellhead and first separator
Allowable: x*
Disallowed:
Comments: *allowed based on the percentage of production flow attributable to 
gas.  The allocation should be based on the Railroad Commission productions 
reports.

Item: Pipeline between wellhead and central separation facility
Allowable: x*
Disallowed:
Comments: *allowed based on the percentage of production flow attributable to 
gas.  The allocation should be based on the Railroad Commission production 
reports.

Item: Pipeline between wellhead and sales line if there is no lease separation 
and no separation prior sale (gas is sold full well stream)
Allowable: *
Disallowed: *
Comments: *Allocate costs of this line between gas and condensate.  Marketing 
costs are allowable on portion of line allocated to gas, and not allowable on 
the portion allocated to condensate.

Item: Pipeline between wellhead and plant if there is no lease separation and 
gas is going full well stream to the plant for processing
Allowable: *
Disallowed: *
Comments: *Allocate costs of this line between gas and condensate.  Marketing 
costs are allowable on portion of line allocated to gas, and not allowable on 
the portion allocated to condensate. 

Item: Pipeline after first separator
Allowable: x
Disallowed:
Comments: Between separator and sales point

Item: Purchase and installation of compressor to increase capacity due to tight 
sands drilling program
Allowable: *
Disallowed: *
Comments: A vacuum type compressor being used to increase production.  The 
deductibility would be based on the well’s flowing pressure (see policy on 
vacuum/suction/wellhead compressors)

Item: Removal of contaminated soil, back fill new dirt
Allowable:
Disallowed: x
Comments:

Item: Repair handrails on vessels at tank battery
Allowable:
Disallowed:  x
Comments:

Item: Repair water leg on heater treater
Allowable:
Disallowed: x
Comments:

Item: Security alarm on compressor
Allowable:
Disallowed: x
Comments: Not necessary and essential

Item: Separators at central facility
Allowable:
Disallowed: x*
Comments: Allowed if first separation has already occurred

Item: Shed/cover over sales compressor
Allowable:
Disallowed: x
Comments: The covering does not physically handle the gas and it is not 
essential to the marketing of the gas. 

Item: Skid mounting of sales compressor
Allowable: x
Disallowed:
Comments: Should be included in the depreciable price.  Skid mounting of gas 
lift compressors is not allowable. 

Item: Stack packs/production units
Allowable:
Disallowed: x
Comments: Basically separators that contain a heat source.  There may also be 
lease use gas consumed on these.

Item: Sweetening chemicals and H2S Sweetening Scavengers
Allowable: x*
Disallowed:
Comments: Used to remove hydrogen sulfide from gas. *Not allowed if used 
downhole. 

Item: Vapor recovery units (VRU)
Allowable:
Disallowed: x*
Comments: Recovering additional vapors is a production function, not marketing. 
 *However, costs may be allowed on the VRU if the additional vapors recovered 
are metered separately and then sold.  In that case, the costs of the VRU can 
be deducted from the additional value received for the vapors recovered and 
sold. 

Item: Drip Stations and the costs of hauling products from drip stations
Allowable:
Disallowed:  x
Comments: Pipeline drip is generally considered to be condensate, so the costs 
of handling it are not deductible.

Item: Culverts to protect pipelines
Allowable:
Disallowed:  x
Comments: Not necessary and essential to market the gas

Other Lease related items

Item: Ad valorem taxes 
Allowable: x*
Disallowed: 
Comments: *Allowable on value of marketing equipment only.  If there is no 
breakdown between marketing equipment versus other equipment, taxes are not 
allowable.

Item: Building or trailer rental
Allowable:
Disallowed: x
Comments:

Item: Cattle guards around lease equipment or on lease roads 
Allowable:
Disallowed: x
Comments:

Item: Clean out dumpsters, trash barrels at lease facility
Allowable:
Disallowed: x
Comments:

Item: Cleaning agents
Allowable: x*
Disallowed: 
Comments: *Deductibility depends on purpose for which they are being used.  
Costs are allowable if used on allowable marketing equipment.

Item: Construction/installation of lease road 
Allowable:
Disallowed: x
Comments:

Item: Cost to acquire pipeline right-of-way
Allowable: x*
Disallowed: 
Comments: Only for the right-of-ways for pipelines prior to the sales point.  
Right-of-way expenses after the sales point are not allowed.  Auditors should 
carefully scrutinize which pipeline right-of-way costs are being booked.

Item: Fence around lease facility
Allowable:
Disallowed: x
Comments: Not essential for marketing the gas

Item: Fire ant treatment around lease, including compressor
Allowable:
Disallowed: x
Comments:

Item: Fire extinguishers
Allowable:
Disallowed: x
Comments:

Item: Heat sensing devices on leases
Allowable: 
Disallowed: x
Comments: Safety expenses are incidental to the marketing function

Item: Hydrostatic testing
Allowable: x*
Disallowed: 
Comments: *Usually refers to testing pressure and amount of water in pipelines. 
 Deductibility depends on which pipelines are being tested.  

Item: Miscellaneous parts, valves, fittings, plugs, duct tape, lubricants, 
tools, etc.
Allowable: x*
Disallowed: 
Comments: *Deductibility depends on purpose for which they are being used.  
Costs are allowable if used on allowable marketing equipment.

Item: Motor freight & hauling 
Allowable: x*
Disallowed: 
Comments: *Deductibility depends on purpose of freight and hauling.  Costs are 
allowable if for allowable marketing equipment.

Item: Mowing, weeding around lease equipment
Allowable:
Disallowed: x
Comments: 

Item: Mowing, weeding pipeline right of way
Allowable:
Disallowed: x
Comments:

Item: Repairing fire wall
Allowable:
Disallowed: x
Comments:

Item: Repair and maintenance on lease roads
Allowable:
Disallowed: x
Comments:

Item: Salt water disposal expenses, including wells or hauling
Allowable:
Disallowed: x
Comments: Water is produced as part of the production operations.  Disposing of 
that water is also a production related expense not related to marketing gas

LABOR EXPENSES:

A portion of both company and contract labor is allowed as a marketing cost 
deduction.  The cost of labor includes salaries and the cost of the employee’s 
benefits.  In other words, all expenses necessary to keep the person who works 
on marketing equipment employed is subject to the deduction.  The exact 
percentage of these expenses that is deductible depends on the employee’s or 
contractors overall duties and the types of equipment on which the employee or 
contractor works.  In the interest of saving time on the part of both taxpayers 
and auditors, a standard percentage has been identified as allowable without 
being supported with documentation.  That percentage is 50 percent of the labor 
expenses on gas wells and 25 percent of the expenses on oil wells.  If the 
taxpayer wants to claim a higher percentage of the labor expenses, that higher 
number must be supported with a detailed analysis of how the employee spends 
his or her time as well as an analysis of the equipment on the various leases 
on which the employee or contractor works.

Incidental employee expenses such as cell phones, transportation costs, and 
supervisory expenses are considered to be overhead and allowed at the 6 percent 
overhead rate.

LABOR EXPENSES

Item: Cellular phone in pumper’s truck, radios, CBs, etc.
Allowable: x*
Disallowed:
Comments: *Include in overhead.  Allow at 6 percent rate.

Item: Cost to operate district office building, warehouses, shops, garages, 
etc.
Allowable:
Disallowed: x
Comments:

Item: Cost of consultant assessing compressor needs 
Allowable: x*
Disallowed:
Comments: This expense is not for an actual compressor involved in marketing 
gas

Item: Cost of secretary in district office
Allowable: 
Disallowed: x
Comments: Does not work on equipment that is physically handling gas. 

Item: Field supervisor cost (salary and transportation)
Allowable: x*
Disallowed:
Comments: *Include in overhead and allow at 6 percent rate

Item: Gauger salaries
Allowable:
Disallowed: x*
Comments: Gaugers normally refer to employees who measure volumes in storage 
tanks.  If this is the case, the gauger’s salary would not be deductible.  
However, the use of this term differs from company to company.  Some gaugers 
are actually doing the work of a pumper.  The determining factor as it relates 
to marketing costs is exactly what the job duties entail. 

Item: Hand tools used by pumper/gauger
Allowable: x*
Disallowed:
Comments: *If the employee’s duties are such that his or her salary is an 
allowable marketing expense, the tools the employee uses are then includable as 
an overhead expense and allowed at the 6 percent overhead rate.

Item: “Break out of heater and removal; set new heater and start hookup”
Allowable: x
Disallowed:
Comments: Allowable if the work is performed on a qualifying heater

Item: Meals/food expenses for pumper/gauger 
Allowable: x*
Disallowed:
Comments: *Include in overhead and allow at 6 percent rate.

Item: Meals/food expenses for other district office personnel
Allowable:
Disallowed: x
Comments:

Item: Pumper/gauger benefit costs
Allowable: x*
Disallowed:
Comments: * Allow the same percentage as for pumper’s salary and benefits.

Item: Pumper salaries/benefits
Allowable: x*
Disallowed:
Comments: *The percentage of salary attributable to pumper’s time spent working 
on marketing equipment is allowable.  The percentage of salary attributable to 
other duties, i.e. production, is not allowable.  A standard percentage is 
often used, i. e., 50 percent of the salary charged to gas wells and 25 percent 
charged to oil wells.  See explanation before this section for more details. 

Item: Training classes for pumpers
Allowable: x*
Disallowed:
Comments: *Allowable as overhead at the 6 percent rate.  Any meals provided at 
company expense during the training session are not allowable.

Item: Safety clothing
Allowable: x*
Disallowed:
Comments: Required by OSHA or EPA.  Allowable at 6 percent overhead rate

Item: Supervisors of company and contract labor
Allowable: x*
Disallowed:
Comments: Allowable at 6 percent overhead rate

Item: Thawing gas lines
Allowable: x*
Disallowed:
Comments: *Allowable if the lines being thawed are after initial separation, 
partially allowable if before initial separation (based on gas to hydrocarbon 
liquids ratio)

Item: Transportation expenses for pumpers/gaugers/field supervisors (trucks)
Allowable: x*
Disallowed:
Comments: *Include in overhead and allow at the 6 percent rate.  

METERS

Item: Gas analysis expenses
Allowable: x
Disallowed:
Comments: To make sure contract requirements are met. 

Item: Meters-sales
Allowable: x
Disallowed:
Comments: Meter on which payment is based.  If sales meter is owned by 
producer, the cost of the meter (depreciation plus monthly maintenance expense) 
is deductible. 

Item: Meter-allocation meter
Allowable: x
Disallowed:
Comments: Allowable if more than one well or lease is pain from a single 
purchaser meter.  If the sales meter is owned by the purchaser, the producer is 
allowed to take the cost of lease allocation meters (since we require lease 
level reporting). 

Item: Meters-check
Allowable:
Disallowed: x
Comments: Used to verify sales volumes; usually located next to the purchaser’s 
sales meter.

Item: Meter to measure lease use gas
Allowable:
Disallowed: x
Comments:

Item: Meter calibration services
Allowable: x*
Disallowed:
Comments:*For sales or allocation meters only.

Item: pens for meters: graphic red pen, graphic green pen, black static pen
Allowable: x
Disallowed:
Comments: Allowable if used in an allowable meter only.

Item: Meter on test separator
Allowable:
Disallowed: x
Comments:

ELECTRICITY

Item: Central separation/compression facility
Allowable: x*
Disallowed:
Comments: *Partially allowable.  Allocate electricity costs based on how much 
is used in each function of the facility

Item: District office building 
Allowable:
Disallowed: x
Comments:

Item: Electronic gate
Allowable:
Disallowed: x
Comments:

Item: Gas lift compressor
Allowable:
Disallowed: x
Comments:

Item: Gas sales compressor
Allowable: x
Disallowed:
Comments:

Item: Generators 
Allowable: x*
Disallowed:
Comments: *Depends upon use.  If used for allowable equipment, it is allowable.

Item: Lease lighting/security
Allowable:
Disallowed: x
Comments:

Item: Maintenance shop
Allowable:
Disallowed: x
Comments:

Item: Oil pumps
Allowable:
Disallowed: x
Comments:

Item: Pumping unit
Allowable:
Disallowed: x
Comments:

Item: Storage building
Allowable: 
Disallowed: x
Comments: 

Item: Electrical control systems and electric line charges
Allowable: x*
Disallowed:
Comments: Partially allowable depending on the types of electrical equipment on 
the lease or facility

PLANTS

In general, costs cannot be taken on a plant if the producer is receiving 
settlement based on a product/residue plant split (getting a percentage of the 
proceeds). The producers/leases pay tax only on the percentage or dollar value 
received from the plant. The percentage kept by the plant is considered the 
processing or marketing fee, and the tax is not paid on that amount. In 
essence, that amount is the marketing cost deduction on the leases involved. In 
most cases, producers have filed their monthly tax returns and paid tax in 
accordance with this method. 

When filing refunds for additional marketing costs, some taxpayers want to 
include the actual costs of operating gas-processing plants. In such cases, 
they will go back and pay additional tax on the full value of the products and 
residue extracted at the plant in place of the percentage originally reported. 
This is allowable, but there are complicating factors that must be considered. 
They are as follows: 

First, auditors must verify that the marketing costs have been offset by 100 
percent of the tailgate value received by the plant for the sale of the 
products (liquid hydrocarbons) and residue. It should be noted that this amount 
should be more than the total of the amounts that the plant has paid to the 
individual leases. It must be the total that the plant receives for processing 
and selling the gas.

Secondly, if the plant is processing gas for unrelated parties, 100 percent of 
the plant costs cannot be taken. Likewise, if the plant operator has other 
interest owning partners in the field sending in-kind gas to      the plant, 
100 percent of the costs cannot be taken.  In either situation, a cost per mcf 
for processing the gas should be calculated.  The total costs should then be 
allocated between the different functions based     on the cost per mcf.  The 
only costs that can be deducted from the plant owner’s taxes are the costs 
attributable to their proportional share of the gas produced and sold.

If a taxpayer changes to a 100 percent revenue/100 percent cost method as a 
result of a refund request, they should continue to report using that method on 
the future monthly tax returns. They cannot switch back and forth on the method 
used.  If they do not continue to repot on the 100 percent revenue/100 percent 
cost method on their monthly tax return, they will not be allowed to use this 
method for future refunds.

If a plant owner and the lease operator are the same entity, the auditor should 
also verify that plants are settling back to the leases based at a fair market 
value. The price should be similar to what other non-owned leases in the area 
are receiving for a like quality of gas.  If not, an assessment for the extra 
value can be made as an adjustment to the gas sales value.

PLANTS

Comments: In the examples below, assume that revenue was paid at 100 percent so 
that costs are eligible to be taken.

Item: Compressors-inlet
Allowable: x
Disallowed:
Comments: 

Item: Compressor-tailgate
Allowable: x*
Disallowed:
Comments: *Compressors handling sales gas before the sales meter are allowable. 
 Compressors handling gas being returned to leases for gas lift, injection or 
lease use, or transmission are NOT allowable.

Item: Control room computers
Allowable: x
Disallowed:
Comments:

Item: De-methanization expenses
Allowable: x
Disallowed:
Comments:

Item: Electricity for office building and storage buildings
Allowable:
Disallowed: x
Comments:

Item: Installing breaker in control room
Allowable: x
Disallowed:
Comments:

Item: Janitorial expenses for office building, storage buildings, and control 
room 
Allowable:
Disallowed: x
Comments:

Item: Painting of plant piping and other facilities
Allowable: x
Disallowed:
Comments:

Item: Propane compressors 
Allowable: x
Disallowed:
Comments: Before the sales meter

Item: Scrubbers
Allowable: x
Disallowed:
Comments:

Item: Water chilling expenses 
Allowable: x
Disallowed:
Comments:

Item: Trucks for intra-plant transportation
Allowable: x*
Disallowed:
Comments: Allowed at the 6 percent overhead rate

Item: Trucks provided for the transportation of plant managers and supervisors 
Allowable:
Disallowed: x
Comments:

OFFSHORE LEASES

Item: Boats – crew boats
Allowable: x*
Disallowed:
Comments: *Used for taking personnel to and from platform.  Allow as part 
overhead at the 6 percent rate.

Item: Boats – used to deliver supplies to production platforms
Allowable: x*
Disallowed:
Comments: *Partially allowable, depending upon what is being delivered.  If 
supplies being delivered are related to marketing costs, i.e. glycol or parts 
for sales compressors, the cost is allowable.

Item: Boats – used for surveillance around platforms (maintenance and security)
Allowable:
Disallowed: x
Comments:

Item: Boat or barge to transport condensate from platform to shore 
Allowable:
Disallowed: x
Comments: The cost of transporting crude oil to shore is allowable as a 
trucking cost for crude oil, but no part of the cost is allowable as a 
marketing cost.

Item: Compressors
Allowable: x*
Disallowed:
Comments: *Allowable if compressing gas for sale.  If the compressor is located 
on the [platform and it compresses gas for transport to shore for sale, and if 
condensate is also placed in the pipeline, compressor costs must be allocated.  
The portion attributable to condensate is not allowable.  

Item: Compressors – gas lift
Allowable:
Disallowed: x
Comments:

Item: Condensate sent to shore via pipeline
Allowable:
Disallowed: x
Comments:

Item: Food for platform personnel 
Allowable: x*
Disallowed:
Comments: *Allowable as overheat at the 6 percent rate.  

Item: Helicopter expense for transporting personnel to and from platform
Allowable: x*
Disallowed:
Comments: *Allowable as overhead at the 6 percent rate.

Item: Housing facilities for platform personnel
Allowable: x*
Disallowed:
Comments: *Part of the platform cost and treated the same as “Production 
platform.”

Item: Pipeline – from platform to shore (gas only line)
Allowable: x*
Disallowed:
Comments: *Allowable if there has been separation on the platform.

Item: Pipeline – from platform to shore (both gas and condensate in line)
Allowable: x*
Disallowed:
Comments: *Allocate as described under “Compressors.”

Item: Pipeline – from satellite wells to central platform
Allowable: x*
Disallowed:
Comments: The costs of this line may be allocated based on the oil to gas ratio

Item: Production platform 
Allowable: x*
Disallowed:
Comments: *An allocation of costs can be made between sales and production 
based on the total square footage of the platform used for marketing equipment 
versus the total square footage of the platform.

Item: Separators on platform
Allowable:
Disallowed: x
Comments: Separators are never allowed per the statute

Item: Separators on shore
Allowable:
Disallowed: x
Comments: 

Miscellaneous Issues

Item: Accounting department salaries
Allowable:
Disallowed: x
Comments: Recording revenue from leases and reporting taxes

Item: Ad valorem taxes on marketing facilities or equipment
Allowable: x
Disallowed:
Comments: Ad valorem tax statements should clearly identify the marketing 
equipment being taxed and the amounts should be separately stated from other 
items being taxed.

Item: Carbon dioxide recovery projects
Allowable:
Disallowed: x*
Comments: *These projects are normally used to enhance production of crude oil. 
 Only an allocation of expenses may be allowed as marketing cost.  The cost of 
removing CO2 from a gas stream that is being sold is allowable.  The cost of 
returning CO2 to leases and injecting back into the formation is not allowed.  
The allocation should be based on a study of the schematics for each individual 
situation.

Item: Brokerage or Marketing Fees
Allowable:
Disallowed: x
Comments: 

Item: Tax-Exempt leases and Partially tax-exempt leases
Allowable:
Disallowed:
Comments: Marketing costs should be allocated to the leases on which the 
expenses are incurred.  The marketing costs for facilities and plants that 
serve a group of leases should be allocated to all leases within the group 
based on the production volume for each lease.  A marketing cost tax credit 
will not be issued for the costs attributable to leases that are tax-exempt.  
Tax credits can be issued for costs attributable to partially tax-exempt leases 
up until the point that the taxable value reaches zero.  Marketing costs can 
NOT be transferred from one lease to another. 

Item: Insurance premiums on any equipment or facilities
Allowable:
Disallowed: x
Comments:

Item: Legal department salaries and expenses
Allowable:
Disallowed: x
Comments: Legal department prepares contracts for marketing gas. 

Item: Production Fees
Allowable:
Disallowed: x
Comments: These fees relate to the amount produced.  Sometimes there is a fee 
for delivering less than the amount called for in the contract.  

Item: Environmental fees and taxes
Allowable:
Disallowed: x
Comments: In the case of the state emissions fee, the statute creating the fee 
specifically states that the entity doing the emitting must pay the fee.  It 
cannot be passed through to another entity.  If deducted as a marketing cost, 
the state would essentially be paying the fee to itself

Item: Environmental fees and taxes
Allowable:
Disallowed: x
Comments: In the case of the state emissions fee, the statute creating the fee 
specifically states that the entity doing the emitting must pay the fee.  It 
cannot be passed through to another entity.  If deducted as a marketing cost, 
the state would essentially be paying the fee to itself

As STAR is the Comptroller's research system for Texas tax policy issues,
only tax-specific audit policy memos (AP Memo) are included here. AP memos
not on STAR can be found on Window on State Government on the
Audit Memos web page.




ACCESSION NUMBER: 200802434L
SUPERSEDED: N
DOCUMENT TYPE: L
DATE: 02/04/2008
TAX TYPE: GAS