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The Court of Appeals of Colorado affirmed a lower court ruling providing that pipelines and fittings located in one of Colorado’s enterprise zones, which are used to gather and deliver natural gas from a taxpayer’s wells to its’ processing facilities, qualify for Colorado’s sales tax exemption because these items of machinery “are in direct use in the manufacturing of natural gas.” (Pioneer Natural Resources USA Inc. v. Colorado Department of Revenue, 2014 COA 101 (Colo. App. Div. I 2014)).



Factual background

Pioneer Natural Resources USA Inc. (Pioneer) was assessed a sales tax deficiency by the Colorado Department of Revenue (CDOR) for tax years 2003 and 2004. The CDOR determined that the pipelines and fittings used by Pioneer were not exempt from Colorado sales tax because these items do not extract or process natural gas or constitute manufacturing within the meaning of the Colorado sales tax statutes. After having appealed the CDOR’s ruling, Pioneer filed a complaint for judicial review in Colorado district court, and the court granted summary judgment in favor of Pioneer.

Pioneer operates over 2,000 wells and ten compressor or processing sites in the Raton Basin, which is located in Colorado’s South Central Enterprise Zone. Pioneer employs a gathering system of pipelines and fittings to maintain pressure in the system, extract natural gas from the ground, and move gas to the processing stations before entering a pipeline for commercial distribution.

Colorado’s manufacturing sales and use tax exemptions

Under Colorado’s general manufacturing sales and use tax exemption statute, “purchases of machinery or machine tools in excess of $500 are exempt from sales tax if they are used in Colorado directly and predominately in manufacturing tangible personal property for sale or profit…” Colo. Rev. Stat. § 39-26-709(1)(a)(II). “Machinery used during the manufacturing process to move material from one direct production step to another in a continuous flow…” is directly used in manufacturing. Colo. Rev. Stat. § 39-26-709(1) (d).

Colorado’s enterprise zone sales and use tax exemption statute is also applicable if machinery is “solely and exclusively in an enterprise zone…” Colo. Rev. Stat. § 39-30-106(1) (a). This statute clarifies that “manufacturing shall include…processing…or otherwise extracting from the earth…any natural resource.”

Opinion and Colorado Department of Revenue arguments

The Colorado court of appeals analyzed the statutes set forth above and determined that Pioneer’s pipelines and fittings for their gas gathering system qualify for the enterprise zone sales and use tax exemption because these items of equipment are machinery used in manufacturing. The court found that Pioneer’s pipelines and fittings move natural gas from the wells in a direct production step of extracting natural gas to processing facilities in a continuous flow, meeting the requirements of the exemption because they “are in direct use in the manufacturing of natural gas” within the meaning of Colorado’s sales tax exemption statutes. The court also considered that the enterprise zone exemption statute enumerates “extracting” and “processing” as manufacturing.

The CDOR raised two arguments against the court’s interpretation of the statutes. First, that Pioneer’s gas gathering system is not extracting or processing and should not be considered as directly used in manufacturing. The court declined to get into a highly technical argument over the meaning of the word “gathering,” and while noting that gathering is different than “extracting” or “processing,” the court stated that it “does not change the fact that the pipelines in Pioneer’s gas gathering system move natural gas from one direct production step to another in a continuous flow.” Second, the CDOR argued that the “continuous flow” provision only applies to machinery used “during the manufacturing process.” The court found that the “continuous flow” provision does not include language that limits its application to the manufacturing process, and that natural gas undergoes a manufacturing process, which includes extracting and processing. Thus, the court found both of the CDOR’s arguments unpersuasive.

Sales and use tax assessment for your business

Pioneer demonstrates the inherent tension between competing interests of state government. While taxing authorities aim to broadly construe sales and use tax statutes to enhance their applicability and limit exemptions to raise state government revenues, state governments also have an interest in promoting and incentivizing economic activity in the state. From a plain reading of the Colorado sales and use tax statutes, the Pioneer court ruled in favor of business, and declined to limit the enterprise zone sales and use tax exemption statute. In assessing whether to challenge a state taxing authority’s interpretation of a tax statute or exemption, it is important for businesses to recognize that even though a state’s taxing authority may assess a tax, courts may not necessarily agree with such state taxing authority’s statutory interpretation, as was the case in Pioneer.