Imposition of Tax

3.1. Imposition of Tax. -- Upon every person exercising the privilege of engaging or continuing within this State in severing, extracting, reducing to possession and producing for sale, profit or commercial use any natural resource product or products, there is hereby imposed a tax in the amount to be determined by the application of rates against the gross value of the articles produced, as shown by the producer, except as otherwise provided, multiplied by the rates in the classifications and according to the effective dates as follows:

3.1.1. On coal, and including the thirty-five one hundredths (.35) of one percent additional severance tax on such coal for the benefit of counties and municipalities, as provided in W. Va. Code §11-13A-6, on

July 1, 1987 - three and eighty-five one hundredths (3.85) percent;
July 1, 1988 - three and eighty-eight one hundredths (3.88) percent; and
March 1, 1989 - and thereafter - five (5.0) percent.

3.1.2. On limestone or sandstone quarried or mined, on

July 1, 1987 - two and two-tenths (2.2) percent;
July 1, 1988 - two and fifty-six one hundredths (2.56) percent;
July 1, 1989 - two and ninety-two one hundredths (2.92) percent;
July 1, 1990 - three and twenty-eight one hundredth (3.28) percent;
July 1, 1991 - three and sixty-four one hundredths (3.64) percent;
July 1, 1992 - four (4.0) percent;
July 1, 1993 - four and fifty one hundredths (4.5) percent; and
July 1, 1994 - and thereafter - five (5.0) percent.

3.1.3. On oil, on

July 1, 1987 - four and thirty-four one hundredths (4.34) percent;
July 1, 1988 - four and two hundred seventy-two one thousandths (4.272) percent; and
March 1, 1989 - and thereafter - five (5.0) percent.

3.1.4. On natural gas, on

July 1, 1987 - six and five-tenths (6.5) percent;
July 1, 1988 - six (6.0) percent;
July 1, 1989 - five and five-tenths (5.5) percent; and
July 1, 1990 - and thereafter - five (5.0) percent.

3.1.5. On natural gas produced from new wells drilled and placed in service on and after July 1, 1987, on

July 1, 1987 - four (4.0) percent; and
March 1, 1989 - and thereafter - five (5.0) percent.

3.1.6. On sand, gravel or other mineral product not quarried or mined, on

July 1, 1987 - four and thirty-four one hundredths (4.34) percent;
July 1, 1988 - four and two hundred seventy-two one thousandths (4.272) percent;
March 1, 1989 - and thereafter - five (5.0) percent.

3.1.7. On timber, on

July 1, 1987 - two and five-tenths (2.5) percent; and
March 1, 1989 - and thereafter - three and twenty-two hundredths (3.22) percent.

3.1.8. On other natural resources, on

July 1, 1987 - two and eighty-six one hundredths (2.86) percent;
July 1, 1988 - three and eighty-eight one thousandths (3.088) percent;
July 1, 1989 - three and three hundred sixteen one thousandths (3.316) percent;
July 1, 1990 - three and five hundred forty-four one thousandths (3.544) percent;
July 1, 1991 - three and seven hundred seventy-two one thousandths (3.772) percent; and
July 1, 1992 - and thereafter - four (4.0) percent;
July 1, 1993 - four and fifty one hundredths (4.5) percent; and
July 1, 1994 - and thereafter - five (5.0) percent.

3.2. Tax in Addition to All Other Taxes. -- The severance taxes apply to all persons severing or processing (or both severing and processing) natural resources in this State and are in addition to all other taxes imposed by law.

3.3. Tax Allocation Agreements Preserved. -- Provisions of any contract entered into prior to July 8, 1985 and which related to the allocation, reimbursement, payment or assessment imposed by W. Va. Code §11-13-2a prior to July 1, 1987, shall apply with full force and effect to the severance tax which is imposed on and after July 1, 1987.

3.4. Producing Natural Resource Products for Others. -- Persons performing under contract, either as prime contractors or subcontractors, the necessary labor or mechanical services for others who are engaged in the business of producing natural resources, are performing a service for the producer and therefore are not taxable as a producer of natural resources for purposes of severance taxes.

3.4.1. The producer of the natural resource products that are extracted by the contract miner is taxable under the severance tax.

3.4.2. Contribution to Capital. -- When the contractor who is drilling the well receives a percentage of the working interest in the gross proceeds from the production from that well, such drilling is treated by the contractor as a contribution of capital to the enterprise and is not considered as income to the contractor derived from severing the natural resource. Once production begins, however, all income, received by the contractor for his working interest in such production, will be included in the gross income subject to the severance tax of the producing well or wells reporting as a joint venture, partnership or group or combination acting as a unit.

3.4.3. Persons engaged in the business of drilling for natural resources, including water, who have no ownership or economic interest in such resources, shall also be treated as "contract miners" and not taxed under the severance tax.

3.4.4. Well Servicing. -- Similarly, persons engaged in the business of shooting, refracturing, and otherwise servicing oil and gas wells for a fee and who do not have an economic interest in the oil or gas are also not required to report their total gross income received from the producer under the severance tax.

3.5. Determination of Producer and Contract Miner. -- Generally, a producer is one who has ownership, title to or an economic interest in mineral deposits or standing timber, and a contract miner is one who does not possess an economic interest but performs services for producers by contract. The contractual form will not necessarily control the status of the parties in regard to severance tax liability. The status of the parties will be determined by the substance of their relationship. Accordingly, although an agreement may be referred to as a lease, where the true substance of the agreement does not convey ownership or the economic interest in the mineral, in place, such agreements will be construed as service contracts.

3.5.1. Economic Interest. -- The concept of critical importance in determining who is the producer is which party has a true economic interest in the mineral. In order to have an economic interest, the taxpayer must have a direct interest in the minerals in place. One must also have a direct interest in the income from the production of the minerals and look solely to mineral sales proceeds for his income. A taxpayer does not have an economic interest simply because a contract entitles him to an economic or monetary advantage in connection with production of the minerals. For example, a person who has no ownership, title in, or leasehold interest in the mineral deposit or standing timber does not possess an economic interest merely because through a contractual relationship he possesses an economic advantage derived from production. The pivotal question involves the ownership of the mineral immediately after it is severed. The owner at that point is the producer.

3.5.2. If a dispute should arise as to which party is the producer and which is the contract miner, the Tax Department shall consider, in addition to the substance of the agreements, other factors which shall include, but not be limited to the following attributes which may indicate the presence of ownership or economic interest subjecting such person to the severance tax.

3.5.2.1. An interest in the mineral in place.

3.5.2.2. An investment which is recoverable through depletion not recoverable through depreciation.

3.5.2.3. Contractual agreements which are not terminable without cause on short notice.

3.5.2.4. Entitlement to claim a depletion allowance for federal income tax purposes.

3.5.2.5. Obligation to pay royalties to another.

3.5.2.6. Exclusive right to sever, mine, cut or extract the natural resource product.

3.5.2.7. Income from the sale of mineral proceeds rather than from other sources.

3.5.2.8. Control over the mineral from the time of extraction to sale.

3.5.3. Interests Not Considered Production.

3.5.3.1. Farm-Out. -- A "farm-out" is an arrangement under which the owner of an operating or working interest (normally considered a "producer") assigns his interest to another person as a means of financing the costs of developing and operating the property. Farm-outs may be structured many different ways; the following is an example: The owner of the operating or economic interest in the mineral transfers (usually by assignment of the lease) his entire operating interest and retains a nonoperating interest in the property. The retained nonoperating interest usually takes the form of an overriding royalty which operates much in the same way as an ordinary royalty, usually designated as a right to receive a specified share of gross income or production from the mineral property. The person who receives the working interest and assumes the entire burden of developing and operating the property should report the entire gross proceeds of sale of the natural resource product under the severance tax without any deduction for the overriding royalty or any other royalty payable to others.

3.5.3.1.a. Example. -- A, a lessee, owns the entire operating interest in property W, an undeveloped lease which provides for 1/8 royalty to be paid to lessor R. In a farm-out arrangement, A transfers the entire operating or working interest in property W to D in exchange for D's obligation to drill a well on the property and 1/16 overriding royalty payment upon production. D drills a successful well and receives $16,000 upon sale of the product.

D is required to report the entire $16,000 under the severance tax (less any allowable transportation deductions).

Both R and A are not required to report under the severance tax.

3.5.3.2. Fractional Interest Retained. -- The owner of the operating interest may choose to transfer a fraction of his interest to another party who agrees to bear a disproportionate share of the development costs. In the event production is obtained, the two parties would report the proceeds in accordance with their respective shares of the operating interest.

3.5.3.2.a. Example. -- F, a lessee, owns the entire operating interest in an undeveloped lease. F retains 25% of the operating interest on a farm-out of the property. G, acquires the remaining 75% of the operating interest from F in exchange for G's agreement to drill and equip a well on the property. The well production derives $10,000 gross proceeds. Although F would receive $2,500 of the income and G $7,500 of the income, the tax for severance tax purpose should be reported and paid under a single account as a group or combination acting as a unit as prescribed in Subsection 6.1 of these regulations.

3.5.4. Royalties Derived From Natural Resources. -- Persons who receive payments, as royalties, from producers of natural resource products are not deemed to be producers thereof and are not required to file a severance tax return. The fact that the payment is called by a name other than royalty shall not alter the taxation of such payment if all the recipient thereof has done is to furnish real property which has a situs in this State and which includes minerals in place, or any interest therein, for hire, loan, lease or otherwise.

Lessees, sublessees or other denominated lessees, including persons to whom an operating interest has been assigned or farmed-out, are producers of all the natural resources produced, regardless of any payment, in kind or otherwise, to lessors, sublessors or other denominated lessors of a part of such natural resources as rent or royalties.

For the purposes of taxation, royalties will include, but not be limited to, ordinary royalties, overriding royalties, lease bonus, delay rental, advance royalty, minimum royalty, shut-in royalty, payment for exploration rights, and the reimbursement by the lessee of lessor's property taxes. In no instance may a producer of natural resources deduct such payments from gross value.

3.6. Partially Producing Coal Within and Without this State. -- In those instances in which the same person partially produces coal within West Virginia and partially produces coal without West Virginia, a portion of the gross proceeds of sale are taxable under the severance tax. The portion of the gross proceeds of the sale that are taxable under the severance tax shall be determined in a reasonable manner based upon the facts and circumstances of the particular situation.

3.6.1. Example 1: Company A, a coal producer, severs coal located in Kentucky. After the coal is mined, it is transported to Company A's processing facility in West Virginia. At the facility in West Virginia, the coal is processed and then loaded for shipment to a purchaser. Company A owes severance tax in West Virginia on the gross value added to the coal by the activities conducted within West Virginia. Guidelines on determining the gross value added to the coal by the activities conducted within West Virginia are set forth in Section 2a of these regulations.

3.6.2. Example 2: Company B, a coal processor, purchases coal from a producer in Kentucky. The processor has the coal delivered to its processing facility located in West Virginia. At the processing facility in West Virginia, the coal is processed and loaded for shipment to a purchaser. Company B owes severance tax in West Virginia on the gross value added to the coal by the processing activities performed in West Virginia. Guidelines on determining the gross value added to the coal by the activities conducted within West Virginia are set forth in Section 2a of these regulations.

3.6.3. Example 3: Company C, a coal producer, severs coal located in West Virginia. After the coal is mined, it is transported to Company C's processing facility located in Kentucky for further processing. Company C owes severance tax in West Virginia on the gross value of the coal attributable to its activities conducted within West Virginia. Guidelines on determining the value added to the coal by the activities conducted within West Virginia are set forth in Section 2a of these regulations.