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In re Appeals of Various Applicants for Exemption from Prop. Taxation in State

Supreme Court of Kansas

December 6, 2013

In the Matter of the Appeals of Various Applicants from a Decision of the Division of Property Valuation of the State of Kansas for Tax Year 2009 Pursuant to K.S.A. 74-2438 and In the Matter of the Application of Various Applicants for Exemption from Property Taxation in the State of Kansas

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[Copyrighted Material Omitted]

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Appeal from Court of Tax Appeals.



1. Administrative agencies do not have authority to decide questions regarding the constitutionality of statutes. In judicial review of an agency action, courts consider such questions in the first instance; and the reviewing court must grant relief under K.S.A. 2012 Supp. 77-621(c)(1) only if the agency action, or the statute or rule and regulation on which the agency action is based, is unconstitutional on its face or as applied.

2. Kansas statutes are presumed constitutional, and all doubts must be resolved in favor of their validity. If there is any reasonable way to construe a statute as constitutionally valid, courts must do so. A statute must clearly violate the constitution before it may be struck down.

3. A legislative definition of a constitutional term must bear a reasonable and recognizable similarity to generally accepted definitions and the common understanding of the term by the people of Kansas.

4. In interpreting and construing a constitutional amendment, the court must examine the language used and consider it in connection with the general surrounding facts and circumstances that caused the amendment to be submitted.

Robert W. Coykendall, of Morris, Laing, Evans, Brock & Kennedy, Chartered, of Wichita, argued the cause, and Will B. Wohlford, of the same firm, was with him on the briefs for appellants.

William E. Waters, of Division of Property Valuation, Kansas Department of Revenue, argued the cause and was on the brief for appellee.


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[298 Kan. 440] Biles, J.

This is a consolidated tax appeal disputing whether natural gas stored in facilities located in Kansas under contract with interstate companies is subject to ad valorem taxation. The Kansas Constitution, Article 11, § 1 (2012 Supp.) exempts merchants' inventory from such taxation, but that exemption does not include tangible personal property owned by a public utility. The taxpayers claim they are entitled to the exemption. They are 40 business entities that fall into three general categories: out-of-state natural gas marketing companies, out-of-state local distribution companies certified as public utilities in their states, and out-of-state municipalities. Each buys natural gas from producers or other marketers and then delivers it to the pipelines under contracts with the pipeline companies allowing the taxpayer to withdraw equivalent amounts of gas at a later time from out-of-state distribution points.

The Kansas Court of Tax Appeals (COTA) determined this natural gas is not exempt because of a statute broadly defining what constitutes a " public utility" for these purposes. See K.S.A. 2012 Supp. 79-5a01. The taxpayers challenge COTA's decision arguing, in part, that it violates the Commerce Clause of the United States Constitution and the Due Process Clause of the Fourteenth Amendment to the United States Constitution, as well as Article 11, § 1(b) of the Kansas Constitution (2012 Supp.), which provides for the ad valorem tax exemption for merchants' inventory.

We hold this taxation does not violate the Commerce Clause or Due Process Clause. And we hold further that K.S.A. 2012 Supp. 79-5a01 is constitutional as applied to the out-of-state local distribution companies. But we also hold that K.S.A. 2012 Supp. 79-5a01 is unconstitutional as applied to the out-of-state natural gas marketing companies and those taxpayers that are out-of-state municipalities. These entities are not public utilities as that term was commonly understood when Kansas voters excluded public utility personal property from the merchants' and manufacturers' inventory exemption.

The COTA order is affirmed in part and reversed and vacated in part. We remand to COTA for further proceedings to decide [298 Kan. 441] where each taxpayer falls within the three described categories because the record on appeal is inadequate for this court to make these individual determinations.

Factual and Procedural Background

This is the fourth time this court has addressed taxation of natural gas stored in interstate pipelines. And with each case, the governing laws have changed, presenting different legal questions and possible outcomes. We refer to those previous cases as necessary because they lay the groundwork for the

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principles guiding the present controversy's resolution.

This particular litigation began in 2009, when the Kansas Division of Property Valuation (PVD) determined the taxpayers were public utilities for property tax purposes under a newly amended statute defining the term " public utility" in the Kansas tax statutes. See L. 2009, ch. 97, sec. 5 (effective July 1, 2009) (now K.S.A. 2012 Supp. 79-5a01[a]). PVD concluded the taxpayers were holding natural gas for resale in storage facilities located in the state and appraised the gas and fixed assessed values thereto for ad valorem tax purposes for the 2009 tax year. See K.S.A. 2012 Supp. 79-5a01(c). PVD determined the quantity of gas each taxpayer owned in the Kansas storage facilities based on an allocation formula, adopted from one of the Federal Energy Regulatory Commission (FERC)-approved tariffs, stating:

" For purposes of reporting storage inventories for state ad valorem taxes, the total inventories of Gas in Market Area Storage Facilities and Field Area Storage Facilities in any particular state shall be determined. Inventories in Market Area Storage Facilities shall be allocated to all Shippers with inventories under Rate Schedules PS, and if provided from Market Areas Storage Facilities, WS, FS, and IWS, based on the ratio of total inventories for the state divided by total Storage inventories for all states times the Shipper's total Stored Volume under such Rate Schedules ; inventories in Field Area Storage facilities shall be allocated to all Shippers with inventories for the state divided by total Storage inventories for all states times the Shipper's total Stored Volume under such Rate Schedules." (Emphasis added.)

Taxpayers do not challenge this allocation methodology, but they individually appealed the appraisals and filed requests for ad valorem tax exemption. In doing so, they advanced various arguments [298 Kan. 442] to shield themselves from the tax. They claimed the natural gas at issue was exempt as: (1) personal property moving in interstate commerce under K.S.A. 2012 Supp. 79-201f(a); (2) merchants' and manufacturers' inventory under K.S.A. 79-201m; and (3) merchants' and manufacturers' inventory under Article 11, § 1(b) of the Kansas Constitution (2012 Supp.). They also argued taxation of this gas violates the Commerce Clause, Due Process Clause, and Import Export Clause of the United States Constitution.

PVD disagreed. It filed the exemption requests with COTA, but recommended they be denied. PVD claimed these taxpayers were public utilities, as defined by K.S.A. 2012 Supp. 79-5a01, and noted public utility inventories are not exempt under K.S.A. 2012 Supp. 79-201f or Article 11, § 1 of the Kansas Constitution (2012 Supp.). COTA consolidated the appeals and held an evidentiary hearing based in part on stipulated facts applicable to each taxpayer.

The Taxpayers

COTA classified the taxpayers into three general groups: (1) out-of-state natural gas marketing companies; (2) out-of-state local distribution companies that are certified as public utilities in their respective states; and (3) out-of-state municipalities. And although some of their characteristics will distinguish one group from another in a substantive way, each taxpayer shares a common business model in that it purchases natural gas from various producers or marketers and then designates when and where that gas will be delivered to one of four interstate pipelines. The taxpayer then schedules with the designated pipeline when and where an equivalent amount of gas will be redelivered to an out-of-state location where the taxpayer will take possession of it. In the meantime, gas is stored for the taxpayer somewhere in the pipeline's storage or transportation systems, which may be in Kansas or some other state. Storage is integral to the pipelines' operations, and natural gas is continually deposited and removed to satisfy essential pipeline pressure and balancing requirements, as well as to permit interstate transportation such as the simultaneous delivery and redelivery of natural gas at distant locations.

[298 Kan. 443] The pipelines that own the facilities in which the taxpayers' gas was stored for this tax year are FERC-regulated and owned separately by Northern Natural Gas Company, Panhandle Eastern Pipe Line Company,

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Colorado Interstate Gas Company, and Southern Star Central Gas Pipeline. Each pipeline company commingles the gas one customer deposits with gas deposited by other customers. No effort is made--nor could one succeed--to ensure that the same gas initially brought into the system by a customer is placed into storage and then redelivered to that same customer. The taxpayer's contractual right is simply to withdraw an amount of natural gas equivalent to the amount it deposited into the system. Each pipeline company possesses and controls the gas deposited into its system. Under FERC-approved tariffs, the pipeline companies carry the risk of loss during storage.

Each pipeline company owns and operates underground storage facilities in multiple jurisdictions, including Kansas. And none of the taxpayers owns any facilities in Kansas for the transmission, distribution, or storage of natural gas. None are certified or regulated as Kansas natural gas public utilities or vested with eminent domain powers in this state.

COTA Proceedings

At the COTA hearing, Kent Miller, a Northern Natural Gas vice president, testified that 70 percent of its pipeline customers injected at a delivery point in Ogden, Iowa, and that half of its deliveries were made in Minnesota. This, he said, makes it " highly likely" that a Northern customer will deliver gas in Iowa and then take redelivery in Minnesota. Miller testified that under the PVD's allocation methodology natural gas would be taxed in Kansas even though it never physically entered the state.

Jeff Balfort, an official with Panhandle Eastern Pipeline Company, testified that Panhandle's pipelines cross eight or nine states and Panhandle sells various services related to the transportation and storage of natural gas for shippers. Generally, he said, Panhandle receives gas from Kansas, North Texas, and Oklahoma. And he said it transmits gas to Ohio, Illinois, Indiana, and Michigan. He testified Panhandle has " field zone" storage in Kansas and [298 Kan. 444] Oklahoma and has market zone storage in Michigan, Illinois, Indiana, and Ohio. A field zone is a geographic area where natural gas is produced and gathered for sale to gas distributors, while a market zone is the geographic area where gas is sold to customers. See In re Assessment of Personal Property Taxes, 2008 OK 94, 234 P.3d 938, 944, n.4-5 (Okla. 2008), cert. denied sub nom. Missouri Gas Energy v. Schmidt, 559 U.S. 970, 130 S.Ct. 1685, 176 L.Ed.2d 179 (2010).

John Wine, a Kansas attorney who had previously served as Kansas Securities Commissioner and chair of the Kansas Corporation Commission, submitted a report and testified on the taxpayers' behalf. He expressed his opinion that public utilities share certain common characteristics in that they: (1) enjoy natural monopolies; (2) provide essential services; (3) possess restricted or protected service territories; (4) are subject to regulations that restrict the rates they can charge for services; (5) are obligated to provide a nondiscriminatory service to the public; and (6) are usually given eminent domain powers by the state. Wine also testified that the definition of public utility enacted by the Kansas Legislature in K.S.A. 2012 Supp. 79-5a01 was not consistent with his view of what constitutes a public utility, stating:

" [T]he fact that someone might be brokering or marketing a--a commodity, a natural gas commodity, does not make it a public utility looking at those common characteristics in--in any way. I mean, any more than a--a facility that held some coal that might eventually be delivered to an electric utility to burn to make electricity, it wouldn't make that--that marketer of coal a public utility."

Wine later limited this assertion to the taxpayers who are marketers and brokers of natural gas, stating: " The Marketers, Brokers, or other entities that trade in gas, and possess the right to take delivery of that gas from a federally regulated pipeline do not possess any characteristics of a public utility except for the fact that they deal in natural gas, a commodity that is highly regulated."

Regarding the other taxpayers, Wine testified that three local distribution companies operated in their home states in a manner consistent with the general meaning of a

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public utility, as did 13 public utilities. And when asked whether there was anything " inconsistent with them being public utilities for [certain] purposes in one state and not another," Wine responded, " There is nothing [298 Kan. 445] inconsistent about that at all." But when PVD attempted to elicit similar testimony from Wine concerning five municipal utilities PVD considered local distribution companies, Wine testified he did not know if it was appropriate to call them local distribution companies if they were not a public utility, even though the municipal utilities were providing analogous services. This statement was not further clarified, and COTA factual finding No. 22, which summarizes Wine's testimony, does not address the out-of-state municipal utilities. This factual anomaly hampers our discussion of the issues related to these entities as discussed below.

COTA denied the taxpayers' exemption requests. It held that all the taxpayers were public utilities under K.S.A. 2012 Supp. 79-5a01 and, therefore, their gas did not qualify for the merchants' inventory exemption as codified in K.S.A. 79-201m. It also held the out-of-state municipalities' gas did not qualify for exemption under K.S.A. 2012 Supp. 79-201a Second because that statute's plain language applies only to property of municipalities or political subdivisions of the state of Kansas. Finally, COTA refrained from addressing whether the tax assessments violated the United States Constitution.

Taxpayers timely appealed. Both sides filed requests to transfer the appeal to this court under K.S.A. 20-3017 and Kansas Supreme Court Rule 8.02 (2012 Kan. Ct. R. Annot. 71), which we granted. On appeal, taxpayers argue: (1) taxing their gas violates the Due Process and Commerce Clauses of the United States Constitution; (2) the gas is exempt merchants' and manufacturers' inventory under K.S.A. 79-201m and Article 11, § 1(b) of the Kansas Constitution (2012 Supp.); (3) the gas is exempt under K.S.A. 2012 Supp. 79-201f(a) because it is moving in interstate commerce and not considered public utility inventory under K.S.A. 2012 Supp. 79-5a01; and (4) the out-of-state municipal utilities qualify for exemption under Article 11, § 1(b) of the Kansas Constitution (2012 Supp.) and K.S.A. 2012 Supp. 79-201f(a).

Our resolution permits us to reduce the issues further. We consider first the arguments concerning the Commerce and Due Process Clauses, and then whether taxpayers in any of the three groups (out-of-state natural gas marketing companies, out-of-state local [298 Kan. 446] distribution companies certified as public utilities in their respective states, and out-of-state municipalities) may be considered public utilities in Kansas.

The Commerce and Due Process Clauses

Taxpayers argue these ad valorem tax assessments violate the United States Constitution's Due Process and Commerce Clauses by taxing out-of-state corporations for natural gas stored in Kansas. They claim this is unconstitutional because their gas is under a common carrier's control and intermingled with other customers' gas so that there is no evidence their gas was ever actually stored in Kansas. They also note the interstate pipeline companies determine whether the gas in the pipeline's system will be stored in Kansas.

The Commerce and Due Process Clauses are closely related, but each presents distinct limits on a state's taxing power. A tax satisfying one clause does not necessarily satisfy the other because the clauses " reflect different constitutional concerns." Quill Corp. v. North Dakota, 504 U.S. 298, 305, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992). The Due Process Clause " centrally concerns the fundamental fairness of governmental activity." 504 U.S. at 312. But the Commerce Clause and its nexus requirement " are informed not so much by concerns about fairness for the individual defendant as by structural concerns about the effects of state regulation on the national economy." 504 U.S. at 312. These clauses also are subject to different limits of ...

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