NO. 93-290

IN THE SUPREME COURT OF THE STATE OF MONTANA

1994

WESTMORELAND RESOURCES, INC.,

Petitioner and Appellant,

V.

MONTANA DEPARTMENT OF REVENUE,

Respondent and Respondent.

APPEAL FROM: District Court of the Thirteenth Judicial District,

In and for the County of Big Horn,

The Honorable Robert W. Holmstrom, Judge presiding.

COUNSEL OF RECORD:

For Appellant:

W. Anderson Forsythe, Moulton, Bellingham,

Longo & Mather, Billings, Montana

For Respondent:

David L. Nielsen, Tax Counsel, Office of Legal

Affairs, Department of Revenue, Helena, Montana

Filed:

Submitted on Briefs: December 2, 1993

Decided: February 4, 1994

d

Clerk
Justice Terry N. Trieweiler delivered the opinion of the Court.

In 1989, Westmoreland Resources, Inc., petitioned the State

Tax Appeal Board (STAB) to review the Montana Department of

Revenue's (DOR) assessment of additional taxes imposed on

Westmoreland for revenue received due to adjustment formulas found

in four of its contracts for the sale of coal. After the STAB

ruled in the DORIS favor, Westmoreland petitioned the District

Court for the Thirteenth Judicial District in Big Horn County

pursuant to 5 15-2-303, MCA, for review of this decision. The

District Court concluded that the STAB correctly interpreted the

applicable law and that its findings were not clearly erroneous.

Therefore, by order dated April 15, 1993, the court affirmed the

decision of the STAB. Westmoreland appeals from the order of the

District Court.

We affirm.

On appeal, Westmoreland raises the following issues:

1 . Did the District Court err when it found that revenue

received by Westmoreland pursuant to an adjustment formula in its

sales contracts is part of the l'contract sales price" for purposes

of the assessment of coal severance and gross proceeds taxes?

2 . Did the District Court err when it found that revenue

received pursuant to the adjustment formula is properly considered

in the assessment of the resource indemnity trust tax?

3 . Does the taxation of this revenue violate the Commerce

Clause of the United States Constitution?

2
Westmoreland produces coal in Rosebud County, Montana, and

sells this coal to various midwest electric utility companies. At

issue in this appeal are four sales contracts which Westmoreland

negotiated in 1972 with Northern States Power in Minnesota,

Dairyland Power and Light in Wisconsin, Wisconsin Power and Light

in Wisconsin, and Interstate Power in Iowa.

The four contracts have a similar pricing structure and

include a formula which is used to adjust the price of the coal to

compensate for variations in its BTU content. BTU refers to

British Thermal Units and is a measure of the heat energy contained

in the coal.

The contract with Northern States Power (NSP) was the only

contract entered into evidence and will be used as an example in

this discussion. Each contract establishes a base price for the

coal, which is $2.30 per ton in the NSP contract. This base price

is "f.0.b. railroad cars" at Westmoreland's mine in Montana.

F.o.b. is a commercial acronym commonly defined as "free on board."

In this instance, where the contract establishes the price of coal

f.o.b. railroad cars, it means that delivery to the customer is

complete when the coal is loaded onto the railroad cars at the

mine. The customer then independently negotiates with the railroad

company for transportation of the coal to its electric utility

sites.

The contracts also provide for various adjustments to the base

price of the coal. First, certain adjustments are periodically

made for changes in the cost of producing the coal. For example,

3
the NSP contract provides for the base price to be adjusted

periodically to reflect changes in administrative expenses, wages

paid for labor, and cost of equipment.

Second, the contracts include a price adjustment to reflect

variations in the quality of coal. Each contract includes a target

rate or "warranted rate" for the BTU content of the coal that is

sold. In the NSP contract, the warranted rate is 8450 BTU. If the

weighted average BTU content is between 8350 BTU and 8550 BTU, no

adjustment is made in the sale price. However, if the average BTU

content is either higher or lower than these figures, the following

calculation is made in order to standardize the price that the

customer is paying for the coal based on its energy content:

(P + T) x fas received BTU - Warranted BTU)

(Warranted BTU)

P = base price, as adjusted, per ton

T = transportation rate, per ton

This formula establishes a fraction (the "BTU fraction") which

represents a comparison of the "as received BTU" to the "warranted

BTU." The BTU fraction is then multiplied by the sum of the base

price per ton of coal and the average transportation rate per ton

of coal, to yield an "adjustment factor.'* To determine the amount

by which the price of the coal which was purchased is adjusted, the

adjustment factor is multiplied by the number of tons shipped to

the respective customer annually.

The contracts provide that after the adjustment is calculated,

V*seller will issue a debit or credit." In other words, if the

customer overpaid for the coal because the BTU content was lower

4
than the warranted rate, Westmoreland is responsible for issuing

that customer a credit. However, if the customer did not pay

enough for the coal because its BTU content was higher than the

warranted rate, the customer must pay Westmoreland an additional

amount of money for the higher quality coal that was purchased.

It is important to note that the adjustment formula results in

either a transfer of money from Westmoreland to the customer, or

from the customer to Westmoreland. Even though the formula takes

into account an average transportation rate to arrive at the

adjustment factor, the money the customer pays to the railroad is

not affected by the adjustment formula. The cost of transportation

remains the same for each ton of coal that is shipped regardless of

its BTU content.

During the years in question, Westmoreland was able to achieve

a higher average BTU content for the coal it produced and sold than

what was warranted in the four contracts. This resulted in

Westmoreland's receipt of additional revenue from these four

customers due to the adjustment formula.

Westmoreland negotiated these four contracts prior to the

enactment of Montana's current tax structure for the production of

coal.

Three separate taxes are now imposed on coal produced in this

state: the gross proceeds tax found at §§ 15-23-701through -716,

MCA; the coal severance tax found at §§ 15-35-101 through -122,

MCA; and the resource indemnity trust tax (RITT) found at

frfr 15-38-101 through -136, MCA.

5
The taxes assessed pursuant to the gross proceeds tax and the

coal severance tax are calculated on the basis of what is termed

"the contract sales price" of the coal. Contract sales price is

defined in § 15-35-102(5), MCA, as follows:

"Contract sales price" means either the price of

coal extracted and prepared for shipment f.o.b. mine,

excluding that amount charged by the seller to pay taxes

paid on production, or a price imputed by the department

under 15-35-107.

The RITT is computed on the gross value of the coal at the

time it is extracted from the ground. The DCR determines the gross

value at the point of extraction by deducting from the contract

sales price f.o.b railroad cars at the mine, the costs of hauling,

crushing and preparing the coal for shipment.

In 1986, the ECR audited Westmoreland's gross proceeds,

severance, and RITT tax returns for tax years 1981 through 1984.

The DCIR determined that payments received pursuant to the

adjustment formula had been improperly excluded from Westmoreland's

calculation of the "contract sales price" for the assessment of

severance and gross proceeds taxes, and from the calculation of

V'gross value" for the assessment of RITT taxes. Based on this

determination, the DCR imposed additional taxes on Westmoreland for

the tax years 1981 through 1984. Westmoreland appealed this

assessment of additional taxes to the STAB. Following an

evidentiary hearing, the STAB ruled that the revenue received by

Westmoreland pursuant to the adjustment formula was properly

included by the LICR in the computation of taxes owed by

Westmoreland. The STAB found that, for the years 1981 through

6
1984, Westmoreland had received additional revenue because the BTU

content of the coal it had sold exceeded the rate warranted in the

sales contracts. It noted that Westmoreland had paid taxes on the

revenue it received due to the "price component" of the adjustment

formula, but not on revenue received due to what Westmoreland

called the "transportation component" of the formula. After

considering the adjustment formula, the STAB found:

10. All freight or shipping costs from the mine to

the various destinations of the coal are negotiated and

paid by the purchasers, and not by [Westmoreland]. The

freight rate is a per ton rate. The quality of the coal

being shipped has no effect on the determination of the

rate. Anv adiustments made usins the contractual

formula, resultincr in either an increase or decrease in

the vrice of the coal would not result in a vavment to,

or from, the railroad. The transaction is entirelv

between the vurchaser of the coal and rwestmorelandl.

[Emphasis added].

In Finding No. 19, the STAB found that "the adjustment is seen

as a protection of quality. The adjustment has no effect on the

amount paid to the hauler." Finally, the STAB found that there is

"nothing done to the coal during transportation that modifies in

any way, positively or negatively, the BTU content. Once loaded in

the railcar, the BTBs contained in the coal are set."

In its conclusions of law, the STAB concluded that, under the

contracts in question, the final price per ton of coal is not

established until all of the adjustments provided for in the

contracts are made. It stated the following:

13. It is the opinion of this Board that the

adjustment formula, in its entirety, found in the coal

purchase contracts, as it affects the "contract sale

price," is a recognized contract modifier to the base

price of the coal f.o.b. mine. As such, it is a proper

7
ISSUE 1

Did the District Court err when it found that revenue received

by Westmoreland pursuant to an adjustment formula in its sales

contracts is part of the %ontract sales price" for purposes of the

assessment of coal severance and gross proceeds taxes?

Westmoreland contends that both the STAB and the District

Court made erroneous conclusions of law and fact when they held

that the definition of contract sales price includes the

transportation portion of the BTU adjustment formula.

The crux of Westmoreland's argument is that the adjustment

formula found in the four relevant contracts contains a price

related component and a transportation related component.

According to Westmoreland, the formula adjusts not only the mine

head price of the coal but also the cost per ton of transporting

the coal.

Westmoreland asserts that, during the years in question, it

paid taxes on the additional revenue attributable to the price or

llPIV component of the formula, but not on revenue received pursuant

to the transportation or "TV' component. Taxes were paid on only

part of the additional revenue because, according to Westmoreland,

the transportation related revenue was not part of the contract

sales price, which is the basis for the computation of taxes owed.

This assertion is based on § 15-35-102(5), MCA, which defines

contract sales price as "the price of coal extracted and prepared

for shipment f.o.b. mine." Consequently, Westmoreland asserts that

transportation costs, which occur after the coal is delivered

9
f.o.b. railroad cars at the mine, should not be included in the

contract sales price.

In response, the DOR contends that the STAB and the District

Court correctly found that revenue resulting from the BTU

adjustment formula, which takes into account both the base price

per ton and the average transportation rate per ton, constitutes

the final contract price which each customer pays to Westmoreland

for the coal it purchases. The DOR asserts that it was proper to

find that the adjustment formula does nothing to alter actual

transportation costs, but rather determines the final amount owed

to Westmoreland for the purchase of coal.

The DOR further contends that there was substantial evidence

to support the STAB's finding that both the BTU content and the

actual freight costs of each shipment of coal are known prior to

shipment. Therefore, all the formula components are "known*' and

fixed at the time the coal is loaded for shipment. The DOR argues

that the STAB correctly concluded that, although it is

Westmoreland's and its customers' choice to calculate price

adjustments only annually, the adjusted cost of each shipment of

coal, payable by .the customer to Westmoreland, is ascertainable at

the time the coal is loaded for shipment f.o.b. railroad cars and

does not change after shipment.

It is DORIS assertion that the contract sales price, as the

term implies, includes every component of the contract that is used

to determine the price which the buyer pays for the coal.

Furthermore, the DOOR contends that taxes are to be assessed on this

10
final purchase price (the "contract sales price") rather than on

selective, internal components of a formula used to calculate that

final price.

We note first that Westmoreland contends that the STAB made

clear errors of both law and fact. When reviewing an

administrative agency's findings of fact, this Court will defer to

the agency's findings unless they are clearly erroneous. Findings

of fact are clearly erroneous if they are not supported by

substantial credible evidence. Steer, Inc. v. Department of Revenue ( 1990) ,

245 Mont. 470, 803 P.2d 601. Our standard for reviewing legal

conclusions of an agency or a district court is simply to determine

whether they are correct. steer, 803 P.2d at 603.

In this instance, Westmoreland contends that the STAB erred

factually when it found that all revenue received pursuant to the

adjustment formula was part of the "contract sales price" for

assessment of the coal severance and gross proceeds taxes. The

alleged error of law is based on the STAB's and the District

Court's conclusions that the statutory definition of contract sales

price could include this revenue.

After considering the evidence in the record and reviewing the

findings and conclusions entered by the STAB and affirmed by the

District Court, we conclude that there was substantial evidence to

support the STAB's factual determinations. Furthermore, we

conclude that the STAB's and the District Court's conclusions of

law were correct.

11
The record contains sufficient evidence that each customer

negotiates solely with the railroad company regarding

transportation costs. Westmoreland is not responsible for paying

any transportation costs and all of the revenue received after

adjusting the contract price goes solely to Westmoreland, whose

business is the sale of coal, rather than to the railroad.

Furthermore, the evidence demonstrated that the freight rate

charged by the railroad is a constant rate per ton, the BTU content

of the coal which is being shipped has no effect on the

determination of that rate, and the BTU content of the coal does

not change during shipping. Thus, the year-end adjustment, which

takes into account the particular customer's negotiated base price

per ton and average transportation rate per ton, adjusts the

cumulative sales price of the coal purchased during that year, but

does nothing to alter the actual cost that was paid to the railroad

to transport that coal. Instead, the year-end adjustment sets the

final price of the coal to properly reflect the quality of the coal

which was shipped as compared to that which was warranted in the

contract.

A review of the record also supports the contention that,

although price adjustments are made annually, which necessarily

occurs after shipping, the adjusted cost of each shipment of coal,

payable by the customer to Westmoreland, is ascertainable at the

time the coal is loaded for shipment f.o.b. railroad cars, and does

not change after shipment.

12
The evidence is undisputed that Westmoreland is not paid to

transport the coal. Therefore, we conclude that the revenue in

question does not constitute transportation costs incurred

subsequent to delivery of the coal f.o.b. mine. In this case, the

revenue received by Westmoreland represents the final, adjusted

contract price of the coal which is determined by considering its

BTU content and applying the formula agreed upon by the parties.

Although a transportation rate is included in the formula, the

formula adjusts the price payable to Westmoreland for the coal, and

not the costs payable to the railroad for the transportation of

that coal. The formula adjusts the final price of the coal at the

time it is delivered to the customer f.o.b. railroad cars at the

mine.

According to the STAB's findings, application of the formula

as provided for in the contract would result in an increased

contract sales price when the BTU content of the coal is above the

target rate, or conversely, a lower contract sales price when the

BTU content is below the target rate. Therefore, if revenue

decreases due to lower quality coal, the taxes assessed on the

contract sales price would correspondingly decrease. We conclude

that this would be the correct outcome. If Westmoreland or other

coal producers had to reimburse their customers because the coal it

extracted had a lower BTU content, the computation of taxes should

consider this loss of revenue and the contract sales price should

be adjusted accordingly.

13
We hold that there was sufficient evidence to support the

STAB's findings that the BTU adjustment formula in its entirety is

part of the contract sales price, and that revenue resulting from

the application of this formula represents the actual price paid by

the customer for the coal it purchases from Westmoreland.

Furthermore, we conclude that the STAB and the District Court

properly interpreted the statutory and regulatory definitions of

contract sales price and f.o.b. mine price to include the final,

adjusted price of the coal pursuant to these contracts. Therefore,

we hold that the DOR properly included revenue resulting from the

BTU adjustment formula in the assessment of coal severance and

gross proceeds taxes.

ISSUE 2

Did the District Court err when it found that revenue received

pursuant to the adjustment formula is properly considered in the

assessment of the resource indemnity trust tax?

Westmoreland contends that the RITT tax is imposed on the

gross value of the product at the time of extraction from the

ground, and therefore, all transportation related revenue which is

incurred after extraction from the ground should be excluded from

the value of the coal for purposes of assessing the taxes due

pursuant to the RITT.

The DOR agrees that the coal is to be valued at the point of

extraction for the purposes of the RITT. To arrive at this gross

value, the DOR starts with the contract sales price and then

deducts the costs associated with hauling the coal from the mine to

14
the railroad cars, and crushing and preparing it for shipment.

Because the contract sales price is the starting point for

assessing the RITT tax, the WR contends that the STAB and the

District Court correctly held that the adjusted contract sales

price, which takes into account revenue received pursuant to the

adjustment formula, is the starting point for determining the value

of the coal for the assessment of the RITT taxes.

We have already decided that the adjustment formula yields a

final contract sales price, which is the price paid for the

purchase of coal exclusive of transportation costs incurred after

the coal is delivered f.o.b. railroad cars. Thus, we conclude that

the gross value of the coal is properly determined by deducting

from the adjusted contract sales price the costs associated with

preparing the coal for shipment and transporting it from the mine

head to the railroad cars. Therefore, to the extent that the

adjusted contract sales price is the starting point for calculating

the gross value of the coal produced by Westmoreland, we hold that

the court did not err when it upheld the STAB's conclusion that

revenue received pursuant to the adjustment formula is properly

considered by the WR for the purposes of assessing the RITT taxes.

ISSUE 3

Does the taxation of this revenue violate the Commerce Clause

of the United States Constitution?

Westmoreland contends that the DORIS taxation of the revenue

received from the adjustment formula results in discriminatory

taxation of transportation costs and that this violates the

15
commerce clause of the United States Constitution. U.S.C.A. Const

Art. I, § 8, cl. 3. We note that this constitutional challenge is

based upon Westmoreland's interpretation of the holdings in

Commonwealth Edison Company v. Montana (1981), 453 U.S. 609, 101 S. ct.

2946, 69 L. Ed. 2d 884, and CommonwealthEdison Companyv. state (1980),

189 Mont. 191, 615 P.2d 847, and its contention that the BCR is

taxing transportation costs rather than the value of the coal.

The U.S. Supreme Court upheld the constitutionality of

Montana's coal severance tax in CommonwealthEdison, 453 U.S. at 609,

on the basis that the severance tax does not discriminate against

interstate commerce and is apportioned to activities occurring

within the State, i.e., the production of coal, taxed at its value

f.o.b. mine. In CTS Corporation v. Dynamics Corporation of America ( 19 a 7 ) , 4 8 1

U.S. 69, 107 S. Ct. 1637, 95 L. Ed. 2d 67, the Court reemphasized

the principle that a state statute does not violate the commerce

clause if it is evenhandedly applied without regard to whether the

activity is interstate or intrastate in nature.

We have held that the BTU adjustment formula adjusts the

contract sales price of the coal, and that revenue received

pursuant to this adjustment formula does not constitute

transportation related revenue. The Montana coal production taxes

are assessed uniformly on the basis of the Vontract sales price,"

as determined by the parties' contracts, without regard to whether

the coal is to be shipped interstate or intrastate, and are not

based on transportation costs. Therefore, taxation of the revenue

16
received due to the BTU adjustment formula, which is part of the

contract sales price, is nondiscriminatory and does not violate the

commerce clause of the United States Constitution. We hold that

the District Court correctly concluded that Westmoreland's

constitutional challenge was without merit.

For these reasons, the judgment of the District Court is

affirmed.

We concur:

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