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Honorable Robert S. Calvert Opinion Ho. M-1002 Comptroller of Public Accounts Austin, Texas Re: Application of Natural Gas Production tax on deficiency payments under "take or pay" Dear Mr. Calvert: provisions of purchase contracts. Wehave rece~lved your request for an official opinion in regard to the proper application of Chapter 3, Title 122A, Taxation-General, Vernon's Civil Statutes, in calculating the tax onproducers of natural gas receiving deficiency payments under "take or pay" provisions of certain gas purchase contracts, In connection with your request you submit adetailed description of these special provisions which wemayassume adequately presents the taxation problems Inquired about. Theterms of such contract are restated in substance as follows: The"take or pay" provision thereof requires the buyer to purchase from the seller and pay for, whether or not received during each year, adetermined minimumdally quantity of gas per month or per year as the case maybe, at aprice stated in terms of so manycents per 1,000 cubic feet (MCP). In case of failure of buyer to purchase during anyyear the minimumquantity contracted for, for annual minimumpurchases, under contracts providing then within 30 days after such year he Is required to pay seller for the amount of the deficiency, but hemayat any time during the succeeding four years take andreceive such deficiency at the market price then in effect, bypaying therefor only the difference between the price in effect at delivery andthe price actually paid for such deficiency under the contract. Under some contracts which provide monthly minimumgas purchases, even if buyer does not take the minimumamount during the month,

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heis required to pay for it but has the right to take the gas In succeeding months. These latter provisions are referred to as “make-up” periods. Thetypical contract In question expressly provides for the provisions and obligations thereof to go into effect upon the first deliveries of gas thereunder. However, some of the contracts require the buyer to makeminimumpayments before anygas is produced, or purchased. In connection with the foregoing described “take or pay” contracts you have informed us that for manyyears your office has taken the uniform position that the producer wasliable for tax on the entire amount received under such contracts, whether or not the deficiencies, if any, were “made-up”

. Thespecific questions submitted byyou are as follows:

“1* Iwould like your official opinion as to whether the tax levied byArticle 3.01 is required to be reported andpaid to Comptroller at the time the producer receives the minimumprepayment or at the time the gas is actually taken by the purchaser during the make-up period?

“2

. If your answer to question one is that the tax is required to be reported andpaid at the time the gas is actually taken by the purchaser during the make-up period, andfor somereason all or apart of the deficiencies in gas are not madeup during the contractual make-up period and the purchaser has to forfeit any of the minimumprepayments, Is the production tax due onthe forfeited prepayments. If the production tax is due, should the tax be computed at the tax rate in effect at the time the contractual make-up period expired?
“3

. If your answer to question one is that the tax is required to be reported andpaid at the time the producer receives the minimumpayment, please advise whenthe tax Is due in those instances where the producer has received prepayments for a period of time before there wasanygas produced or taken by the purchaser under the terms of the contract?”

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Honorable Robert S. Calvert, page 3 (M-1002)

Chapter 3, Title L22A, Taxation-General, Vernon's Civil Statutes, insofar as pertinent to the foregoing questions, provides as follows:

"Article 3.01 (1) There is hereby levied anoccupation tax on the business or occupation of producing gas within this State, computed as follows: "Atax shall be paid by each producer onthe amount of gas produced-and saved within this State equivalent to seven and one-half per cent (7-s) of the market value thereof as and whenproduced.

... . "Article 3.03 (3) Thetax herein levied shall be due and payable at the'office of the Comptroller at Austin onthe last day of the calendar month, based on the amount of gas oroduced andsaved during the oreceding calendar month, and on or before said date each such producer shall make and deliver to the Comptroller areport onforms prescribed by the Comptroller showing the amount of gas produced,

... ." (Emphasis Therecent decision of our SupremaCourtin Mobil Oil Corporation v. Calvert; 451 S.W.2d 889 (Tex.Sup. 1970), held, in substance, that the proper method of determining the tax due onproduction of natural gas under Chapter 3, Title 122A, Taxation-General, V.C.S., is to compute the tax onthe market value of the gas at the mouth of the well measured by the total proceeds of sale. Article 3.02 provides for this measure. It also has been held that the term "market value" as used in aformer statute (of identical tenor andeffect as our present statute, Art. 3.02) "means the price for which the producer sells the gas". Calvert v. Union Producing Co., 258 S.W.2d 176, (C.A.1953-No writ history). Thus, according to the plain import of Chapter 3, Title 122A, Taxation-General, the tax therein levied is to be computed on the amount of gas produced and saved at the

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rate of 7-l/2$ of the market value of such gas as andwhen produced. Consequently, until such gas Is can be computed thereon under the statute, i;;d;T;a;oi;ax thereby assessed until production and asale or other disposition thereof has occurred. Mindful of the foregoing, weconclude that the tax levied byArticle 3.01 Is not due until actual production of the gas has occurred and such tax Is then measured by Its "market value" as provided in Article 3.02. Attorney General Opinion No. WW-554(1959). Hence, our answer to your question 1is that the time such gas is actually produced during the make-up period, rather than the time of the minimumprepayment, is the taxable event with regard to the “make-up” gas. Your question 2concerns asituation where the deficiencies under the contract are not received during the make-up period and the minimumprepayments madeunder the contract are forfeited. Weassume that asubstantial amount of gas was produced and sold under the contract, although less than the minimumonwhich the price was computed. This default by the buyer under the typical contract described byyou brings about aneffect analogous to one that might be produced by asimilar default of the buyer under a “take or pay” contract having noprovision allowing the "make-up" of any deficiency below the minimumdaily quantity of gas contracted for a specified time at atotal price calculated onthe basis of so manycents per 1,000 cubic feet (MCF). This latter type of “no-makeup” contract has been called to our attention as being one of “the several different fact situations” arising under "take or pay" provisions of gas purchase contracts mentioned in your inquiry but not described in detail.Asaconsequence of the absence of the production and the purchase of the deficiency bythe buyer under either of the next foregoing described contracts, there is noproduction or sale thereof onwhich atax could be assessed against such gas not produced andsold. However, the price paid for the substantial amount actually purchased andreceived wasset by the terms of such contracts at the total figure determined by the minimumamount of gas therein contracted for. Whether the difference between the amount of gas agreed to be purchased and the amount actually received under the contracts is termed a “deficiency”, andaproportionate part of the total contract price is called a “forfeiture”, Is of noimport whenconsidered inrelation to the issue actually involved. -4890-. .

Honorable Robert S. Calvert, page 5 (M-1002)

Theparamount issue under each contract is the determination of the total proceeds of the sale of the gross production under each of the contracts in question. There is no difficulty in determining the gross production. This is the respective amount actually produced andourchased bv buyers under the contracts. Thus, the total-proceeds of the gas actually produced under such contracts is the total amount received under the contracts, includinn the navn lculated onthe so-called deflciencles~, -55 _,-,.nents 'he tax onthe Gtal amount of gas produced andpurchased under such contracts is measured bysuch total proceeds of sale and based on the tax rate in effect at the time such gas is actually produced, rather than at the time of the minimum prepayments. Weare cognizant of the fact that aquestion of contract construction mayarise Independent of the proper construction of the tax statute and its application to each contract. Mobil Oil Corp. v. Calvert, 451 S.W.2d 889(Tex.Sup.1970). However, weare here passing only upon the construction to be placed upon the tax statute. Theprior opinions of this office support the above conclusion andwould have to be overruled if weconcluded otherwise. This sameholding and construction wasmadein Attorney General Opinion No. Q-6355 (1946); andsee also Opinion No. v-555(1948). It is the policy of this office to follow earlier~ opinions onthe samesubject where not patently erroneous. Attorney General Opinions Nos. O-1659 (1939); c-69 (1963); and~-605 (1970). This Is likewise the rule followed by the courts concerning the meaning of astatute. Thomasv. Groebl, 147Tex.70, 212 S.W.2d 625 (1948). Such aconstruction -is entitled to great weight where, as here, it has been followed over aperiod of years by the state agency charged with the administration andenforcement of the statute. Thompson v. writ), Calvert, 301 S.W.2d 496,(Tex.Civ.App.~~l9571 no

Gaynor Construction Co. v. Board of Trustees, etc., 233S.W.2d 472 (Tex.Civ.App. 1950, nowrit). In view of the foregoing considerations, you are advised that the total price paid under the contracts in question is the measure of the market value of the actual amount of gas produced and sold, based onthe tax rate in effect at the time such gas is actually produced.

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Ourforegoing answers to question 1and2preclude the answering of question 3.

-SUMMARYUnder natural gas purchase contracts containing "take or pay" provisions, the time the gas is actually produced is the event which actuates the accrual of the tax under Ch. 3, Title 122A, TaxationGeneral, V.C.S. Thetotal price paid under any of such contracts Is the measure of the actual amount of gas produced andsold thereunder, based on the tax rate in effect at the time such gas is actually produced. Y{J very truly,

General of Texas Prepared byR. L. Lattimore Assistant Attorney General APPROVED: OPINIONCOMMITTEE Kerns Taylor, Chairman W.E. Allen, Co-Chairman James Broadhurst William Craig Milton Richardson Houghton Prownlee SAMUEL

D. MCDANIEL Staff Legal Assistant NOLAWHITE First Assistant

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