Honorable George H. Sheppard

Comptroller of Public Accounts Austin, Texas

Dear Sir: Opinion No. O-4025 Re: Gas Production Tax Claim against Canadian River Gas Company - determination of

“:~-?arkct value” ofnatural I,&:;w~.~erArticle 7047b, l>rior to May I, 1941,

We are in receipt ofyour I<:lt<:r~1S&~iilber 23, 1941, which reads as follows:

“We have recently made an investigation ofthe books and records ofthe Canadian River Gas Company. This company is the producer ofgas which supplies through affiliates the gas used inAmarillo and **Dalhart,** Texas; Denver and Colorado Sprin!;s, Colora~~lI;an(l., one-fourth ofthe requirements oftli<!gin::ISIC;licago. “Reports to this office for the month of July 1941 sho,wthat eighty-nine per cent of all gas handled by pipelines inthe Panhandle area was exported from Texas to other States; and that the owners ofthe pipelines produced eighty-=four per cent of all gas carried by said pipelines, buying only sixteen per cent oftheir requirements f,roio other producers.
“This compnay admits a probable liability under **Method** Iofabout $28,000 without penalty and interest.

“‘I am attaching copy ofauditor’s report for your study and consideration. Please refer to **your** Opinion NonO-633 dated April 26, 1939 and advise me as toyour opinion oftllc cool, c-i ~~~;~ti~~~~‘ 1.~) I::;.: indetermining this co~~npany's liabiliry t,,,.J't Ai,tic It:,'!..47b prior LOMay I, 1941; also, t;le c,orrcc:t ,.,~~thwito u:jc under this law as amended by House Jill NO. 6.”
IlllClcrtlicfacts :!rc:;cnt:~:r: int?,i!;,Ir,i!::,r !~~:,;r~~r’,~:<!r ~.vit~;~~ the report ofMr J. I~!<:i::unCrvxil al!a<~I~,:~,~! t(l(:r~~:(,~,;J:~J\~L

a,,I: l~i::l;~,cfollowing. .

Honorable George H. Sheppard, page 2 (No. o-4025)

question:

What is the correct method to use indetermining

this company’s liability under Article 704713prior to May 1, 1941; also, the correct method touse under this law as amended byHouse Bill No. 8?

Since receiving **your** letter ofSeptember 23 above set out,
we have released Opinion No. O-3516 addressed toyou written byMr. Cecil C. Rotsch, October 16, 1941, wherein the determination of market value ofnatural gas under Article IIofHouse Bill 8as enacted by the 47th Legislature, 1941, being Article 704713, as amended, is discussed at length. The writer is advised by Mr. Nelson Brown of **your** department that this opinion answers the question submitted by **your** letter above set forth with reference to the correct method to use indetermining the liability ofthe Canadian River Gas Company subsequent to May 1, 1941, under House Bill No. 8, above mentioned. Therefore, this opinion will be confined to the correct method to use indetermining the liability of Canadian River Gas Company prior toMay 1, 1941.

The material part ofthe statute in question, which is House Bill 547, Chapter 73, page 111,Acts 1931, 42nd Legislature, amended by House BiIl’8, Chapter 495, page 2040, Acts 1936, 3rd Called Session, 44th Legislature, all ofwhich prior to its amendment byArticle IIof House Bill 8as ehaeted by the 47th Legislature, was codified as Article 704713ofVernon’s Annotated Civil Statutes ofTexas, reads as follows:

“Sec. 1(a) That from and after the date herein fixed, every person engaging or continuing within this State, in the business of producing and saving in paying quantities, for sale or for profit, any **natural gas,**  including casinghead gas, from the soil or waters ofthis State, and

“(b) Every person who imports natural gas into this State and thereafter sells the same in intrastate
commerce in this State, the tax to be imposed on the first sale; (provided, however, that ifany gas is imported into this State from another state, inwhich latter State
a severance, occupation or excise tax is imposed, the person importing such gas shall not be required to pay another~tax thereon under the provisions of this Act),

“(c) Are hereby declared tobe ‘producers’ and engaged in the business of producing natural gas withinthis State and shall make quarterly on the 25th day ofJanuary, April, July and October each year, a report to the Comptroller,

. . . .”Honorable George H. Sheppard, page 3 (NO. O-4025)

“Set, 3, A tax shall be paid by each such producer
on the amount ofgas produced and saved within this State, and on gas imported into the State, upon the first sale thereof in intrastate commerce upon the following basis:

“A tax equivalent to three per cent (3%) of the market value ofthe total amount of gas produced and saved within this State, or sold, if imported into this State, at the actual market value thereof, as and when produced.
,, . .”

OnApril 26, 1939, we released Opinion No. O-633 addressed to you and written by Cecil Rotsch, amember ofthis department, wherein we discussed the “place where market value should be determined in taxing natural gas under Article 704713” prior to its amendment by the 47th Legislature. We held in this opinion that the tax levied byArticle 704713was a **“ severance**  tax”

. We quote from said opinion as follows:

“We believe that this tax is what is soiiletimes referred toas a ‘severance tax,’ and if that is true it is reasonable to believe that the legislature intended to charge the tax immediately upon the gas being severed from the earth. The Louisiana Natural gas tax act, which is almost identical with the Texas statute we are considering, was held to be a ‘severance tax’ in the case of Gulf Refining Co. v. McFarland, 154 La. 251, 97 **SOU. 433.**  **In 57**  Corpus Juris 538 ‘severance tax’ is defined as follows:

” ‘Severance tax. An excise tax upon the privilege of severing, or upon the right to sever the natural resources from the soil; a tax upon the natural **resources** from the soil.’

“We should look at this tax from a practical,standpoint, and see how it operates. Ifwe charge this tax on the basis ofthe higher market value at the place of **sale** seven miles away instead of on thebasis ofthe lower market value at the well, then all the operator has to do in order to escape the higher tax would be to sell and convey its ‘compressor stations’ and seven mile pipe line to another concern, and sell its gas to this other concern at 3 cents at the mouth of thewell, and let this other concern compress the gas and transport it **seven miles**  and resell itat 3; cents. The legislature is presumed tohave known the actual conditions the act was to apply towhen itpassed it; and itintended for the law to operate ina practical
manner. We think it intended for the tax to be paid on the basis ofthe market value at the well.”

Further quoting from Opinion No. O-633:- .

Honorable George H. Sheppard, page 4 (No. o-4025)

“Usually the price paid by the purchasing pipe line company is aproper criterion onwhich to figure market value, but it could be a producer anda purchaser would enter into a contract for a price less than the market value or more than the market value for reasons known only to themselves, and such a price inthose cases should not be taken by the Comptroller as market value. He should be governed by ‘the actual market value,’ which may change from time to time.

“Our answer toyour inquiry is that under the facts of the case inquestion you should charge the natural gas tax, provided for inArticle 7047&b, on the basis ofthe actual market value at the well, and not on the basis ofthe actual market value at theplace ofthe:firtst?s&i+elif~~tKat’

~‘p~cei$&wtiy from the~we&l;!~ and you are advised.;th&.if .M,~il~s~.ha,~..~~io;:.l~t.~alue gt:~.t@we.te:ll ‘y& .my d+=rrrpi,w- +~gk:e‘L’ &l&&+;;f:(t~ we:~~~~<~&j&g the actual m&rk&%&+& ~~ere,3he+e! is‘$rmn.rket~~aa&,:$educ ting the;;c~~t-,of,,t~~,th~‘*~S:~t~mr$r~k,t. : > ~,~,; :, ~:

We believe that this opinion, which we expressly approve, fully answers the question submitted by you. You will note that in the last four lines of the above quotation from the opinion we advise you as follows: “and you are advised that ifthe gas has no market value at the well you may determine its market value at thewell by taking the actual market value where there 1sa market and deducting the cost of taking the gas to that market.”

We believe from the facts set forth inyour letter and the attached report ofMr. Brown that acting under this opinion method six
as set forth on page 2 ofthe report ofMr. Brown would be the proper i-?BthorIto follow indetermining the tax liability of Canadian River Gas C~...>any under Article 704713prior toMay 1, 1941, however we will discuss the proposition further.

As we understand the report sent to us by Mr. Brown, Canadian River Gas Company is a part ofan intricate corporate structure consisting ofa maze of corporations the ownership ofall ofwhich
can ultimately be traced to the same interests and these interests substantially control the production, transportation and ultimate sale ofthe major portion ofall gas taken from the Panhandle gas field. These inter-woven corporations operate under contracts with themselves resulting in the sale ofgas from the Panhandle field at prices ranging from net cost to seven or eight cents per thousand cubic fee. We further understand from Mr. Brown’s report that the result ofthis control ofthe production, transportation and ultimate sale ofpractically all of the gas produced in the Panhandle field is that sc~me independent well operators must sell their gas for as low as one-half cent per thousand. -

Honorable George H. Sheppard, page 5 (No. o-4025)

cubic feet by virtue ofthe fact that they have no market and no transportation system to dispose of such gas. Assuming that these facts are **true** and could be sustained to the satisfaction ofajury we are constrained to the belief that same wouldjustify afinding that there is actually no established market value at the well inthis field as is usually the case in oil and gas fields inTexas. Infact such has been judicially determined inthe case of Consolidated Gas Utilities Corporation v. Thompson and Texoma Natural Gas Company v. Thompson, reported in 14Fed. Supp. 318, wherein the **court** inspeaking of gas produced in the Panhandle gas field for light and fuel purposes says the following onpage 324 ofthe opinion:

“As to gas for these uses, there is not, there
never has been, a real market in thefield, for except for a small quantity consumed inoperating wells and plants, gas for this use is not sold in thefield, Itis transported on contracts to distant points for delivery at the burner tips. The commission’s proration order
was therefore based not upon market demand inthe field, but upon the amount required by plaintiffs and other pipe lines for supplying their customers at distant points,”
Therefore inview ofthe facts before us and inview ofthis decision, and, assuming that the fact that there is no market value for gas at the well in the field inquestion can be established, we will discuss the question presented from such standpoint.

Inthe case ofAtchison T. &S. F. Ry. Co, v. Nation and Slavens, 92 S. W. 823, the court of Civil Appeals sets out the rule for determining market value where there is no market value at the particular place inquestion. The following is aquotation from said case:

“The rule is well settled that where the question is what was thevalue ofproperty at a particular place and there was no market value there, proof may be given of such value at other places with the cost oftransportation in order to enable the**jury** to deduce the value at the place inquestion.” Citing Sutherland on Damages (2nd Ed.), Section 445. Again in the case ofKerr v. Blair, 105S. **W. 548,**  the **court** indiscussing the proposition ofdeterming the market value of rice at a particular place when itwas shown that there was no’market value at that place says the following:

“The above testimony would show that the rice was in the shock to be threshed by defendant, and ifthey failed to thresh itas they contracted to do, plaintiff’s damages would be measured by reference to its market value as threshed at that place or at the nearest place where ithad a market value. Ifthe evidence showed it had a market value at Bay City, afew miles distant, it
was sufficient to afford abasis for measuring damages.”
8.- .

Honorable George H. Sheppard, page 6(No. O-4025

Inthe case of Dale Oil &Refining Company v. the City of Tulia, 25 S. W. (2d) 671, the court in determining the market value ofoil has the following to say:

“Where there has been no sale of personal property or a commodity ofagiven kind inthe particular place involved, then its mark& vlaue may be shown by proving such value at the nearest market and adding thereto the costs oftransportation.” Having determined that there is no market value for gas at the well inthe Panhandle gas field the gross receipts ofthe producer less the cost ofgetting the gas to market, whatever that ultimate market may be, seems to us tobe the basis upon which todetermine the market value ofgas at the well for purposes oftaxation under Article 7047b. Arriving at this conclusion the question is then presented whether or not the tax levied under Article 7047b would constitute a tax on property outside the State ofTexas or wguld result in aburden on inter-state commerce and hence become repugnant to the Constitution ofthe United States. We donot believe that this would be the result simply because ofthe fact that the Comptroller in determining the market value at the well would have to ascertain the ultimate sale price ofthe gas in other states and the cost of its transportation thereto by **virtue** ofthe fact that a substantial portion ofthe gas produced is transported and ultimately sold in Northern and Eastern and in some cases Western States.

Inthe case ofAmerican Manufacturing Company v. City of St. Louis, 250 U. S. 459, which was a case inwhich the taxpayer manufactured furniture inSt. Louis part ofwhich went into storage inNew York before being s.old in that State. The **court** held that such sales in another state were exempt from the local occupation tax, and that that tax was not on sales, and that the tax did not consti~tute aburden on interstate commerce.

Inthe case ofHope Natural Gas Company v, Hal~l,by the Supreme **Court** ofAppeals ofWest Virginia, reported in 135S. E. 582, the court, in construing an occupation tax on among other things the production ofnatural gas, the **statute** providing:

“The meansure ofthis tax is the value ofthe entire production in this state, regardless of the place ofsale or the fact that deliveries may be made to points outside the state.”
held, that the sale price necessarily included the cost of delivery saying that such sale price would not reflect the worth ofthe commodity in the State, but the worth within the State plus the cost of transportation.

Inthe Hope Natural Gas Company case, supra, the court inthe opinion says the following:Honorable George H. Sheppard, page 7(NO. O-4025

“In Wallace v. Hines, 253 U. S. 66, 40 Sup. Ct. 435, (64 L. Ed. 782), the Supreme **Court** Said:

“‘?~‘The only reason for allowing a state to look beyond its borders when it taxes the property offoreign corporations is that it may get the true value ofthe things within it; when they are a part of an organic system ofwide extent, that giires them avalue above what they otherwise would possess. The purpose is not to expose the heel ofthe system toa mortal dart -- not, inother words, to open to taxation what is not within the state.’

“By parity of reasoning, we can as well say that the only reason for permitting consideration ofthe price plaintiff receives for delivering gas through its transmission system toanother state is to get the true value of the gas within the state before itenters into interstate commerce, and that purpose is not to open to taxation interstate commerce itself.”

The Hope Natural Gas Company case, supra, involved a state offacts quite similar to the facts presented in this situation, that is, the chief business ofthe plaintiff inerror was the productian and purchase ofnatural gas in **West** Virginia and the continuous and uninterrupted transportation ofthis through pipelines inPennsylvania and Ohio, where it is sold, delivered and consumed. The corporation owned 3178producing wells located in 25 counties ofWest Virginia, from which it-took in the year ending June 30, 1925, more than twenty-five billion cubic feet ofgas. Most ofthis passed into interstate commerce by continuous movement from the wells. We are confronted with practically the same situation here. Practically all ofthe production ofgas from the Panhandle field is controlled by the intricate corporate **structure as**  **above set**  **out** and
a major portion ofthis production is transmitted through transmission lines all controlled by the same interests to the various markets in other states.

Inthe case of Cumberland Pipeline Company v, Commonwealth, by the **Court** ofAppeals ofKentucky, reported in 15S.W..(Zd) 280-286, which was a case involving a license or franchise tax on those engaged in the production of crude petroleum in the State ofKentucky which tax provided for the payment annually of one per cent ofthe market value of all crude petroleum produced and further provided in Section 1thereof that the State Tax Commission must find the market value from monthly reports showing sales of such crude petroleum and from such other reports and information
as it may **secure** and further providing that the Commission should make an appropriate allowance for the cost oftransportation from the producing wells to the market. Itwas held that the value ofpetroleum at the wells should be ascertained from the evidence ofthe market value after the oilHonorable George H. Sheppard, page 8 (No. o-4025)

had completed itsjourney through the channels of commerce and had been sold in the market. The following is aquotation from page 284 ofthe opinion in this case:

“It requires that the value at thewells should be ascertained from the evidence ofthe market **value** after the oil has completed itsjourney through the channels pfa c,ommerce and has been sold in the,market. Itis but a mea$g adopted and prescribed tofind the mar-

. ket value ofthe oil at thewell where itwas produced. There is seldom, ifever, a market at the place of producti~on. Thor product ~,:,lu:;tbc ca.rris::l to th:: :Ilarkct:i, T;le

While Article 7047b does not provide amethod for determining market value ,as was provided in the Kentucky statute as above shown, we believe that such method is but the adoption of the rule of !~a..~

tobe used indetermining the market value at a particular place W~ICZI

Lh:rc is no market value at that place. Infact on page 284 of the opinion in the Cumberland Pipeline case, supra, the court in effect lays down this rule as follows:

“The act requires the state tax commission to resort to the same sources for evidence that would naturally and necessarily be selected toestablish the fact of market **value** ifthe Act were silent upon that subject. The method is not anew one, but conforms to the legal rules ofevidence for the ascertainment of market value. 22 C. J. 1 151, p, 187; 35 Cyc. 638;

‘Woerman v. McKinney-Guedry Co., 174 Ky. 521, 192 S. W. 684.
“The market value ofa commodity is its selling price inthe usual and ordinary course ofbusiness, but, ifthere be no market at a particular place at which it is desired to fix the market value, then the market value is taken at the nearest point available, with adjustments to care for the cost oftransportation to that market. Campbellsvllle Lumber Company v. Bradlee &Wiggins, 96 Ky. 494, 29 S. W. 313; Log Mountain Coal Co. v. White Oak C. Co., 163 Ky. 842, 174 S. W. 721. The plain mandate ofthe act of 1918 is that the tax commission shall find the market value at the place of production by taking the actual sales
as reported from the pipeline companiss, and such other evidence thereof as may be available, and deductlng therefrom the carriage charges. The result reached inthat way is the market value ofthe oil at the well. (Underscoring ours)_. -

Honorable George H. Sheppard, page 9 (No. o-4025)

Further quoting from the opinion in the case of Cumberland Pipeline Company v. Commonwealth, supra, onpage 285 thereof, we find the following:

“In its final analysis, the tax is measured by

the market value ofthe product at the placesofproduction. Itis quite true that the value is ascertained by taking evidence of sales inanother state after the article has been carried in interstate commerce, but the use of such evidence is not forbidden. Itis not put ‘apart inakind of civil sanctuary,’ where the state may not venture for facts relevant and important inthe administration of its tax laws. Davis v. C. C. C. &St. L. **R.** Co., 217 U.S. 157, 30 S. Ct. 463, 54 L. Ed. 708, 27 L. R. A. (N. S.) 823, 18Ann. Cas. 907; Baltic Mining Co. v. **Mass,** 213 U. S. 68, 34 S. Ct. 15, 58 L. Ed. 127. Itis not possible to find the value of mineral products at the mine where there is no market, products market, except by taking thevalue at the neare,s.t market and neare,s.t deductine deducting the cost oftransportation. Interstate commerce j

transportation. Interstate commerce is not affected
or burdened by the use thus made ofevidence resulting from transactions therein. There is no basis for the contention transactions therein, contention that the tax on the producer is invalid because the amount producer invalid because ofthe investment is ascertained by considering incidents,

investment ascertained considering incidents, facts, or results flowing from interstate commerce. American C Mfg. Go. v. St. Louis. 250 U. S. 460. 39 S. Ct. 522, 63 L. Ed. Ipd84o*zthe Hall case, 102 W. Vi. 272, 135 S. E. 582, affirmed 274 U.S. 285, 47 S. Ct. 639, 71 L. Ed. 1049, L. Ed. 1084. Inthe 582, affirmed 274 U the producer and carrier ofnatural gas were the same corporation, and the act levied the tax at the well based on the entire porduction wherever sold. As the carrier was also the producer, the result was that the selling price corresponded closely to the gross receipts, and the act
was susceptible tothe construction that the gross receipts for the gas produced, including the interstate transportation,
was subject to the tax. The Supreme Court ofAppeals of West Virginia construed the act to exclude the cost oftransportation by limiting the power to tax tothe place of production. The kentucky Act of 1918 expressly required the cost oftransportation tobe given proper weight, and applies by its terms to the producer alone.” (Underscoring ours)

Let us take by way ofanalogy aparty inTexas who is desirous of selling a piece of antique furniture which he owns and let us assume for the purpose ofthis analogy that the only market for such an article is inNew York City. The party inTexas is the owner ofa moving van into which he places the piece offurniture and transports same toNew York where it is ultimately sold. We believe that in determining the market value ofthis piece offurniture that
same would be the ultimate sale price less the cost oftransporting ittoNew York, taking into consideration all ofthe incidental costs of such transportation.Honorable George H. Sheppard, page lo (No. O-4025)

From athorough study ofthe cases hereinabove referred to and the report on the operations of Canadian River Gas Company which you have submitted to us, we are ofthe opinion and you are therefore advised that the correct method touse in determining the tax liability of Canadian River Gas Company under Article 704713ofthe Revised Civil Statutes of Texas prior toMay 1, 1941, is method six as contained inthe report of Mr. Brown onpage 2thereof, which method as we understand it, is as follows:
Take the gross receipts received for the gas

at its ultimate wholesale destination, that is, at the first sale, where there is an established, bona fide, market, and subtract therefrom all costs oftransportation and allow in addition thereto eight per cent return on invested capital the remaining figure being the value ofthe gas at the well.

The eight per cent allowance above as we understand it, is
anarbitrary figure set upby Mr. Brown, which he considers a reasonable return on the investment, but, of course, whether same is reasonable or not would be a matter forjudicial determination.

are Trustingthat theiforegtiing fully answers your;inq~utry,-we

Yours very truly

ATTORNEY GENERALOFTEXAS

BY Douglas E. Bergman Assistant DEB:db:ps