. 

THEA'ITORNE=Y 

OF 

Aua~xw, 

GENERAL 

TEXAS 

-hCXAS 7e711 

June 10, 1974 

The Honorable Robert S. Calvcrt 

Comptroller of Public Accounts 

State Finance Building 

Austin, Texas 

Opinion No. H- 323, 

Re: Entitlement to gas production 

tax refund under Articles. 1. 045 

and 3. 01, Taxation-General, V. T. C. S. 

Dear Mr. Calvert: 

Your:opinion request requires us to determine whether a particular 

gas producer is entitled to a refund of overpayment of the gas production 

tax imposed by Article 3.01, Taxation- General, V. T. C. S. which imposes 

a tax on the production of gas equal to I 112% of its market value when 

produc’ed. 

The Supreme Court ‘has interpreted the term, “market value” to 

mean the price at which the producer sells his gas. W. R. Davis, Inc. 

v. State, 180 S. W. 2d 429 (Tex. 1944). The price at which gas can be 

sold in interstate commerce, however, is subject to regulation by the 

Federal Power Commission, (FPC) under the Federal Natural Gas Act, 

L5 u. s. c., Sec. 717, et seq. The FPC usually permits a seller of gas 

to collect an increased rate as provided in his gas sales contract, but 

subject to its final review and approval. Until the rate is fixed by the 

FPC. a producer of gas does not know for certain the market value of 

his product and, as a result, cannot determine how much productian tax 

is owed under Article 3.01. 

The Comptroller has solved this problem by requiring producers 

to pay the production tax on the basis of the temporary rate permitted by 

the FPC subject to later adjustment upon a final determination by that 

body. If the FPC subsequently lowers the applicable rate, the tax will 

also be lower, and the taxpayer will be entitled to a credit or refund. 

If the rate is raised, a tax deficiency results. See Article 1. DA, Taxationp. 1491 
The Honorable Robert S. Calvert page 2 (H-323) 

General, V. T. C. S. and Attorney General Opinions H-172 (1973) and 

ww-477 (1958). 

Your opinion request concerns the application for refund of an 

overpayment of the gas production tax submitted ‘by Dorchester Gas 

Producing Company (Dorchester). From November 7, 1959 to October 

1, 1970, Dorchester sold gas to Northern Natural Gas Company (Northern) 

pursuant to, a gas sales agreement between the parties. The rates 

established in the agreement were collected subject to final approval by 

the FPC, and they provided the basis upon which Dorchester computed 

the gas production tax it owed. On September 18, 1970, the FPC issued 

Opinion No. 586 in which it determined the just and reasonable rates for 

Dorchester’Q sale of gas to Northern; this opinion has since been upheld 

in final appellate proceedings. The opinion reduces the rate that Dorchester 

can charge Northern for the gas sold during the period in question from 

that provided in the agreement between the parties and requires Dorchester 

to refund all amounts collected in excess of the approved rate. 

While Dorchester and Northern have computed and reported to the 

FPC the amount to be refunded, the actual refund has not yet been made. 

Instead Dorchester and Northern have entered into an “exploration fund 

agreement” performance b1y which,; Dorchester would serve as a substitute for its obligation to make a refund. This agreeme’nt’: has been submitted to the FPC for approval, and it does not become effective until approval 

is granted. 

Under the agreement’s terms, Dorchester would retain the amount 

it id required to refund to Northern and would assume any income tax 

liability that results. Dorchester would expend this money in a gas exploration and development program subject to Northern’s approval. Any 

gas reserves developed under the program would be owned by Dorchester 

but dedicated for sale to Northern under contracts reflecting price, quality, 

and other conditions prevailing at the time of discovery. The price of the 

gas sold to Northern as a result of the exploration agreement would be 

discounted in an amount, up to 125% of the amount required to be refunded 

by Dorchester, the discount to be payable solely out of 25% of Dorchester’s 

p. 1492 
The Honorable Robert S. Calvert page 3 (H-323) 

net working interest income from the gas dedicated to Northern. The 

discount would be regularly deducted by Northern from the monthly 

payments it would make to Dorchester under the applicable contracts. 

If any of the original refund amount remains unspent at the termination 

of the exploration agreement, it must be paid directly to Northern. 

Before the agreement is to become effective, the FPC must approve it, 

Dorthester must acquire a suitable bond indemnifying.Northern against 

any liability, .that might result, and Northern must obtain a favorable 

Internal Revenue Service ruling as to the tax consequences of the agreement. ,,: 

With reference to Dorchester’s application for a refund, you ask 

four questions. You. first ask whether in this situation there has been a 

“final determination” as referred to in Article 1. 045 (F)(l), TaxationGeneral, V. T. C. S., which provides: 

Notwithstanding any provision of any other Article 

of this Title, when any administrative proceeding before 

any local, state, or federal regulatory agency or judicial 

proceeding arising therefrom, results in a final determination which affects the amount of tax liability imposed 

by any Article of this Title,. such final determination shall 

be, reported to the Comptroller within sixty (60) days after 

becoming final, with a statement of the reasons for the 

difference in tax liability, in such detail as the Comptroller 

may require. [emphasis added] 

In Attorney General Opinion H-172 (1973) we said that a final determination in a rate proceeding before the FPC occurs when the amount of 

refund has been agreed to by the parties and approved by the Commission 

or. in the absence of agreement, has been ordered by the Commission. 

In Dorchester’s case the rate it can charge for the gas sold to 

Northern during the period in question has been established by the FPC 

in Opinion No. 586, and that opinion has been upheld in final appellate 

proceedings. Because the rate fixed in the opinion is lower than what 

was actually charged, Dorchester is required to make a refund to Northern. 

The parties have agreed upon the amount that must be refunded and 

the form of payment and, as required by the opinion, have submitted a petition 

p. 1493 
The Honor able Robert S. Calvert page 4 (H- 323) 

seeking FPC approval of their agreement. 

But the FPC has not yet granted its approval. The opinion states 

at pgs. 33-34 that any amount to be refunded shall be retained subject 

to further order of the Commission directing disposition and that the 

proceedings shall remain open for such further action~as may be necessary 

with respect to individual cases. Thus, while the applicable rate has been 

finally determined, the amount of refund required of Dorchester and the 

form of payment have not yet been approved. Until FPC approval is 

granted, or some other disposition is ordered, we do not believe that a, 

final determination affecting Dorchester’s gas production tax liability, as 

contemplated by Article 1. 045, has yet occurred. 

Your second question is whether Dorchester would be entitled to 

a refund of gas production taxes if the exploration agreement is ultimately 

approved by the FPC. When the contract price charged by a gas producer 

is denied by the FPC and the producer is required to refund the disallowed 

portion to its customers, then under Article I...&%, -the production tax paid 

by reason of the disallowed portion of the contr,act pric,e should be refunded 

to the producer or allowed as a credit in subsequent tax r.epnrts. You ask 

whether performance of the gas exploration agreement by Dorchester would 

have the same tax consequences under Art. l.llA as would a refund. 

Under the terms of the exploration agreement the full amount’of ,the 

refund will be retained as income by Dorchester. Dorchester will not, 

however, have unrestricted use of,this fund; it will be obligated to expend 

the money, subject to Northern’s approval, in a search for new gas 

reservea. Any reserves discovered till, be owned by Dorchester but dedicated for sale to Northern at a discount. 

There can be no doubt that this arrangement will be more beneficial 

to Dorchester than having to pay the refundable amount directly to Northern. 

Under it, Dorchester’s search for new reserves is subsidized by Northern. 

At the same time we must assume that the exploration agreement is also 

of substantial benefit to Northern; otherwise Northern would not have agreed 

to it in lieu of a direct refund. The agreement provides Northern with an 

opportunity to secure future supplies of gasat a discount, an opportunity 

p. 1494 
The Honorable Robert S. Calvert page 5 (H-323) 

apparently of considerable value to Northern. 

But regardless of which party has the better end of the bargain, it 

can hardly be argued that approval of the agreement by the FPC would give 

Dorchester the benefit of the full contract price originally charged Northern 

and upon which production taxes were paid. Instead FPC approval will 

further confirm that a portion of the original price has been disallowed and 

that as a result Dorchester has had to assume new obligations with respect 

to this money. The gas exploration agreement is in effect simply an 

alternative method of making the required refund which has been proposed 

by Dorchester and accepted by.Northern. If approved by the FPC, Dorchester 

will not be relieved of its obligation to make a refund-but will be permitted 

to do so in a manner other than direct repayment. In these circumstances 

we believe Dorchester would be entitled to a refund of the gas production 

taxes it paid on the amount charged Northern in excess of the rate fixed 

by the FPC. 

Your third question is whether the taxpayer would still be entitled 

to a refund of g,as production taxes if, in lieu of a direct refund, the FPC 

approved an exploration agreement similar to that submitted by Dorchester 

but without the provision for a discount on future sales in the event new 

production is obtained. The absence of a discount provision would not 

change the fact that the original contract price has been disallowed by 

the FPC, that a lower rate has been established, and that as a result the 

producer /taxpayer is required to refund that portion of the contract price 

charged in excess of the approved rate. Even without a discount provision, 

the exploration agreement is nevertheless an alternative method for making 

the required refund under which the producer loses unrestricted use of the 

refund amount and assumes substantial new obligations with respect to it. 

In this situation the amount of the refund can no longer be considered part 

of the price received for the gas sold and accordingly the taxpayer ,would 

be entitled to a refund of the gas production taxes paid on this amount. 

Your final question is whether the taxpayer is entitled to a refund 

of gas production taxes whenever the FPC fixes the rate lower than the 

contract price even though the taxpayer is never required to make a refund 

p. 1495 
The Honorable Robert S. Calvert page 6 (H-323) 

or do anything l lse’in order to repay the amount overcharged. In this, 

situation, even though a lower rate has been established, the taxpayer has 

been permitted to retain the full contract price free of restriction. In 

effect he has been permitted a higher price for the gas sold and therefore 

should have to pay production taxes calculated on the basis of this higher 

amount. In our opinion he would not be entitled to a refund. The gas production tax imposed by Article 3. 01 is based on the price actually received, 

not the rates established by the FPC. 

SUMMARY 

A, final determination in a rate proceeding 

before the Federal Power Commission occurs 

when the amount of refund has been agreed to 

by the parties and approved by the Commission or, 

in the absence of agreement, has’been ordered 

by the Commission. 

A taxpayer is entitled to a refund of gas production taxes if the FPC establishes a rate lower 

than the contract price and requires him to make 

a refund of the amount overcharged, even though 

he is permitted to satisfy this obligation through 

a gas exploration agreement with or without a 

discount provision. Article 1.11A , Taxation-General, 

V. T. C. S. 

Very truly yours, 

Attorney General of Texas 

p. 1496 
. . 

, 

The Honorable Robert S. Calvert page 7 (H-323) 

DAVID M. KENDALL, Chairman 

Opinion Committee 

p. 1497