### . 

## 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 aparticular gas producer is entitled to a refund 

### ofoverpayment ofthe gas production tax imposed by Article 3.01, Taxation- General, V.T. C.S. which imposes a tax on the production ofgas equal to I 112%of its market value when produc’ed.

The Supreme Court ‘hasinterpreted the term, “market value” to mean the price atwhich theproducer sells his gas. W.R. Davis, Inc. v. State, 180S.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, L5u. s. c., Sec. 717, et seq. The FPC usually permits a seller of gas to collect an increased rate as provided inhis gas sales contract, but subject to its final review andapproval. Until the rate is fixed by the FPC. a producer ofgas 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 onthebasis ofthe temporary rate permitted by the FPC subject to later adjustment uponafinal determination by that body. Ifthe FPC subsequently lowers the applicable rate, the tax will also be lower, andthe taxpayer will be entitled to a credit or refund. If the rate is raised, a taxdeficiency results. See Article 1.DA, Taxationp. 1491The Honorable Robert S. Calvert page 2 (H-323)

General, V. T. C.S. andAttorney 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 ‘byDorchester **Gas** Producing Company (Dorchester). From November 7, 1959to 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, andthey provided thebasis uponwhich Dorchester computed the gas production tax it owed. OnSeptember 18, 1970, the FPC issued Opinion No. 586in which it determined thejust 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 theparties 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 b1ywhich,; 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 notbecome effective until approval is granted.

Under the agreement’s terms, Dorchester would retain the amount it id required to refund to Northern andwould assume any income tax liability that results. Dorchester would expend this money ina gas exploration and development program subject to Northern’s approval. Any gas reserves developed under theprogram would be owned by Dorchester but dedicated for sale to Northern under contracts reflecting price, quality, and other conditions prevailing atthe time of discovery. The price ofthe gas sold to Northern as a result ofthe exploration agreement would be discounted inanamount,upto 125%ofthe amount required tobe refunded by Dorchester, the discount to be payable solely out of 25%ofDorchester’s

p. 1492The 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 itwould make to Dorchester under the applicable contracts. If any of the original refund amount remains unspent at the termination ofthe exploration agreement, it must be paid directly to Northern. Before the agreement is tobecome effective, the FPC must approve it, Dorthester must acquire a suitable bond indemnifying.Northern against any liability, .thatmight result, and Northern must obtain afavorable 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 inthis situation there has been a

“final determination” as referred to inArticle 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 afinal determination which affects the amount oftax liability imposed by any Article ofthis Title,. such final determination shall be,reported to the Comptroller within sixty (60) days after becoming final, with a statement ofthe 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 ina rate proceeding before the FPC occurs when the amount of refund has been agreed to by the parties andapproved by the Commission or. in the absence of agreement, has been ordered bythe 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, andthat opinion has been upheld in final appellate proceedings. Because the rate fixed inthe opinion is lower than what was actually charged, Dorchester is required to make a refund to Northern. The parties have agreed uponthe amount that must be refunded and the form ofpayment and, as required by the opinion, have submitted apetition

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

seeking FPC approval oftheir 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 ofthe 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 ofrefund required ofDorchester and the form ofpayment have not yet been approved. Until FPC approval is granted, or some other disposition is ordered, we donotbelieve 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 ifthe 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...&%,-theproduction tax paid by reason ofthe disallowed portion ofthe contr,act pric,e should be refunded to the producer or allowed as a credit in subsequent tax r.epnrts. You ask whether performance ofthe gas exploration agreement by Dorchester would have the same tax consequences under Art. l.llA as would a refund.

Under the terms ofthe 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; itwill be obligated to expend the money, subject to Northern’s approval, ina search for new gas reservea. Any reserves discovered till, be owned by Dorchester but dedicated for sale to Northern at adiscount.

There can be no doubt that this arrangement will be more beneficial to Dorchester thanhaving topay 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 ofa direct refund. The agreement provides Northern with an opportunity to secure future supplies of gasat a discount, an opportunity

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

apparently of considerable value to Northern.

But regardless ofwhich party has the better end of the bargain, it can hardly be argued that approval ofthe agreement by the FPC would give Dorchester the benefit ofthe full contract price originally charged Northern and upon which production taxes were paid. Instead FPC approval will further confirm that aportion ofthe 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 ofmaking the required refund which has been proposed by Dorchester and accepted by.Northern. Ifapproved by the FPC, Dorchester will not be relieved of its obligation to make a refund-but will be permitted to do so inamanner other than direct repayment. Inthese circumstances we believe Dorchester would be entitled toa refund of the gas production taxes it paid onthe amount charged Northern in excess ofthe rate fixed by the FPC.

Your third question is whether the taxpayer would still be entitled to a refund of g,asproduction taxes if, inlieu ofa direct refund, the FPC approved anexploration agreement similar to that submitted by Dorchester butwithout the provision for a discount onfuture 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, andthat as a result the producer /taxpayer is required to refund that portion of the contract price charged in excess ofthe approved rate. Even without a discount provision, the exploration agreement is nevertheless analternative method for making the required refund under which the producer loses unrestricted use ofthe refund amount and assumes substantial new obligations with respect to it. In this situation the amount ofthe refund can nolonger be considered part of the price received for the gas sold andaccordingly the taxpayer ,would be entitled to a refund ofthe 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. 1495The 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 ahigher price 

### forthe gas sold and therefore should have to **pay** production taxes calculated onthe basis ofthis higher amount. In our opinion hewould notbe entitled to a refund. The gas production tax imposed by Article 3.01is based onthe price actually received, not the rates established by the FPC.
SUMMARY A,final determination ina rate proceeding before the Federal Power Commission occurs when the amount of refund has been agreed to by the parties andapproved by the Commission or, in the absence of agreement, has’been ordered by the Commission.
A taxpayer is entitled to a refund ofgas production taxes ifthe FPC establishes a rate lower thanthe contract price and requires him to make a refund ofthe 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