United States: Oregon Tax Court Rules On Apportionment Treatment Of Receipts From Electricity And Natural Gas

On September 17, the Oregon Tax Court held that the sale of electricity did not constitute the sale of tangible personal property for corporation income tax apportionment purposes for the taxpayer's tax years ending March 31, 2002 through March 31, 2004. As such, for purposes of sourcing the taxpayer's sales of electricity, the cost of performance rule was applied rather than sourcing sales according to the ultimate destination location.¹ The Court also held that the taxpayer's sale of natural gas (which was considered to be tangible personal property) was appropriately sourced based on the ultimate destination, and not necessarily the initial delivery location. As a result, the taxpayer's sales of electricity and natural gas at issue were not sourced to Oregon.

Background

The taxpayer, a Canadian company engaged in the business of selling both electricity and natural gas at wholesale, initially delivered its products within Oregon pursuant to its contracts. However, most of the electricity and all of the natural gas was ultimately destined to users located outside the state.² A majority of the costs of performance associated with the electricity sales were incurred in Canada.

Electricity Was Not Tangible Personal Property

The first issue before the Court was whether the sale of electricity constituted a sale of tangible personal property or a sale of something other than tangible personal property. If electricity was deemed tangible personal property, the sale would be sourced to the location where it was delivered to the purchaser.³ In contrast, if the electricity was characterized as something other than a sale of tangible personal property, the sale would be sourced based on costs of performance.⁴

In determining that electricity was not tangible property for the relevant tax years, the Court considered expert testimony, the position of the Multistate Tax Commission (MTC) and the case law of other Uniform Division of Income for Tax Purposes Act (UDITPA) states. The expert testimony was relevant in considering the statutory language regarding "tangible personal property" that is "delivered or shipped" without regard to the free on board (f.o.b.) or other conditions of the sale.⁵ Based on both expert testimony and the language of the statute, the Court concluded that the sale of electricity was the transfer of a "force," and not the transfer of tangible personal property.

To further support its conclusion, the Court added that the MTC viewed electricity as intangible in nature during the years at issue. Moreover, because Oregon had adopted the provisions of the UDITPA, the stance of other UDITPA states was persuasive. First, a California tax tribunal held that the sale of electricity was the sale of a service and not the sale of tangible personal property.⁶ In addition, a Massachusetts tax tribunal found that electricity was "similar to heat, light and sound and as such was not tangible."⁷ Due to these cases and the fact that consistent and uniform application of UDITPA provisions among UDITPA states was important to taxpayers, the Court found that electricity was not tangible personal property. The Court also summarily rejected the Department's argument that sales tax cases characterizing electricity as tangible personal property should impact the result for corporation income tax purposes.

As the Court concluded that the sale of electricity was not the sale of tangible personal property for Oregon corporation income tax purposes, the sale of electricity could only be sourced to the state if a greater proportion of the income-producing activity was performed in Oregon than in any other state, based on costs of performance.⁸ Because a greater proportion of income-producing activity took place outside the state, the sales could not be sourced to Oregon.

Natural Gas Sales Were Sourced Based on Ultimate Destination

The Court found in favor of the taxpayer and held that the natural gas sales were deemed to have occurred outside Oregon for purposes of computing the sales factor. Prior to considering this issue, the Court noted that the parties had stipulated that natural gas constituted tangible personal property. As a result, the Court stated that receipts are sourced to Oregon when delivered or shipped to a purchaser within the state.⁹ The dispute between the parties was based on the fact that a contractual point of delivery was within Oregon, but the ultimate purchaser was located outside the state. The Department contended that the delivery point controlled, whereas the taxpayer argued that the ultimate destination was determinative.

According to the Court, most of the UDITPA states that have considered the sourcing of natural gas have adopted the "ultimate destination approach," especially when the seller delivered the property to a common carrier in a particular state for further shipment to an ultimate destination outside that state.¹⁰ Based on the record, the gas in the present case appeared to be transmitted over interstate pipelines that functioned as "common carriers."

Therefore, the UDITPA states' decisions supported the conclusion that the gas was appropriately sourced to the ultimate destination.

The Court further stated that the ultimate destination rule served the purpose of the sales factor, which was to recognize the market state's role in the income-producing process. This underlying purpose also favored the taxpayer. Thus, the Court concluded that the ultimate destination rule applied to sales of natural gas and that the taxpayer's sales of natural gas were not considered Oregon sales.

Commentary

The taxpayer successfully argued that sales from electricity should be considered sales from intangibles sourced via the cost of performance rule, and sales from natural gas should be considered sales from tangible personal property sourced via the ultimate destination rule. However, significant regulatory changes were made by the Department after the tax years at issue in the case. In 2007, the Department amended the sales factor apportionment regulation to include electricity in the definition of "tangible personal property"¹¹ and promulgated a new regulation to provide that the sourcing of electricity and natural gas sales is based on the contractual point of delivery rather than ultimate destination.¹² A sale occurs in Oregon if the electricity or natural gas is delivered or shipped to a purchaser with a contractual point of delivery in the state. These sales are sourced to Oregon regardless of whether the purchaser uses the property in Oregon, transfers the property to another state or resells the property in Oregon. These regulations, which interpret a statute that has not changed since the tax years at issue in this case, completely change how to source sales of electricity and natural gas.

In a footnote, the Court explained that the Department asserted that it has long held the administrative position that electricity is tangible personal property. However, the Court noted that "[i]t is not clear that there is such a long held policy." The Court emphasized that its conclusion was based on the statute, the factual record of the case and the considerations that must go into construing a uniform law. As explained by the Court, "[e]ven if the department had properly articulated its position on this question, that position could not trump the conclusion of this court based on the factors the court has considered." While the Court did not directly address the regulatory changes made by the Department in 2007, the Court's comments could be taken to mean that the regulations may constitute an erroneous interpretation of the existing statute. The decision calls into question whether a taxpayer may now have standing to challenge the sourcing rules required to be used under the current Department regulation for open tax years. Of course, the Department could appeal the decision and forestall action on potential challenges to the new regulations.

This decision also raises the issue of treating electricity as tangible personal property for one tax regime, but not necessarily for another tax regime within the same state. For instance, while this issue may be of lesser concern to Oregon, which lacks a state sale and use tax, California treats electricity as an intangible for income tax purposes, but treats it as "tangible personal property" for sales and use tax purposes.¹³ This can create confusion and compliance difficulties for taxpayers that have to grapple with the varying treatments of electricity on a sate-by-state level and also , in some cases, a tax-by-tax level.

Footnotes

1 Powerex Corp. v. Department of Revenue, Oregon Tax Court, No. TC 4800, Sep. 17, 2012.

2 "Most" of the users of the electricity were located outside Oregon, but some users were located in the state.

3 OR. REV. STAT. § 314.665(2).

4 OR. REV. STAT. § 314.665(4).

5 OR. REV. STAT. § 314.665(2).

6 Appeal of PacifiCorp, California State Board of Equalization, 2002-SBE-005, Sep. 12, 2002.

7 EUA Ocean State Corp. v. Commissioner of Revenue, Massachusetts Appellate Tax Board, No. C258405-406, April 24, 2006.

8 OR. REV. STAT. § 314.665(4).

9 See OR. REV. STAT. § 314.665(2).

10 The Court pointed out that the MTC does not agree with the majority of states.

11 OR. ADMIN. R. 150-314.665(2)-(A).

12 OR. ADMIN. R. 150-314.665(2)-(C).

13 CAL. R

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