United States: Texas Court Rules Natural Gas Destined For Interstate Commerce Properly Subject To Local Property Tax

The Texas First Court of Appeals has ruled that the owner of natural gas stored in a Texas reservoir was properly assessed local property tax, regardless of whether the gas was sold in interstate commerce.1 Rejecting the taxpayer's contention that the "dormant" U.S. Constitution Commerce Clause rendered the assessment unconstitutional, the Court concluded that the tax did not fail any of the four prongs of the substantial nexus test established in Complete Auto.2

Background

ETC Marketing, Ltd. (ETC) is a marketer of natural gas with offices and employees in Texas. ETC buys, sells, and markets natural gas to customers located outside Texas, but is not in any way restricted from selling to Texas customers. Its affiliate, Houston Pipeline Company (Houston Pipeline), operates an intrastate natural gas pipeline and a reservoir for the storage of natural gas in Texas.

ETC buys natural gas destined for sale to interstate purchasers from multiple sellers, and "immediately entrusts" the product to Houston Pipeline for storage. ETC's storage agreement with Houston Pipeline allows it to purchase gas and "time the market" by holding the gas for delivery at a later date in order to maximize the sale price.3 Because natural gas is considered to be fungible, the points of transfer from ETC to Houston Pipeline and ultimately to ETC's customers do not necessarily relate to a physical location associated with the seller's gas, as gas owned by various marketers is physically commingled in the pipeline system which includes both intrastate and interstate pipeline. Distinct volumes of gas are segregated by paper allocation, but due to the fungible nature of the product, cannot be separately identified and tracked by the owners.

Since the reservoir where ETC stores its natural gas is located in Harris County, Texas, the Harris County Appraisal District (HCAD) appraised the value of approximately 33 billion cubic feet of natural gas owned by ETC and stored in the reservoir for calendar year 2010, and assessed related ad valorem taxes. While ETC conceded that it was the owner of the natural gas, it contended that all of the gas stored in the reservoir was exempt from property tax under the Commerce Clause of the U.S. Constitution because the gas was destined to be sold in interstate commerce. HCAD countered that the sale of gas was not in interstate commerce, but even if the sale were considered to be in interstate commerce, it would still be subject to tax under the Complete Auto test. The 127th District Court rejected ETC's summary judgment motion and rendered final judgment for HCAD, holding that the stored gas was subject to ad valorem taxation as the gas was not in interstate commerce.4 ETC appealed the decision to the Court of Appeals.

Application of Complete Auto to Ad Valorem Tax

Texas law provides that all tangible personal property is subject to property tax if it is located in a taxing unit for longer than a temporary period, unless forbidden by law.5 In addition, property exempt from ad valorem taxation by federal law is exempt from taxation.6 Noting that the federal exemption applies only to activities related to interstate commerce, the Court accepted that the natural gas at issue was in the stream of interstate commerce. To decide whether an applicable exemption was available under federal law, the Court focused its attention on whether the application of property tax to the natural gas failed any of the prongs of the dormant Commerce Clause test established in Complete Auto. The Court considered each of the four factors necessary to allow a local government to tax goods in interstate commerce: (i) substantial nexus to the taxing state; (ii) fair apportionment; (iii) no discrimination against interstate commerce; and (iv) a fair relation to state-provided services.7 Importantly, the Court noted that the burden of proof is on the taxpayer to show that the tax fails to meet at least one of the prongs.8

Substantial Nexus

First, to survive constitutional scrutiny, a tax must apply to an activity that has a substantial nexus with the taxing state. ETC argued that physical presence alone does not satisfy the substantial nexus prong in ad valorem cases. The Court disagreed, referencing both federal and Texas cases in which physical presence was found to be sufficient to meet this part of the test.9 The Court focused on ETC's physical presence in Harris County and other parts of Texas, including its offices, employees and stored natural gas, in finding a substantial nexus between the activity being taxed and Texas.

Fair Apportionment

The second prong of the Complete Auto test is whether the tax is fairly apportioned (i.e., each state taxes only its fair share of an interstate transaction). In order for the requirements of this prong to be met, a tax must be both internally and externally consistent.10

A tax is considered to be internally consistent when it is structured so that if every state were to impose an identical tax, multiple taxation would not result.11 The Court quickly dismissed this requirement, noting that because ETC was not attempting to store gas in two states at the same time, there was no risk of multiple taxation.

The external consistency test examines whether the state has taxed only the portion of revenue from the interstate activity which reasonably reflects the in-state component of the activity being taxed.12 ETC argued that the ad valorem tax at issue was externally inconsistent because it would be impossible to determine, at any given time, the actual physical location of each molecule of its owned natural gas. However, because ETC had conceded its ownership of 33 billion cubic feet of natural gas stored in the reservoir located in Harris County, the Court rejected this contention. Accordingly, the Court found the ad valorem tax to be fairly apportioned.

Discrimination Against Interstate Commerce

The Court subsequently considered whether the ad valorem tax discriminated against interstate commerce. Noting that the U.S. Supreme Court had previously determined that "ad valorem tax of general application ... is of necessity non-discriminatory,"13 the Court concluded that this particular tax was valid.

Fair Relation to State-Provided Services

The final prong of the Complete Auto test considers whether the tax is fairly related to services provided by the state. The Court noted that no detailed accounting of the services provided to a taxpayer was necessary to prove this fact, but instead "police and fair protection, along with the usual and usually forgotten advantages conferred by the State's maintenance of a civilized society, are justifications enough."14

ETC argued that this prong was not satisfied because the gas was entrusted to Houston Pipeline, which pays property taxes on the reservoir and related equipment. Also, ETC argued that Houston Pipeline had complete and exclusive control over the activity being taxed, which was storage of gas in the reservoir. Finding that ETC had not met its burden of proof on this issue, the Court noted that ETC retained control over the disposition of the gas in the reservoir, as indicated in the evidence provided during the district court's decision. While the gas is stored in the reservoir, the Court found that ETC "enjoys the benefit of public services which facilitate gas storage, which in turn allows it to accomplish its business objective of buying natural gas and holding it for sale at some later point in time." Thus, the Court concluded that the ad valorem tax was fairly related to the services provided by Texas.

In ruling against ETC, the Court reiterated that it was not necessary to resolve the dispute between ETC and the HCAD regarding whether the natural gas was sold in interstate commerce to evaluate the validity of the tax. The ad valorem tax was properly imposed because ETC stored the gas in Texas for the business purpose of selling the gas at a higher price at a later time.

Commentary

The interstate commerce exemption is especially significant for taxpayers engaged in the oil and gas industry in Texas because it is one of the few exemptions potentially applicable to ad valorem taxes on oil and natural gas. Three general exemptions from Texas ad valorem taxes are available for tangible personal property: (i) the freeport exemption; (ii) the goods-in-transit exemption; and (iii) the interstate commerce exemption. The freeport exemption applies when certain types of property are transported outside Texas within 175 days,15 but is not available for oil, natural gas or other petroleum products. Similarly, the goods-in-transit exemption does not apply to oil, natural gas, or petroleum products.16 Thus, businesses in the oil and gas industry generally must rely solely on the interstate commerce exemption for relief from Texas property taxation.

This decision is distinguishable from two recent Texas appellate court decisions that were favorable to the taxpayer and addressed the same constitutional concerns.17 Both cases involved petroleum products being stored in Texas that were later to be transported out of state. In Peoples Gas, the Sixth District Court of Appeals, which sits in Texarkana, held that the natural gas could not be taxed locally because there was insufficient nexus.18 In BP America, the Eleventh District Court of Appeals, which sits in Eastland, held that an ad valorem tax could not be imposed on crude oil stored in a tank farm that is an integral part of an interstate pipeline system.19 The Texas Supreme Court has yet to rule in either of these cases. It is interesting to note that the dissenting opinion in ETC cited Peoples Gas as indistinguishable on the substantial nexus issue.20

The issue of whether property tax properly applies to stored oil and natural gas has been highly litigated in recent years, both in Texas and in other states. For example, both the Oklahoma and Kansas State Supreme Courts found against taxpayers in recent decisions, finding that property tax was validly assessed.21 The United States Supreme Court has refused to hear both the Oklahoma and the Kansas cases,22 despite the fact that the Solicitor General of the United States was requested to file a brief expressing the views of the federal government on this issue.23

The Court's insightful analysis reflects the far-reaching effect of the Complete Auto precedent.24 In practice, Complete Auto's four-prong test continues to lessen the practical effect of the Dormant Commerce Clause, and defenses based upon the concept, with respect to interstate commerce (in contrast to foreign commerce).

Finally, it is important to note that ETC is an appellate court decision that is binding in the area of the court's jurisdiction,25 but is not binding in other parts of Texas. The taxpayer will still have an opportunity to appeal to the Texas Supreme Court.26

Footnotes

1 ETC Marketing, Ltd. v. Harris County Appraisal District, Texas Court of Appeals, First District, No. 01-12-00264-CV, Oct. 2, 2014.

2 Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). The test addresses whether the entity has substantial nexus under the Commerce Clause, thereby allowing a state to impose a tax.

3 ETC has historically stored gas in the reservoir for several months at a time, buying it during warmer months and selling it to northern markets in the winter months. The length of time the gas is stored depends on the volume, time of year, and demand for natural gas.

4 Harris County Appraisal District v. ETC Marketing, Ltd., 127th District Court, No. 2010-71360.

5 TEX. TAX CODE ANN. § 11.01.

6 TEX. TAX CODE ANN. § 11.12.

7 Barclays Bank PLC v. Franchise Tax Board, 512 U.S. 298, 310-11 (1994).

8 Vinmar, Inc. v. Harris County Appraisal District, 947 S.W.2d 554, 555 (Tex. 1997).

9 Relying upon Quill Corp. v. North Dakota, 50 U.S. 298 (1992), which reaffirmed that physical presence satisfies the first prong of the Complete Auto test for sales and use tax purposes. Several Texas cases reached the same conclusion with respect to ad valorem taxes. See, for example, Rylander v. 3 Beall Bros. 3, Inc., 2 S.W.3d 562, 570 (Tex. Ct. App. 1999), cert. denied, 538 U.S. 1013 (2003) and Peoples Gas, Light, and Coke Co. v. Harrison Central Appraisal District, 270 S.W.3d 208 (Tex. Ct. App. 2008), cert. denied, 131 S. Ct. 2097 (2011).

10 Goldberg v. Sweet, 488 U.S. 252 (1989).

11 Id.

12 Id.

13 Japan Line, Ltd. v. Los Angeles County, 441 U.S. 434, 445 (1979).

14 Okla. Tax Comm'n v. Jefferson Lines, Inc., 514 U.S. 175, 200 (1995).

15 TEX. CONST. art. VIII, §1-j.

16 TEX. TAX CODE ANN. §11.253(a)(2)(D).

17 See Peoples Gas, Light & Coke v. Harrison Central Appraisal District, 270 S.W.3d 208 (Tex. Ct. App. 2008), in which the Court held that a tax assessment on stored natural gas was invalid because of a lack of substantial nexus; Midland Central Appraisal District v. BP America Production Co., 282 S.W.3d 215 (Tex. Ct. App. 2009), in which ad valorem tax was found to be improperly assessed on oil passing in interstate commerce through an interstate pipeline, but temporarily held in Texas.

18 The majority in ETC distinguishes Peoples Gas by saying the natural gas marketer's "only connection to Texas was through the 'structure and location' of the separately owned pipeline which made the decision about where to store the gas and paid its own ad valorem taxes on the facility and equipment used for storage of natural gas in Texas. In contrast, ETC Marketing had a physical presence in Harris County including employees, offices, and – most significantly – natural gas that it had specifically contracted to store with Houston Pipeline. Unlike the pipeline at issue in Peoples Gas, Houston Pipeline's facilities are located entirely within Texas, including the Bammel reservoir in Harris County. There was no evidence that the gas was already bound for another state when it was committed to Houston Pipeline."

19 The majority distinguishes BP from ETC because the oil in the BP case "was not held in the tank farm for storage purposes or for any business purpose of the owner other than its transmission through the pipeline."

20 ETC Marketing, No. 01-12-00264-CV (Keyes – dissenting) pg. 9.

21 In re Assessment of Personal Property Taxes, 234 P.3d 938 (Okla. 2008); In the Matter of the Appeals of Various Applicants from a Decision of the Division of Property Valuation of the State of Kansas for Tax Year 2009 Pursuant to K.S.A. 74-2438, 313 P.3d 789 (Kan. 2013).

22 Certiorari was denied for the Kansas case on Oct. 6, 2014, while certiorari in the Oklahoma case was denied on Mar. 1, 2010.

23 In her brief to the Court, the Solicitor General argued that the Oklahoma Supreme Court had correctly rejected the dormant Commerce Clause challenge.

24 In comparison, this is the precedential effect some commentators thought, and some tax practitioners wished, the U.S. Supreme Court decision in the Quill case (Quill Corp. v. North Dakota, 504 U.S. 298, 309 (1992)) had. The precedential effect of Quill has, however, been relied upon sparingly by the courts.

25 Counties served by the First Court of Appeals are Austin, Brazoria, Chambers, Colorado, Fort Bend, Galveston, Grimes, Harris, Waller and Washington.

26 The taxpayer filed a motion for rehearing with the Court of Appeals on October 20. If the Court refuses to rehear the case, the taxpayer will have 45 days from that refusal to file a petition for review with the Texas Supreme Court. Indeed, there might be increased incentive for the Texas Supreme Court to take this case (if appealed) to resolve a perceived split in the Courts of Appeals between ETC on one side, and BP America and Peoples Gas on the other.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.