United States: Two Administrative Agencies – To Whom Is The Deference To Be Given – Board Of Tax Appeals Or Department Of Revenue?

In Commonwealth v. Petrotek,1 the Kentucky Court of Appeals considered the calculation of tax assessments on unmined oil reserves. The appeal concerned taxes levied against four oil wells that pumped a significant amount of oil within the first year (2008) but dried up soon after. KRS 132.820(1) allows the Department of Revenue (the "Department") to value and assess unmined reserves "at no more than fair market value in place, considering all relevant circumstances." Because the General Assembly offered no guidance for determining fair market value of unmined resources, the Department developed a formula to estimate the value of unmined resources and then levied taxes accordingly. In the Department's formula, the Department relied solely on production data from the previous calendar year and refused to consider production data occurring after January 1st in the tax-assessed year. Because tax bills for the current year were calculated by using data from the prior year, Petrotek received a small tax bill in 2008 based on production numbers from 2007. But in 2009, when production had drastically slowed, Petrotek received a large tax bill based on peak production data from 2008. Petrotek challenged the Department's 2009 assessment, arguing that the 2009 assessment violated KRS 132.820(1) because the assessment taxed Petrotek for more than the fair market value of the wells. Petrotek took its case to the Kentucky Board of Tax Appeals (the "Board"), which considered that post-January 1, 2009 production was much less than the production numbers used to calculate the 2009 tax bill and found that "post-January 1 production data constituted a 'relevant circumstance' within the meaning of KRS 132.820(1), and thus should have been incorporated in the Department's assessment for the 2009 year." 

On appeal, the court considered the amount of deference courts must give to an administrative agency's statutory interpretation. The court cited the landmark administrative law decision of Chevron2 in noting that "[i]f an administrative agency is charged with implementing a statute, and the language of that statute is ambiguous, courts must defer to that agency's interpretation so long as it is reasonable." However, the court noted that it would defer to an agency interpretation only if the interpretation was an adopted regulation or formal adjudication. Because this case dealt with conflicting interpretations by two agencies with the power to interpret KRS 132.820(1), the Department and the Board, the court first considered the threshold issue of whether the agencies' interpretations were regulations or formal adjudications.

The court determined the Department only corresponded with taxpayers in an informal manner and did not issue any regulations. Therefore, the court did not defer to the Department's interpretation because the interpretation did not constitute a regulation or formal adjudication. The court found that the Board, however, engaged in a formal adjudication, and thus the court considered whether it must defer to the Board's interpretation of KRS 132.820(1) under the Chevron framework.

Under the Chevron analysis, the first step requires the court to use ordinary tools of statutory construction to determine whether the General Assembly has "directly spoken to the precise question at issue." If the court determines the General Assembly has directly spoken, the court must give effect to the clearly stated intent of the General Assembly. If, however, the General Assembly has not spoken and the statute is silent or ambiguous about the particular issue, the court proceeds to the second step of the Chevron analysis and determines "whether the agency's answer is based on a permissible construction of the statute." If the agency's interpretation is permissible, the court should generally follow that interpretation.

In applying the Chevron framework, the court concluded it must defer to the Board's interpretation of KRS 132.820. First, the court determined the General Assembly did not specifically address whether post-January 1 production data constituted a "relevant circumstance" within the meaning of the statute. Furthermore, the court concluded KRS 132.820 was ambiguous because a reader could interpret the term "relevant circumstance" in many different ways. Next, the court concluded that the Board's interpretation of the statute was reasonable by relying on Kentucky cases that define the term "fair cash value" and a case from another jurisdiction that determined the refusal to consider post-January 1 data in valuing an oil and gas lease that suffered a decline in production ignored relevant information. Therefore, the court concluded that the Board's determination of post-January 1 data as relevant was appropriate.


1. Kentucky Court of Appeals, No. 2013-CA-001152-MR (June 19, 2015, Not To Be Published).

2. Chevron, U.S.A., Inc. v. NRDC, Inc., 467 U.S. 837 (1984).

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