United States: Kentucky Supreme Court Holds Producer Solely Responsible For Payment Of Severance Tax

On a request for certification of the law from the United States Court of Appeals for the Sixth Circuit, the Supreme Court of Kentucky held that the producer severing natural gas from the earth is solely responsible for payment of the severance tax.  In re: Appalachian Land Co. v. EQT Production Co., 2013-SC-000598-CL (Aug. 20, 2015)(to be published).  The court certified that, absent a specific lease provision apportioning severance taxes between the lessor and lessee, the producer/lessee may not deduct severance taxes or any portion thereof prior to calculating royalties to be paid the lessor.

On December 1, 1944, Robert Williams leased all oil and gas within his property to West Virginia Gas Company for the sole purpose of operating for, producing and marketing oil, gas and gasoline.  Appalachian Land Company ("Appalachian") succeeded Mr. Williams as lessor.  EQT Production Company ("EQT"), a natural gas producer, succeeded West Virginia Gas Company as lessee.  Under the terms of the lease, the lessee, now EQT, is required to pay the lessor, now Appalachian, a royalty interest on natural gas extracted from the land at the rate of 1/8 the market price of gas "at the well".  In 2008, Appalachian filed a class action lawsuit against EQT in the U.S. District Court for the Eastern District of Kentucky, claiming EQT underpaid royalties owed to Appalachian. 

The heart of the dispute centered upon the fact that natural gas is not sold in its raw state "at the well", but rather "downstream" at an interstate pipeline connection after being transported and processed.  Thus, lessees like EQT mathematically work back from the price "downstream" at the point of sale to arrive at the wellhead price, which is then used to calculate royalties owed the lessor.  In the instant case, EQT deducted from the sales price all post-extraction processing costs, transportation costs, and all severance taxes; EQT then paid Appalachian 1/8 of the remainder. 

Appalachian argued EQT should not have deducted severance taxes in arriving at a "market price" for royalty purposes.  The district court disagreed and entered judgment on the pleadings in favor of EQT, also denying Appalachian's motion to alter or amend the judgment.  Appalachian appealed to the Sixth Circuit, which certified the following question to the Supreme Court of Kentucky:

Does Kentucky's "at-the-well" rule allow a natural-gas processor to deduct all severance tax paid at market price prior to calculating a contractual royalty payment based on "the market price of gas at the well," or does the resource's at-the-well price include a proportionate share of the severance taxes owed such that a processor may deduct only that portion of the severance taxes attributable to the gathering, compression and treatment of the resource prior to calculating the appropriate royalty payment. 1

The Kentucky Supreme Court first stated that Kentucky follows the majority "at the well" rule for determining royalty payments, citing its decision in Baker v. Mangum Hunter Production, Inc., 2013-SC-000497-DG (Aug. 20, 2015) (to be published), rendered the same day.  Under the "at the well" approach, production costs (associated with severing the gas from the earth) are not deducted from the sales price when calculating royalties.  Post-production costs (incurred after the gas is severed and reaches the wellhead) are deducted from the sales price for royalty calculation purposes.

Turning to the specific severance tax provisions at issue, the court noted that KRS 143A.020(1) states that "[f]or the privilege of severing or processing natural resources in this state, a tax is hereby levied at the rate of four and one-half percent (4.5%) on natural gas . . . to apply to the gross value of the natural resource."  The tax applies to "all taxpayers severing and/or processing natural resources in this state . . . ."  KRS 143A.020(2). 

The court found Burbank v. Sinclair Prairie Oil Co., 202 S.W.2d 420 (Ky. 1946), a 1946 decision concerning the apportionment of the oil severance tax, to be instructive.  In Burbank, the court held that the act imposing the oil severance tax could not be construed to place any part of the tax on one who is simply a royalty owner.  Likewise, the court found Appalachian was merely a royalty owner and was not involved in either severing or processing the gas.  Indeed, the court stated, "the natural gas tax is assessed for the 'privilege of severing or processing the gas'.  This is a privilege Mr. Williams surrendered over seventy years ago." 

The court found the authorities cited by EQT and Amicus Curaie, the Kentucky Oil and Gas Association, Inc., to be distinguishable because these authorities involved state statutes that specifically provided for the payment of severance taxes by the royalty owner.  In sharp contrast, the court stated, the Kentucky legislature specifically excluded from the definition of taxpayer under KRS Chapter 143A "[a] party . . . who receives an arm's length royalty."  Thus, the court found Appalachian had no statutory liability for the severance tax.

The court also held Appalachian had no contractual liability for the tax.  KRS Chapter 143A was enacted 36 years after the lease in question was executed; therefore, the court stated, the original parties to the lease could not have intended the apportionment of gas severance taxes at the time the lease was executed.  Additionally, because the severance tax does not enhance the value of the gas, the court found it would run contrary to the parties' intent and the purpose of the "at the well" rule for the royalty owner to share in an expense that does nothing to improve the quality of the product beyond the wellhead. 

Finally, the court rejected the argument of Amicus Curaie that imposing the entirety of the severance tax expense on producers would have a devastating impact on small producers that are the backbone of Kentucky's oil and gas industry.  The court reasoned that, as a matter of economics, the severance tax would inevitably be paid by the market participant most willing to endure it.  Furthermore, the court found it immaterial whether its decision ultimately reduces profits to producers to a sum that drives them out of the market, as tax policy is a legislative concern. 

Justice Abramson authored a dissenting opinion, joined by Chief Justice Minton.  The dissent argued the second option proposed by the Sixth Circuit should be adopted, and the producer/lessee should be permitted to deduct the portion of the tax attributable to post-production costs that the processor is allowed to deduct from the sales price prior to calculating the royalty.  The dissent argued such a result would preserve "the parties' contracted for proportionate shares of 'market price at the well'" and be consistent with the legislature's intention to impose the severance tax on "severing" and "processing" the gas.  Under the majority's interpretation, the dissent argued, the producer bears the full brunt of the severance/processing tax.  According to the dissent, the majority's holding ignores the language of KRS Chapter 143A, which focuses both on the severance and processing stages of getting the product to market for the first sale.


1. Notably, the Kentucky Supreme Court rejected both options presented by the Sixth Circuit, instead concluding that in the absence of an agreement to the contrary, lessees may not deduct any severance taxes prior to calculating a royalty value.

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.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
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
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions