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L.P. v. Montezuma County Board of Commissioners

Supreme Court of Colorado, En Banc

June 19, 2017

Kinder Morgan CO2 Co., L.P., Petitioner
Montezuma County Board of Commissioners; Colorado Board of Assessment Appeals; and Colorado Property Tax Administrator. Respondents

         Certiorari to the Colorado Court of Appeals Court of Appeals Case No. 13CA2187

          Attorneys for Petitioner: The Poe Law Office LLC Alan Poe Rachel Poe. Centennial, Colorado.

          Attorneys for Respondent Montezuma County Board of Commissioners: Dufford, Waldeck, Milburn & Krohn, L.L.P. Nathan A. Keever Grand Junction, Colorado.

          Attorneys for Respondent Colorado Property Tax Administrator: Cynthia H. Coffman, Attorney General Frederick R. Yarger, Solicitor General Robert H. Dodd, Senior Assistant Attorney General Denver, Colorado.

          No appearance on behalf of Respondent Colorado Board of Assessment Appeals.



         ¶1 The petitioner in this case, Kinder Morgan CO2 Company, L.P., operates oil and gas leaseholds in Montezuma County, Colorado. In 2009, the assessor for Montezuma County issued a corrective tax assessment on these leaseholds for the previous tax year, retroactively assessing over $2 million in property taxes, after an auditor concluded that Kinder Morgan underreported the value of gas produced at the leaseholds. Kinder Morgan contends that the assessor lacked authority to retroactively assess these taxes because the statutory scheme for property taxation of oil and gas leaseholds-which authorizes retroactive assessments when "taxable property has been omitted from the assessment roll, " § 39-5-125(1), C.R.S. (2016)-does not authorize a retroactive assessment when an operator has correctly reported the volume of oil and gas sold but has underreported the selling price at the wellhead. We are therefore asked to decide whether this statutory scheme authorizes retroactive taxation where an operator underreports the selling price at the wellhead of the oil and gas it produces.

         ¶2 Because Colorado has established a self-reporting scheme for property taxation of oil and gas leaseholds, and because the legislature's amendments to that scheme describe the "underreporting of the selling price or the quantity of oil and gas sold [from a leasehold]" as a form of omitted property, see §§ 29-1-301(1), 39-10-107(1), C.R.S. (2016), we conclude that the statutory scheme authorized the retroactive tax assessment in this case. We further conclude that the Board of Assessment Appeals did not err in determining that Kinder Morgan underreported the selling price by claiming excess transportation deductions, given Kinder Morgan's relationship to the owner of the pipeline through which the gas was transported. We therefore affirm the judgment of the court of appeals.

         I. Property Taxation of Oil and Gas Leaseholds

         ¶3 Because this case concerns the assessment of property taxes on oil and gas leaseholds, we begin by describing the legal framework governing these taxes and the relation of these taxes to other pertinent forms of taxation.

         ¶4 An estate in minerals such as oil and gas is a form of real property. § 24-65.5-101, C.R.S. (2016); § 39-1-102(14), C.R.S. (2016); see Hagood v. Heckers, 513 P.2d 208, 214 (Colo. 1973); Simson v. Langholf, 293 P.2d 302, 307 (Colo. 1956). Once the owner of such a mineral estate leases the right to extract oil and gas from the land, the lease may create various interests, which generally take the form of either a working interest (the oil and gas company's right to extract the minerals and develop them for profit) or a royalty interest (the estate owner's right to receive a share of the production or a share of the value of proceeds of production). See generally 1 Patrick H. Martin & Bruce M. Kramer, Williams & Meyers, Oil and Gas Law §§ 201-216 (2014 ed.). Oil and gas leaseholds are subject to taxation as real property.[1] § 39-7-102, C.R.S. (2016); Colo. Const. art. X, § 3(1)(b). Unlike most real property interests, however, the value of an oil and gas leasehold interest comes not from the physical space or land the leasehold occupies, but rather, from the quantity and value of oil and gas underground. See Washington Cty. Bd. of Equalization v. Petron Dev. Co., 109 P.3d 146, 150-51 (citing Colo. Const. art. X, § 3(1)(b)).

         ¶5 The legislature has plenary authority to assess, levy, and collect taxes, including taxes on real property. Bd. of Cty. Comm'rs v. Vail Assocs., Inc., 19 P.3d 1263, 1273 (Colo. 2001). Nevertheless, the legislature's authority to tax is circumscribed by article X of the Colorado Constitution. Id. (citing Bartlett & Co., Grain v. Bd. of Cty. Comm'rs of Baca Cty., 382 P.2d 193 (Colo. 1963)). As relevant to this case, section 3 of article X limits the legislature's ability to assess property taxes by requiring that taxes be based on the "actual value" of the property. Petron Dev. Co., 109 P.3d at 149; see also San Miguel Cty. Bd. of Equalization v. Telluride Co., 947 P.2d 1381, 1383 (Colo. 1997) ("[A]ctual value is the guiding principle for the taxation of real property in Colorado.").

         ¶6 The legislature also has the authority to prescribe appropriate methods for determining the "actual value" of property. See Petron Dev. Co., 109 P.3d at 149. For most types of real property, the legislature has required the county assessor to consider and document three approaches to determine the "actual value" of the property: the cost approach, the market approach, and the income approach.[2] § 39-1-103(5)(a), C.R.S (2016).

         ¶7 By contrast, oil and gas leaseholds and lands are valued under the provisions of article 7 of title 39. § 39-1-103(2). Under the provisions of article 7, the holder of an oil and gas lease must submit an annual statement, from which the county assessor determines the property's value and the leaseholder's property tax liability. See §§ 39-7-101, -102. The annual statement must include, among other information, the volume of gas or oil sold and the selling price of the gas or oil "at the wellhead"-a term that refers to "the physical location where the extracted material emerges from the ground." § 39-7-101(1)(c)-(d); Petron Dev. Co., 109 P.3d at 153.

         ¶8 The sale of unprocessed oil or gas, however, rarely occurs at the wellhead; instead, the oil or gas is typically gathered from multiple wells, processed, and transported away from the wellsite before sale. See Petron Dev. Co., 109 P.3d at 151-54. As a result, an operator typically must estimate its "selling price at the wellhead" for purposes of section 39-7-101(1)(d) by deducting from its final, downstream selling price the costs of gathering, processing, and transporting the extracted material. Id. at 153- 54; § 39-7-101(1)(d) ("The net taxable revenues shall be equal to the gross lease revenues, minus deductions for gathering, transportation, manufacturing, and processing costs borne by the taxpayer pursuant to guidelines established by the [Property Tax Administrator]."). This calculation-that is, the deduction of gathering, processing, and transportation costs from the final, downstream selling price-is known as a "netback" method of calculating wellhead selling price. Petron Dev. Co., 109 P.3d at 152.

         ¶9 An operator's netback calculation depends on whether the operator contracts with a related or an unrelated party to perform these gathering, processing, and transportation services. If the operator enters into a bona fide, arm's-length transaction with an unrelated party to perform these services, then the operator may deduct the full amount paid for these services from its final, downstream sales price in its netback calculation (the "unrelated-parties netback method"). See 3 Div. of Prop. Taxation, Colo. Dep't of Local Affairs, Assessor's Reference Library: Real Property Valuation Manual ("ARL") 6.35-6.36 (Rev. Jan. 2017). If the operator instead enters into a transaction with a related party (such as another subsidiary of the same parent company) to perform these services, then it may deduct only a portion of the amount paid for these services (the "related-parties netback method").[3] 3 ARL 6.39-6.41. The operator need not disclose the methodology or details of its netback calculation in its annual statement, see § 39-7-101(1)(a)-(f), although an assessor may elect to require this information to be submitted separately, and the assessor may rely on this information if it conducts a review or an audit, see 3 ARL 6.34-6.35.

         ¶10 Section 39-2-109(1)(k), C.R.S. (2016), requires the Property Tax Administrator to prepare and publish guidelines providing procedures for county assessors to audit oil and gas leaseholds for property tax purposes, which the Administrator has done in the Assessor's Reference Library. Under these guidelines, an assessor may initiate an audit and request the source documents regarding sales volume and sales price from which the operator prepared its annual statement. 3 ARL 6.52. The assessor then determines whether a change in the property's valuation is warranted and may issue a corrective assessment or an abatement. Id. at 6.53-6.58. The guidelines state that retroactive assessments are authorized under the statutes providing for assessments on property that has been previously "omitted from the assessment roll" and that abatements are authorized under the statutory provision allowing for refunds and abatements if taxes have been "illegally or erroneously levied and collected." See id. at 6.55 (citing § 39-10-107), 6.58 (citing § 39-10-114).

         ¶11 With this legal framework in mind, we turn to the facts of this case.

         II. Facts and Procedural History

         ¶12 Kinder Morgan CO2 Company, L.P., produces, transports, and sells carbon dioxide (CO2) for use in oil and gas operations. Kinder Morgan is the operator of the McElmo Dome Unit, [4] a large CO2 deposit in Montezuma County and Dolores County, near the Four Corners area of Colorado. The CO2 extracted from the McElmo Dome Unit is compressed and transported through the Cortez Pipeline across New Mexico and into West Texas. There, the CO2 is sold to various oil and gas operators, who inject the CO2 into existing West Texas oil fields to enhance oil recovery.

         ¶13 In addition to Kinder Morgan, several other companies and individuals own working interest leaseholds and royalty interests in the unit. As the operator of the unit, Kinder Morgan manages the unit's development by paying for the facilities and equipment and supplying the labor to produce CO2, which the various working interest leaseholders own in proportion to the relative sizes of their leaseholds. Kinder Morgan then bills the other working interest leaseholders for its expenses in operating the unit and arranging for transportation of the CO2 to the point of sale. As the operator, Kinder Morgan also files annual property tax statements for all of the leaseholds.

         ¶14 The Cortez Pipeline-through which the CO2 is shipped-is owned by Cortez Pipeline Company and operated by Kinder Morgan. Cortez Pipeline Company, in turn, is a partnership. At the time of the disputed tax assessment, Kinder Morgan owned a 50% interest in Cortez Pipeline Company. The remaining interest in the partnership was owned by Mobil Cortez Pipeline Company (37%) and Cortez Vickers Pipeline Company (13%). Cortez Pipeline Company charges the same, fixed tariff to any entity that ships CO2 through the pipeline. In 2007, that tariff was 22 cents per MCF[5] of CO2.

         ¶15 When Kinder Morgan submitted its annual property tax statement for the 2008 tax year, it reported a wellhead selling price of 52 cents per MCF. Kinder Morgan calculated that wellhead selling price using the unrelated-parties netback methodology, under which Kinder Morgan deducted (among other costs) the full 22-cent transportation tariff it paid to Cortez Pipeline Company. Based on Kinder Morgan's annual statement, the ...

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