State, Department of Revenue v. ConocoPhillips Alaska, Inc., 080311 AKTAX, 3AN-10-05484 CI

Docket Nº:3AN-10-05484 CI
Opinion Judge:ERIC A. AARSETH Superior Court Judge
Party Name:STATE OF ALASKA, DEPARTMENT OF REVENUE, TAX DIVISION, Appellant, v. CONOCOPHILLIPS ALASKA, INC., Appellee.
Case Date:August 03, 2011
Court:Superior Court of Alaska
 
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STATE OF ALASKA, DEPARTMENT OF REVENUE, TAX DIVISION, Appellant,

v.

CONOCOPHILLIPS ALASKA, INC., Appellee.

No. 3AN-10-05484 CI

Superior Court of Alaska, Third Judicial District, Anchorage

August 3, 2011

ORDER

ERIC A. AARSETH Superior Court Judge

Appellant, the State of Alaska, Department of Revenue, Tax Division ("DOR") conducted an audit in 2003 of Appellee ConocoPhillips Alaska, Inc. ("CPAI") and disallowed tax deductions for a payment related to the repurchase of an oil tanker and assessed an offset for costs associated with an oil transfer. CPAI appealed the administrative decision. After the DOR decision was affirmed in an informal conference, CPAI again appealed to the Office Of Administrative Hearings ("OAH") who ruled in CPAI's favor. The DOR now appeals. Oral arguments were heard on July 19, 2011.

Background for Make-Whole Premium

CPAI's affiliate Polar Tankers bought an oil tanker, the Polar Endeavor, in 2001. CPAI immediately sold the tanker to Arctic Funding, LP for $205 million through a synthetic lease agreement. The synthetic lease allowed Polar Tanker to finance the purchase of the tanker by selling the tanker to Arctic Funding while simultaneously leasing the vessel. Appellant's Brief at 5. Polar Tanker was able to list the expense of the tanker on its financial statement as a lease rather than as a debt for the purchase price, but the tanker could still be treated as an asset that could be capitalized and depreciated for tax purposes. Appellant's Brief at 5-6.

The lease agreement had a "repurchase" clause. The lease terminated in 10 years at which point Polar Tankers could buy back the tanker by paying the original financed price ($205 million) or Polar Tankers could terminate the lease early by paying $205 million plus a "Make-Whole Premium" ("MWP"). The MWP would compensate Arctic Funding's noteholders for the loss of interest caused by early termination of the lease. In December 2003, Polar Tankers terminated the lease and repurchased the tanker. The MWP paid was $32, 156, 402 and was derived using a pre-determined interest calculation.1 Had the lease run the full 10 years, Polar Tankers would have paid $103.6 million in lease payments.

The DOR determined that the MWP was not a deductible transportation cost. The DOR concedes that the $205 million repurchase price as well as the yearly lease payments that would have been paid had the tanker not been repurchased qualified as deductible transportation costs.2

Background for Administrative Fee

CPAI and Williams Alaska, Inc. ("Williams") had an Exchange Agreement where CPAI would divert oil from TAPS to Williams to use in Williams' Fairbanks refinery. Williams would return the same volume of oil, but the oil Williams returned would be of a lesser quality. The Quality Bank imposes a fee whenever different qualities of oil get mixed together in the TAPS. The fee compensates the other shippers for the loss in value when the lower quality oil gets mixed in with the higher quality oil.

The Quality Bank sent a notice of the fee to CPAI and then CPAI paid the other oil shippers. CPAI was then reimbursed by Williams for the Quality Bank degradation fee. In addition, Williams paid CPAI an administrative fee for the exchange.

The DOR determined that this administrative fee was nondeductible compensation for oil transportation. CPAI argues that the administrative fee was not payment for the cost of transporting oil, but rather, was simply an administrative fee for channeling oil through Williams' refinery.

Issues

I. What standard of review applies to the DOR's interpretation of complex tax statutes?

II. Did the DOR have a reasonable basis for finding that the Make-Whole Premium was not an "ordinary and necessary business expense" incurred in the transportation of oil.

III. Did the DOR have a reasonable basis for finding that the Administrative Fee for the oil exchange was an offset of oil transportation costs?

I. Discussion of Standard of Review

The DOR maintains that its adjustments to CPAI's "transportation cost deductions were well within reasonable interpretations of the production tax regulations." Appellant's Brief at 3. The DOR argues that "[a]n Alaska oil producer's production tax liability is not determined – as implied by the OAH decision – by the terms of a producer's third-party contracts, but by application of the applicable Alaska production tax statutes and regulations." Appellant's Brief...

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