Tesoro Corp. and Subsidiaries v. State, Department of Revenue, 042811 AKTAX, 05-0155-TAX

Docket Nº:OAH 05-0155-TAX
Opinion Judge:Fred Torrisi, Judge.
Case Date:April 28, 2011
Court:Superior Court of Alaska




OAH No. 05-0155-TAX

No. 3AN-09-8897 CI

Superior Court of Alaska, Third Judicial District, Anchorage

April 28, 2011


Fred Torrisi, Judge.

Appellant Tesoro Alaska reminds us that a state "may not tax value earned outside its borders."1 It argues that the Alaska Department of Revenue is ignoring the economic reality that most of the $89 million income that it has taxed wasn't earned in this state—$75 million in its view—and wasn't even connected to business activities conducted here. The State maintains that the taxpayer was properly deemed a unitary business, and that it fashioned appropriate relief under a catch-all provision of the statute2 that reduced Tesoro's tax by a third. The parties filed (long) briefs in support of their positions, and the matter was argued last fall.3

Table of Contents

Statement of facts (in part).


Alaska Cases.


Gulf Oil


Earth Resources


Alaska Gold


Standard of Review.


Were the segments unitary?


Was separate accounting required?




Statement of facts.4

As California Supreme Court Justice Werdegar wrote,

Ours is a global economy. In contrast, government and the taxing authority used to fund it are national and local. This geographic disparity generates difficulties when each jurisdiction seeks its piece of the economic pie, a pie generated by economic activity that knows no borders.5

Administrative Law Judge Mark T. Handley sought to sort out these difficulties, hearing this matter on appeal from an informal conference decision of the Department of Revenue's Tax Division. He ruled that Tesoro failed to show that DOR's determination that it was unitary during the-1994-98 audit period was incorrect.6 His discussion of the company's background cites the record and gives a good picture of how Tesoro developed into the company that it was during the relevant tax years.

As the price of oil declined significantly during the 1980s, Tesoro struggled and entered the 90s with a gas exploration and production unit [E&P] based in Texas, and an Alaska oil refinery and marketing unit [R&M], among other units. The corporate headquarters was in Texas, while most R&M activities were in Alaska.7 Its brief sets forth in some detail what happened to the company during this period, as it sold assets, wrote off losses and restructured management, in an effort to become more efficient, evolving in its view from an integrated company to one that was non-unitary in nature.

The company was fortunate to have a contract with Tennessee Gas, and success in producing natural gas from the Bob West field in Texas, which, after litigation, yielded high revenues, 8 while its presence in Alaska consisted of its oil refinery, gas stations, and both marine and aviation fuel sales. In addition to E&P and R&M, Tesoro had three other segments: corporate, finance and marine services.9 "While refining oil purchased from others, Tesoro did not produce or transport oil in a pipeline until 1995, when it purchased the Kenai Pipeline Company [KPL], which changed its tax status under AS 43.20.072, which in turn requires apportionment. This occurred just as the company was realizing significant profits, enhanced by a settlement with Tennessee Gas and the sale of some of its proven reserves. Tesoro emphasizes the independence of its two principal divisions during this period, and its brief describes the personnel and operations of each in some detail.10 There were, however, overlapping directors and senior staff, and the ALJ found that the subsidiary boards rarely even met, with board-level decisions made by Tesoro's Board of Directors.11

Tesoro and its operating subsidiaries entered into an administrative services agreement that allocated costs in a manner it believed to approximate their value on the open market. The company emphasizes that these services were in no way operational, but rather included such tilings as compliance with federal law, riling necessary reports, cash management and accounting services.12 While Tesoro views this as arms-length and about the same as if the divisions had contracted with an outside firm, both quantifiable and essentially immaterial, the ALJ saw it as a natural and highly beneficial example of centralized management, 13

Tesoro maintains that the revenue stream that produced most of its income during the audit period came from events unconnected to Alaska and its R&M division. It prevailed in litigation over a contract with Tennessee Gas, 14 and, faced with an enforceable take-or-pay contract, this company bought out its contract, yielding altogether over $ 127 million. Tesoro also sold a gas field which it believed to be overvalued, generating another $68 million. So while the Department of Revenue looks at the factors which it believes satisfy the criteria to label Tesoro a unitary business, the taxpayer protests that DOR is missing the forest for the trees; that it is plain that for the years in question, we know exactly where the money was made. It argues that the record fully supports its analysis that only $14 of 89 million was attributable to Alaska operations during the audit period, with 1996 standing out as the poster child for unfairness—$6 of 60 million actually earned here in the company's view. The Department views those "Alaska" numbers as basically irrelevant in the context of the formula apportionment scheme that was applied, based on flows of value found by the ALJ to exist among the taxpayer's various divisions.[15]

Looking at factors used in the Uniform Division of Income for Tax Purposes Act [UDITPA], [16] Tesoro maintains that despite high gross sales numbers, the profit margin for its Kenai refinery was transparently thin, while its out-of-state income, due to the unique circumstances noted above, was very high. Similarly unfortunate, from its point of view, was die fact that the Alaska refinery was expensive to build, while its Texas gas fields were still valued at their acquisition costs, artificially low in light of later discoveries. Since the Department's response to tiiese arguments is rooted in die Alaska Supreme Court cases of GulfOil, [17] Earth Resources, [18] and Alaska Gold [19] it might help to begin with tiiese cases, and then return to Tesoro's broad challenge to a scheme that it believes to be taxing income earned wholly outside the borders of this state.

Gulf Oil.

What happened in Gulf OH is not strictly analogous to what Tesoro claims here, but the general theme has some similarities. Gulf was hit by very high foreign taxes that amounted to nearly all the income it earned in those countries, and yet it was not allowed to deduct these taxes under AS 43.20.031(c). Leasehold interests here were also valued at cost, despite the failure to yield any product. The supreme court characterized both issues as matters of fairness, 20 and one remedy that was statutorily available—section 18—included separate accounting.[21]

The foreign countries, primarily members of OPEC, adjusted their taxes to the point where a company "would just barely continue to produce."[22] In 1977, for example, Gulf paid over Si billion in income taxes to earn $13 million in after tax income, and in 1976, it claimed to have paid an effective rate of over 100% in those countries. Meanwhile, leases in Alaska that it had written off as worthless, were valued by the state at their acquisition cost at S33-94 million, far exceeding any other property that the company had. It had few or no employees in Alaska, it extracted no oil here, and it argued that it should pay no income taxes here.[23]

The court recognized that "the use of formula apportionment is the legislative decision that a certain degree of distortion will be tolerated, " and the question raised "is whether the result is unfair to a degree that exceeds those tolerable limits."[24] After finding each of the solutions proposed by Gulf somewhat arbitrary, the court turned to the constitutionality of the state's taxing method.

It began with a 1920 opinion of the U.S. Supreme Court which upheld the scheme generally, [25] and it also cited Container Corp. for the proposition that proper allocation is not only difficult to achieve in practice, but also to even describe in theory.[26] It referred to "the steep burden of proof' required to establish a constitutional violation, [27] and declined to find a violation on the facts presented by Gulf. Further, citing Amoco[28] and ARCO[29] it concluded that dry holes were useful to an exploration company. It concluded by commenting on Gulfs claim of a distortion ranging from 1100-53, 000%:

However, showing a difference between Gulfs calculation and the DOR's calculation is a far cry from showing that there is a "grossly distorted result." The existence of a distortion depends on the validity of the underlying assumption in Gulfs brief that "Gulf really earned nothing in Alaska.'1 That assumption relies on Gulfs separate geographic accounting. In this case, the basic weakness of separate accounting is highlighted: Gulfs calculation fails to account for hard-to-quantify contributions of value resulting from activities such as the drilling of dry holes. Gulf did conduct business in Alaska: it explored for oil, entered into leases, drilled, and analyzed the results. Because these activities are integral to the production of income, a corresponding portion of Gulfs worldwide income can constitutionally be attributed to Alaska.[30]

The state argues that the same is true here—Tesoro's contention that it earned very little in Alaska relies on separate geographic accounting, while...

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