City of Liberal v. Seward County

CourtUnited States State Supreme Court of Kansas
Citation802 P.2d 568,247 Kan. 609
Docket NumberNo. 64358,64358
PartiesCITY OF LIBERAL, Kansas, Appellant, v. SEWARD COUNTY, Kansas, Appellee.
Decision Date07 December 1990

Syllabus by the Court

1. The basic rules and legal principles concerning the exemption of property from taxation are stated and applied.

2. Under the facts of this case, the royalty interest of the City of Liberal in an oil and gas lease, covering a portion of the undeveloped land surrounding the municipal airport, which was executed solely for the purpose of generating revenue, does not constitute property "used exclusively" by the City as contemplated by K.S.A. 79-201a Second or Article 11, § 1(b)(2) of the Kansas Constitution.

3. Under the facts of this case, it is held that the royalty interest of the City of Liberal is not exempt from taxation.

Rex A. Sharp, Neubauer, Sharp, McQueen, Dreiling & Morain, P.A., Liberal, argued the cause and was on the brief, for appellant.

Tom R. Smith, Smith & Miles, Chartered, Liberal, argued the cause and was on the brief, for appellee.

ALLEGRUCCI, Justice:

This is an appeal by the City of Liberal (City) from a judgment of the Shawnee County District Court affirming an order of the Board of Tax Appeals (BOTA), which denied exemption of royalty interest owned by the City from ad valorem taxation. We granted the appellant's petition for review.

The facts are undisputed. After World War II, the United States conveyed a large tract of land to the City, which is now used as the municipal airport for the City. The enabling deed to the City required all income from the land be used for airport maintenance. Part of this land surrounding the airport has been developed into an industrial park. A portion of the undevelopedreal estate not used for airport hangars, runways, etc., was leased in 1983 for oil and gas development purposes. The land has been leased to an oil and gas producer, and presently wells are operating on the property. At the time of the execution of the lease, the City reserved a royalty interest in the leased property and receives royalty income for the gas being produced from the land. It is this royalty interest that the City seeks to exempt from taxation.

The royalty income is used by the City exclusively for the maintenance, operation, and improvement of the airport. At the hearing before BOTA, the Board was informed that the income from the property was being used for airport maintenance, which by law could be supported by taxes or by bonds. The funds were deposited in the airport fund, which was also supported by a city-wide 2.5 mill tax levy for airport maintenance.

BOTA found the facts in City of Arkansas City v. Board of County Commissioners, 197 Kan. 728, 420 P.2d 1016 (1966), nearly identical to the present case and concluded that the leases were not a governmental function but were taxable as in a trade or business. BOTA concluded that the lease existed purely for the production of revenue, and the only participation of the City was to receive payments. BOTA concluded that disposition of the proceeds from the leases was not material to the exemption question. Because the operation of the lease was not essential to the operation of the airport, BOTA concluded that it was not used for a governmental or proprietary function but, instead, was used solely to generate income, and its absence would not affect airport operations.

Here, the decision by the district court upheld the conclusion by BOTA. The district court, however, did not discuss City of Arkansas City but, instead, relied upon Salina Airport Authority v. Board of Tax Appeals, 13 Kan.App.2d 80, 761 P.2d 1261, rev. denied 244 Kan. 738 (1988), in concluding that the leased properties were not in any way used for a proprietary function of the government. The fact that the airport authority received rental income from the properties did not constitute use within the meaning of the statute. The district court found the royalty payments received by the City similar to the rent received by the airport's leased properties and concluded that the City was not entitled to an exemption from ad valorem taxation.

The Court of Appeals, 792 P.2d 1077, reluctantly affirmed the district court because it found the facts here indistinguishable from those in City of Arkansas City. The court also found K.S.A. 79-201a Second to be indistinguishable from the 1963 amendment to G.S.1949, 79-201, which was the basis for the decision in City of Arkansas City. The Court of Appeals noted: "While we might not agree with the decision announced in City of Arkansas City, we are bound to follow it. It is controlling in this case; therefore, we have no choice but to affirm."

The sole issue before us is whether the City of Liberal's royalty interest from oil and gas leases is exempt from ad valorem taxation. BOTA concluded the royalty interest was not; the district court and the Court of Appeals agreed.

We first note that, on appeal, orders of BOTA are subject to judicial review in accordance with the Act for Judicial Review and Civil Enforcement of Agency Actions, K.S.A. 77-601 et seq. See K.S.A.1989 Supp. 74-2426(c). Under that Act, the court's scope of review is controlled by K.S.A. 77-621, which this court recognizes as somewhat broader than the traditional three-pronged scope of review set forth in Kansas State Board of Healing Arts v. Foote, 200 Kan. 447, Syl. p 1, 436 P.2d 828 (1968). The applicable provision of the scope of review relevant here is set forth at K.S.A. 77-621(c)(4), which states that the court shall grant review only if BOTA "has erroneously interpreted or applied the law." The burden of proving the invalidity of the agency action is on the party asserting invalidity, which here would be the City. K.S.A. 77-621(a)(1). In determining whether the invalidity of the agency action has been established, "due account shall be taken by the court of the rule of harmless error." K.S.A. 77-621(d).

The City asserts that it is exempt from paying ad valorem taxes on the royalty interest in the oil and gas leases on the real estate connected with the airport based upon the statutory exemption of K.S.A. 79-201a, which provides, in relevant part:

"The following described property, to the extent herein specified, shall be exempt from all property or ad valorem taxes levied under the laws of the state of Kansas:

....

"Second. All property used exclusively by the state or any municipality or political subdivision of the state. All property owned ... by the state or any municipality or political subdivision of the state which is used or is to be used for any governmental or proprietary function and for which bonds may be issued or taxes levied to finance the same, shall be considered to be 'used exclusively' by the state, municipality or political subdivision for the purposes of this section."

The City also contends that the royalty interest in the oil and gas leases is exempt under Kan.Const. art. 11, § 1(b)(2), which provides that "[a]ll property used exclusively for state, county, municipal, literary, educational, scientific, religious, benevolent and charitable purposes ... shall be exempted from property taxation."

The interest in question here is a royalty interest, which is "the compensation paid to the owner of the mineral interest in land where gas, oil, or other inorganic substance is produced and usually consists of one-eighth or other agreed share of the financial proceeds thereof." Rathbun v. Williams, 154 Kan. 601, 603, 121 P.2d 243 (1942). An owner of a mineral interest may sell and assign a royalty interest. An assignee of a royalty interest may, in turn, sell it to another assignee. Thus, royalty interests are considered personal property and are taxed as personal property. 154 Kan. at 604, 121 P.2d 243.

Basic rules and legal principles concerning the exemption of property from ad valorem taxes were summarized by this court in Tri-County Public Airport Auth. v. Board of Morris County Comm'rs, 245 Kan. 301, 304-05, 777 P.2d 843 (1989), as follows:

"Whether particular property is exempt from ad valorem taxation is a question of law if the facts are agreed upon. T-Bone Feeders, Inc. v. Martin, 236 Kan. 641, 645, 693 P.2d 1187 (1985); [citation omitted]. Taxation is the rule, and exemption from taxation the exception under the Kansas Constitution and statutes. T-Bone Feeders, Inc. v. Martin, 236 Kan. at 645 ; City of Arkansas City v. Board of County Commissioners, 197 Kan. 728, Syl. p 1, 420 P.2d 1016 (1966); [citations omitted]. Constitutional and statutory provisions exempting property from taxation are to be strictly construed against the one claiming exemption, and all doubts are to be resolved against exemption. In re Application of Int'l Bhd. of Boilermakers, 242 Kan. 302, 305, 747 P.2d 781 (1987); [citations omitted]. Where the language of a statute, in particular, is relied upon as creating an exemption from taxation, it must be strictly construed against the party claiming the exemption, and he must bring himself clearly within the exemption. Meadowlark Hill, Inc. v. Kearns, 211 Kan. 35, 41, 505 P.2d 1127 (1973); [citation omitted]. Strict construction, however, does not warrant unreasonable construction. Trustees of The United Methodist Church v. Cogswell, 205 Kan. 847, Syl. p 2 [, 473 P.2d 1 (1970) ]."

As previously indicated, the decision of the district court upholding BOTA's denial of the exemption in this case relied upon Salina Airport Authority v. Board of Tax Appeals, 13 Kan.App.2d 80, 761 P.2d 1261. The district court found the royalty payments made to the City of Liberal similar to the rental income received by the Salina Airport Authority. The district court concluded that, in both cases, the fact that income was being generated for the operation and maintenance of the airport did not constitute use within the meaning of the tax exemption statute, and therefore an exemption from ad valorem taxation was not...

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