Director of Taxation, Dept. of Revenue v. Kansas Krude Oil Reclaiming Co., 56515

Decision Date11 December 1984
Docket NumberNo. 56515,56515
Citation236 Kan. 450,691 P.2d 1303
PartiesDIRECTOR OF TAXATION, DEPARTMENT OF REVENUE, Appellant, v. KANSAS KRUDE OIL RECLAIMING COMPANY, Appellee.
CourtKansas Supreme Court

Syllabus by the Court

1. Where a court reviews an agency's order on a question of law, that review is not limited by the statute. In reviewing questions of law, a court may substitute its judgment for that of the agency.

2. In the absence of valid statutory authority, an administrative agency may not, under the guise of a regulation or order, substitute its judgment for that of the legislature. It may not exercise its powers derived from the legislature to modify, alter, or enlarge the legislative act which is being administered.

3. Rules of statutory construction are stated.

4. In an appeal by the Director of Taxation from an order of the Board of Tax Appeals, the record is examined and it is held: The Board of Tax Appeals erroneously granted the crude oil contained in the basic sediment and water an exemption from the excise tax imposed by the Mineral Severance Tax Act, which was not specifically or by implication granted by the legislature.

Mark A. Burghart, Topeka, argued the cause, and William L. Edds, Topeka, Gen. Counsel, Dept. of Revenue, was with him on the briefs for appellant.

Dale M. Sprague, McPherson, argued the cause, and Timothy E. McCoy, McPherson, was with him on the brief for appellee.

LOCKETT, Justice:

This is an appeal by the Director of Taxation from an order of the Kansas Board of Tax Appeals granting the product identified as basic sediment and water (BS & W) an exemption from the Kansas Mineral Severance Tax, K.S.A.1983 Supp. 79-4216 et seq.

Taxation is the power by which the State raises money to defray the necessary expenses of government for a public purpose. In 1983, the legislature passed and the Governor signed the Mineral Severance Tax Act to meet the State's fiscal needs and to provide additional resources for educational and highway funding. The tax is an excise tax based upon the privilege of severing specified minerals from the earth and water of this state.

An excise tax is a charge imposed upon the performance of an act, enjoyment of a privilege, or the right to engage in an occupation. The term "excise tax" and "privilege tax" have been used interchangeably.

The Mineral Severance Tax Act (Act) imposes an excise tax upon the severance and production of oil in Kansas, effective May 1, 1983. K.S.A.1983 Supp. 79-4216 et seq. No specific exemption for crude oil contained in BS & W is included in the exemption section, K.S.A.1983 Supp. 79-4217(b). K.S.A.1983 Supp. 79-4217(a)(1) does allow a reasonable and bona fide deduction for BS & W when the amount of oil or gas produced is measured by tank tables.

Persons falling within the category of producer are required to pay their rateable share of the excise tax. Those persons considered first purchasers are required to withhold the tax and remit the same to the State. K.S.A.1983 Supp. 79-4220(a).

The creation of BS & W was described in an early Kansas case, Hamilton v. Gas and Fuel Co., 117 Kan. 25, 230 P. 91 (1924):

" 'During the early development in the El Dorado field there was very little water commingled with the oil as it was produced. It was comparatively free from impurities and was marketable in the condition in which it was pumped. Later salt water came into the wells and gradually increased in volume, and during the last few years a large percentage of the fluid produced by the wells has been salt water, amounting on many leases to more than ninety per cent. This is commingled with the oil and has to be pumped out with it. The mixed fluid thus pumped out is run into a tank. Since the water is heavier than the oil, a considerable portion of it settles by gravity into the bottom of the tank and is drawn off without disturbing the oil. A large amount of water, however, remains mixed with the oil, and under ordinary temperature will not separate. It was found that by heating the mixture a still greater portion of the water, which has remained suspended in the oil, could be separated and precipitated to the bottom and again drawn off; but even when the fluid was heated the water descending carried with it considerable oil. This mixture, with such other impurities as are brought up by the pump, forms an emulsion at the bottom of the tank, which is called "basic sediment," or most generally "B.S." This B.S. gradually thickens in the bottom of the tank, and much of it has to be scraped out and thrown away, and most operators deposit it in large artificial ponds upon the leases, where occasionally it is finally disposed of by burning.' " 117 Kan. at 29, 230 P. 91.

Kansas Krude Oil Reclaiming Company (Kansas Krude) is in the business of reclaiming pipeline quality petroleum from BS & W and selling the reclaimed product to refiners. Reclaiming involves the treatment of BS & W with chemicals and heat in established treatment plants and facilities. The objective of the process is to separate the impurities in BS & W from the oil to produce a marketable pipeline quality petroleum.

Kansas Krude buys BS & W from tank cleaners and/or lease operators at a fixed price based on an estimate of the quantity of recoverable oil contained in the BS & W. The estimate is based on a process known as "grind out" which determines how much oil is contained in the emulsion. The grind out process, however, is only an estimate, and the company does not always recover the amount of oil it estimated it would recover. Kansas Krude pays the operator or "bottom hauler" a per barrel price which is for the sludge and BS & W, not the price of a barrel of pipeline quality oil. The BS & W is purchased in loads averaging 20-30 barrels from all types of leases, some of which are exempt from taxation under the Act. All BS & W is commingled in batches of 250 barrels for processing through the plant facilities of Kansas Krude.

The Department of Revenue (the Department) issued an opinion June 23, 1983, which concluded that BS & W was within the definition of "oil" as defined in the mineral tax statute and was, therefore, subject to the tax. By taxing the BS & W, the Department treated Kansas Krude as "first purchaser." Kansas Krude is not responsible for the payment of the excise tax from its profits, but is required to withhold the tax from its payment to the seller and to remit the tax to the Department. On July 21, 1983, Kansas Krude appealed. The Board of Tax Appeals (BOTA) conducted a hearing on August 22, 1983. BOTA issued its opinion October 26, 1983, concluding that the product identified as BS & W was granted an implied exemption and assigned an allowance from taxation based on 79-4217(a)(1) of the Kansas Severance Tax Act. After its motion for rehearing was denied, the Department filed its notice of appeal on January 17, 1984.

The Act imposes a tax upon the severance and production of coal, salt, oil or gas for sale, transportation, storage, profit or commercial use of these minerals. Severance of oil defined in K.S.A.1983 Supp. 79-4216(k) means the production of oil through extraction or withdrawal of the same from below the surface of the soil or water by natural flow, mechanical flow, forced flow, pumping or any other means employed to get the oil from below the surface of the soil or water and shall include the withdrawal by any means whatsoever of oil upon which the tax has not been paid, from any surface reservoir, natural or artificial, or from a water surface.

The Department claims that whether oil recovered from BS & W is subject to the excise tax imposed under the Act involves only a question of law and, therefore, the appellate court's review of BOTA's decision is unlimited. In addition, the Department claims that BOTA acted arbitrarily and capriciously, BOTA's order was contrary to the evidence and BOTA exceeded its statutory authority. Kansas Krude claims that a BOTA decision carries with it "a strong presumption of correctness" and, therefore, should not be overturned.

K.S.A.1983 Supp. 74-2426(e) denies an appeal from any order pertaining to the assessment of property for ad valorem tax purposes or the assessment of excise taxes unless the order is unreasonable, arbitrary or capricious. Where a court reviews an agency's order on a question of law, that review is not limited by the statute. In reviewing questions of law, a court may substitute its judgment for that of the agency. BOTA's determination that our legislature granted an implied exemption and assigned an allowance from taxation to BS & W under the Act is a question of law, therefore subject to our review without the limitations imposed by K.S.A.1983 Supp. 74-2426(b)(4).

The Department argues that the oil recovered from BS & W is oil within the statutory definition. Since there is no difference in crude oil of pipeline quality and the crude oil removed from BS & W, there is no logical reason to exclude crude oil removed from BS & W from a tax simply because a different process is used to obtain marketable crude oil. Kansas Krude concedes that BS & W has no value unless it contains sufficient recoverable crude oil of pipeline quality.

The excise tax imposed on the severance of oil is to be applied equally to the gross value of each barrel of oil severed at 8% of the gross value. K.S.A.1983 Supp. 79-4217. The gross rate is the sales price of oil at the time of removal of the oil from the lease or production unit. Where the sales price is not the true value or market price of the oil subject to tax, then the Director is allowed to determine the value of the oil subject to the tax. The Department has determined the price per barrel for oil severed is that price per barrel that a willing buyer will pay for a barrel of crude oil or a barrel of BS & W containing crude oil. The lower price paid per barrel for BS & W actually reflects the market value of the recoverable...

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