In re Appeals of Edmiston Oil Co., Inc.

Decision Date16 July 2010
Docket Number2004-507-DT
CourtTax Court of Kansas


Joelene R. Allen, Judge

Now the above-captioned matters come on for consideration and decision by the Court of Tax Appeals of the State of Kansas on Taxpayers' Second Motion for Summary Judgment. The Court has jurisdiction over the subject matter and the parties pursuant to K.S.A. 74-2438.

Oral arguments were conducted on October 26, 2009. The Department appeared by counsel John Michael Hale. Taxpayers appeared by counsel S. Lucky DeFries and Jeff Wietharn.

Having reviewed Taxpayers' Second Motion for Summary Judgment and supporting evidence, along with all papers filed by the parties relative to the motion, and having considered the oral arguments of counsel, the Court enters the following order. I.

Nature of Case and Procedural Background

This is a sales and use tax refund claim brought pursuant to K.S.A 79-3606(kk). Taxpayers are oil and gas businesses operating oil and gas wells in the State of Kansas. They seek refunds for tax paid in connection with that portion of their well machinery and equipment used to lift oil and gas from natural formations to the earth's surface. Counsel has represented to the Court that refund claims with respect to Taxpayers' other well equipment have been settled.

For purposes of this order, well machinery and equipment used to lift oil and gas to the surface of the earth is referred to as "pre-extraction equipment" and the balance of the machinery and equipment used at Taxpayers' well sites is referred to as "post-extraction equipment."

In 2007 the parties filed cross motions for summary judgment requesting a narrow declaration regarding the meaning of the term "extracted from the earth" under K.S.A 79-3606(kk)(2)(D)(i). The Department argued that oil and gas is "extracted from the earth" only after it has been lifted to the earth's surface. Taxpayers contra argument was that oil and gas is "extracted from the earth" immediately upon entering the underground well bore. The Court's predecessor, the Board of Tax Appeals (BOTA), rejected Taxpayers' interpretation and endorsed the Department's interpretation, setting forth its findings and conclusions in an Order on Motions (certified June 24, 2008). The Order on Motions declares that the operative meaning of the term "extracted from the earth" under K.S.A. 79-3606(kk)(2)(D)(i), as applied to Taxpayers' oil and gas operations, contemplates extraction from the surface of the earth, not merely extraction from an underground formation.

The motion at bar, Taxpayers' Second Motion for Summary Judgment, asserts alternative grounds for exemption, as articulated on page 2 of Taxpayers' supporting memorandum:

[W]hether we look at the pumping and down-hole machinery and equipment as exempt preproduction, or simply as part of the integrated plant, the pumping and down-hole machinery and equipment should be found to be exempt.

The specific statutory provisions now cited by Taxpayers in support of their exemption claim are subsections (kk)(l)(A) (kk)(2)(A), and (kk)(3) of K.S.A. 79-3606.

Taxpayers indicate that they are not at this time seeking reconsideration of the June 24, 2008 BOTA Order on Motions construing the term "extracted from the earth" but are preserving that issue for later review.


Uncontroverted Facts

The Court finds the material facts are uncontroverted. Taxpayers' statement of uncontroverted facts numbered five (5) and six (6) are conclusions, not facts, and will be treated as such for purposes of this motion. Statements seven (7) and eight (8) are not material. Following is a summary of the uncontroverted facts.

Oil and natural gas is contained in the earth and rock formations along with water and other materials. After a successful well is drilled to the total depth, casing pipe is typically installed in the well and cemented in place to prevent the rock formations from collapsing and closing up the hole. Oil and gas are trapped in the rock formations under considerable pressure. The well bore created by drilling into the rock creates a low pressure point. The oil and gas migrate through the rock to the low pressure point to equalize the pressure in the formation. This migration into the well bore is the primary method of extracting oil, gas, condensate, and water from the earth.

Once the pressure in the formation has been depleted sufficiently, there is no longer enough pressure to carry the fluids to the surface. At that point, fluid migration or extraction of the fluids from the rock ceases as the reservoir finds new pressure equilibrium. To overcome this new equilibrium point, pumping equipment is installed, known in the industry as "artificial lift." Artificial lift refers to the use of artificial means to increase the flow of liquids, such as crude oil or water, from a producing well. Generally this is achieved by means of a mechanical device inside the well (pump or velocity stream), or by decreasing the hydrostatic column by injecting gas into the liquid down hole.

The most common type artificial lift is the rod pump operated by the pumping unit. Another common artificial lift tool is an electrical submersible pump (ESP), which contains an electrical motor attached to a centrifugal propeller, which drives the oil to the surface. This pump is attached to the bottom of the tubing, and an electrical supply line is run down the outside of the tubing from the surface to the pump; as oil flows into the casing from the producing formation, the ESP pumps the oil up to the surface. When oil is pumped it cannot be pumped by sucking the oil from the surface; that would cause the oil to vaporize in the well bore, causing cavitation in the pump and resulting in damage to the pump. Consequently, oil must be pushed from below, not pulled from above. Even though the motor used for pumping the oil in a sucker rod pump is located at the surface, the mechanical force is conveyed to the bottom by the sucker rods.

In some cases, due to pressure declines in the tubing or well bore, some separation may occur in the tubing on the way to the surface. The primary purpose of the tubing is to convey the oil to the surface so that it can be separated from the gas and water produced along with the oil. The majority of the separation is done using surface equipment.

Generally, the pumping unit is connected to the rods, the rods are connected to the pump, the pump is connected to the tubing, the tubing is connected to the wellhead, the wellhead is connected to the flow (lead) lines, and the flow lines are connected to the tank battery.

The pumping and downhole machinery and equipment are an integral or essential part of oil and gas well operations. Without such machinery and equipment, the oil and gas is not able to reach the surface, particularly after the formation pressure has been depleted. The pumping and downhole machinery and equipment is dedicated to the oil and/or gas well where the same is located and cannot be easily (if at all) moved or applied to tasks away from the well.


Summary Judgment Standards

"Summary judgment is appropriate when the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. The Court is required to resolve all facts and inferences which may reasonably be drawn from the evidence in favor of the party against whom the ruling is sought. (Citations omitted.)" See State ex rel. Stovall v. Reliance Ins. Co., 278 Kan. 777, 788, 107 P.3d 1219 (2005).

The purpose of summary judgment is to eliminate delay in legal disposition where there is no real issue of material fact. Timi v. Prescott State Bank, 220 Kan. 377, 386, 553 P.2d 315 (1976). The movant has the burden of demonstrating that there are no genuine questions of material fact and that he is entitled to judgment as a matter of law, which is a strict burden. See Saliba v. Union Pacific R.R., 264 Kan. 128, 131, 955 P.2d 1189 (1998). Summary judgment as a matter of law must be conclusively shown. Cessna Aircraft Co. v. Metropolitan Topeka Airport Authority, 23 Kan.App.2d 1038, 1041, 940 P.2d 84 (1997), rev. denied (1997).


Issue Presented

The sole issue presented in Taxpayer's Second Motion for Summary Judgment is whether the uncontroverted facts establish as a matter of law that Taxpayers' pre-extraction equipment qualifies as exempt pre-production line equipment pursuant to subsections (kk)(1)(A), (kk)(2)(A) and (kk)(3) of K.S.A. 79-3606. For purposes of this motion, we assume the validity and correctness of the BOTA Order on Motions certified June 24, 2008, and adopt the interpretation of K.S.A. 79-3606(kk)(2)(D)(i) set forth therein.


Positions of the Parties

Taxpayers contend that their pre-extraction well equipment is exempt as a matter of law under two statutory provisions extending exemption status to machinery and equipment used in certain operations at a plant or facility prior to the production line. The statutory provisions relied upon by Taxpayers include subsections (kk)(2)(A), and (kk)(3) of K.S.A 79-3606. Taxpayers' argue that the pre-extraction equipment can be likened to a conveyor belt used to move raw materials to the oil and gas wells (the production line). In framing their arguments, Taxpayers rely extensively on this Court's recent decision in In re LaFarge Midwest/Martin Tractor Co., Inc., COTA Docket No 2006-8532-DT. LaFarge is currently pending before the Kansas Supreme Court after ...

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