In re Edmiston Oil Co.

Decision Date13 January 2012
Docket NumberNo. 104,950.,104,950.
Citation46 Kan.App.2d 969,269 P.3d 833
PartiesIn the Matter of the Appeals of EDMISTON OIL COMPANY, INC., et al., from Orders of the Division of Taxation on Applications for Refund of Sales/Use Tax.
CourtKansas Court of Appeals


Syllabus by the Court

1. When courts are called upon to interpret statutes, they begin with the fundamental rule that they must give effect to the intent that the legislature expressed through the plain language of the statutes, when that language is plain and unambiguous. An appellate court's first task is to ascertain the legislature's intent through the statutory language it employs, giving ordinary words their ordinary meaning.

2. Statutes imposing a tax must be interpreted strictly in favor of the taxpayer. Tax exemption statutes, however, are interpreted strictly in favor of imposing the tax and against allowing an exemption for a taxpayer's property that does not clearly qualify. Strict construction of an exemption provision does not, however, warrant unreasonable construction.

3. As amended in 2000, K.S.A. 2010 Supp. 79–3606(kk) does not change the fact there are dual threshold requirements for the sales and use tax exemption of machinery and equipment used in a processing operation: To be eligible for exemption, the subject machinery and equipment must be both used (a) as an integral or essential part of an integrated production operation, and (b) by a manufacturing or processing plant or facility. The amended statute, however, has additional requirements: (1) The integrated production operation must be engaged in at a manufacturing or processing plant or facility that meets the statutory definition, and (2) that plant or facility must be owned or controlled by a manufacturing or processing business that also meets the statutory definition for such an operation. The definition of processing business includes operations at an oil or gas well where the oil or gas extracted from the earth is subject to certain listed treatments or preparations.

4. Giving ordinary words their ordinary meaning, it is undeniable that in the case of oil and gas wells, extraction does not stop at the bottom of the well bore but must also include withdrawing the fluids to the surface. Movement or migration of fluids occurs in the subsurface rock formation, but those fluids have not yet been extracted from the earth until they reach the surface.

5. In qualifying for a sales and use tax exemption under K.S.A. 2010 Supp. 79–3606(kk)(1), as to the listed treatments, processes, or preparations required by K.S.A. 2010 Supp. 79–3606(kk)(2)(D)(i) to be performed to meet the statutory definition of a processing operation, none of these occur at the bottom of the well bore. Although some apparently natural separation may occur in the tubing, the uncontroverted facts establish that the primary purpose of the tubing is to convey the oil to the surface so that it can be separated with surface equipment. Under the facts of this case, there are no uncontroverted facts to suggest that fluids are otherwise—at the bottom of the well bore or within that well bore—cleaned, separated, crushed, ground, milled, screened, washed, or otherwise treated or prepared by any of the subject machinery or equipment as required by the exemption scheme in K.S.A. 2010 Supp. 79–3606(kk). When the primary use of the equipment is for a nonproduction purpose, the equipment does not qualify for exemption under K.S.A. 2010 Supp. 79–3606(kk)(2)(F) and (6).

6. Comparing the sales and use tax exemption and mineral severance tax statutory schemes, the severance tax statute, K.S.A. 2010 Supp. 79–4216( l ), equates the severing of oil with extraction or withdrawal from below the surface of the soil or water, and the severing of gas is equated with extraction or withdrawal from below the surface of the earth or water. The sales and use tax exemption statute for machinery and equipment used in integrated processing operations, K.S.A. 2010 Supp. 79–3606(kk)(2)(D)(i), that employs the phrase “extracted from the earth” is thus not materially different from the severance tax scheme. Both statutes seem to clearly measure severance and extraction at the earth's surface. Moreover, severance tax is generally defined as a tax imposed on the value of oil, gas, timber or other natural resources extracted from the earth.

7. The plain language of the statutory subsection in K.S.A. 2010 Supp. 79–3606(kk) requires that the substance in question be extracted from the earth before examining the nature of the treatments or preparations that may be performed on such an extracted hydrocarbon stream.

8. All definitional and explanatory subsections of K.S.A. 2010 Supp. 79–3606(kk) must be read within the context of the entire statute and do not constitute separate and independent avenues to exemption.

Jeffrey A. Wietharn and S. Lucky DeFries, of Coffman, DeFries & Nothern, of Topeka, for appellants.

John Michael Hale, of Legal Services Bureau, Kansas Department of Revenue, for appellee.



Edmiston Oil Company and a host of other oil and gas producers (Taxpayers) appeal the decision of the Kansas Court of Tax Appeals (COTA) that denied them a sales and use tax exemption on down-hole machinery and equipment, as well as surface pumping equipment, under K.S.A. 2010 Supp. 79–3606(kk). Concluding that the subject machinery and equipment is not used as an integral part of integrated production operations by a processing plant or facility operated by a processing business where the oil or gas that has been extracted from the earth is then treated or prepared before its transmission to a refinery or wholesale distribution as contemplated by the applicable statute, we affirm COTA in denying the tax exemption for the purchases of such machinery and equipment.

Factual and Procedural Background

Taxpayers applied to the Director of Taxation for a refund of sales and use taxes paid in Kansas for the purchases of certain oilfield machinery and equipment after the legislature substantially amended K.S.A. 79–3606(kk) in the 2000 session. See L.2000, ch. 123, sec. 1; K.S.A. 2010 Supp. 79–3606(kk). Specifically, their claims remaining in this appeal include requests for sales and use tax refunds on purchases of pumping and down-hole machinery and equipment, including gas compressors and lines; surface pumping units, engines, and motors; down-hole pumps, rods, tubing, tubing strings, production casing strings, and cathodic protection; valves and fittings; and electrical equipment. Taxpayers essentially claimed these purchases were for machinery and equipment used as an integral part of an integrated production operation by a processing plant owned by a processing business, and thus eligible for exemption under K.S.A. 2010 Supp. 79–3606(kk).

After the Director of Taxation denied these refund applications and that denial was upheld by the Secretary of Revenue, Taxpayers appealed the matters to COTA. COTA's small claims division upheld the denial of refunds, and Taxpayers then petitioned COTA for an evidentiary hearing. COTA resolved the claims on two rounds of summary judgment proceedings, based on uncontroverted facts as follows:

“6. Oil and gas is contained in rock formations, or [in] the earth. Oil and gas is free to move through rock formations over time, so [it] must accumulate in traps to pool sufficient quantities to warrant drilling, equipping and producing the oil or gas.

“7. Traps can be structural in nature in which the oil and gas accumulate in the upper part of rock folds or in faults and fractures. Traps can be stratigraphic in nature where oil and gas accumulates in the upper part of the changes in rock types that prevent the further migration of the oil and gas. Traps can be a combination of structural and stratigraphic traps. To remove oil and gas from the earth, wells are drilled to locate and extract the oil and gas from the rock and out of the earth and then deliver it to the surface where it can be sold.

“8. After a successful well is drilled to the total depth, casing pipe is run into the well and cemented in place. This prevents the rock formations from collapsing and closing up the hole. The casing in the well bore then becomes the equivalent of a mine shaft for extracting the oil and gas from the earth or rock formation. Without the casing in the well, over time, the well would fall in or collapse on itself, plugging off the well.

“9. After the production casing is cemented in the hole, a perforating ‘gun’ is lowered inside the casing to the depth where the oil or gas was identified during drilling. The ‘gun’ is set off, firing individual focused charges that burn a hole through the casing and cement into the rock formation. This opens channels into the rock or earth for the oil, gas, condensate and water to migrate to the well bore.

“10. The perforated interval will require additional treatment before the rock will allow the fluids to flow properly. Acid is pumped into the perforated interval to dissolve the cement and the rock around the perforations, to provide better channels for flow.

“11. In some rock formations, the oil, gas, condensate, and water is trapped in the rock because the pore spaces are not well connected, or lack permeability. Such wells require more than perforations and acid to cause the fluids to migrate to the well bore. In those cases, the rock formation is given a frac treatment which involves pumping a gelled fluid, or an inert gas like nitrogen or carbon dioxide, along with sand at high pressure into the rock. The pressures generated by this treatment create small cracks or fractures in the rock that get filled with the sand. When the frac treatment ends, the pressure slowly dissipates and the rock formation relaxes and begins to close the artificial fractures that were created. The sand that was pumped along with the fluids fills the newly...

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