In re Tax Appeal of City of Wichita

Decision Date19 March 2004
Docket NumberNo. 89,934,89,934
Citation277 Kan. 487,86 P.3d 513
CourtKansas Supreme Court

Brian K. McLeod, assistant city attorney, argued the cause, and Gary Rebenstorf, city attorney, and Richard D. Greene, of Morris, Laing, Evans, Brock & Kennedy, Chartered, of Wichita, were with him on the brief for appellant.

John Michael Hale, of Legal Services Bureau, Kansas Department of Revenue, argued the cause and was on the brief for appellee.

The opinion of the court was delivered by


The City of Wichita (City) appeals the decision of the Kansas Board of Tax Appeals (BOTA) affirming the Kansas Department of Revenue's (Revenue Department) assessment of sales tax, compensating use tax, and interest for transactions by the water utility department (water department). The City additionally appeals BOTA's denial of attorney fees and the issuance of a protective order regarding internal Revenue Department documents. We affirm.

Procedural History

The Revenue Department conducted an audit of the City for the period of June 1, 1992, through May 31, 1995, and the notice of assessment of retailer's sales tax, compensating use tax, and interest was issued on February 5, 1996. The City appealed the assessment on April 1, 1996, requesting a hearing pursuant to the Kansas Administrative Procedure Act, K.S.A. 77-501 et seq. The Secretary of Revenue's designee, Douglas Hager, conducted an administrative hearing beginning on March 27, 1997. On December 29, 1997, Secretary of Revenue Karla Pierce determined that the case should be stayed pending the resolution of the case of In re Appeal of Water District No. 1 of Johnson County, 26 Kan. App. 2d 371, 988 P.2d 267, rev. denied 268 Kan. 846 (1999), because it contained similar issues to those in this case.

On September 29, 1998, Hager wrote to the City's counsel advising of the recent amendments contained in K.S.A. 79-2975, which required that a "written final determination" should be issued on or before October 1, 1998. Hager asked the City if it wanted a final written determination issued prior to the conclusion of Johnson County. The City responded that it was requesting a final written determination on all other issues in this case, even if the primary issue would be resolved by Johnson County.

The Secretary scheduled final arguments in the case for January 14, 1999, before the issuing of a determination. On February 11, 1999, Hager bifurcated the case and issued a summary final determination upholding the assessment of sales tax on electricity purchased to pressurize water in the City's water distribution system. The parties agreed to have this sole issue decided because it related to the pending Johnson County. The appeal regarding this issue was ultimately decided by this court in In re Tax Appeal of City of Wichita, 274 Kan. 915, 59 P.3d 336 (2002) (City of Wichita I).

The remaining issues, relating to the assessment of sales tax, compensating use tax, and interest relating to the City's water department, were decided in a final written determination on June 30, 2000, by Hager's successor, David Heinemann. Heinemann upheld the Revenue Department's assessments and interest and denied the City's request for attorney fees. The City appealed this final determination to BOTA.

BOTA conducted a de novo hearing on the matter in October 2001. On June 14, 2002, BOTA entered an order affirming the assessment of sales tax on certain water department fees and interdepartmental transfers and compensating use tax on computer hardware and related equipment. BOTA denied the City's requests for an abatement of interest and for attorney fees. On November 13, 2002, BOTA issued an order on reconsideration upholding all of its original findings. The City appeals from the BOTA decision, and this court transferred the appeal from the Court of Appeals pursuant to K.S.A. 20-3018(c).

Standard of Review

BOTA is considered the paramount taxing authority in Kansas: however, if BOTA's interpretation of law is erroneous as a matter of law, appellate courts will take corrective steps. City of Wichita I, 274 Kan. at 923. "Tax exemption statutes are to be construed in favor of imposing the tax and against allowing an exemption. However, the taxing statutes will be construed favorably to the taxpayer where there is a reasonable doubt as to the meaning of the statutes." 274 Kan. 915, Syl. ¶ 3.

K.S.A. 77-601 et seq. sets forth our scope of review. See K.S.A. 74-2426(c). K.S.A. 77-621(a) provides that "[e]xcept to the extent that this act or another statute provides otherwise: (1) The burden of proving the invalidity of agency action is on the party asserting invalidity." K.S.A. 77-621(c) further specifies that this court may grant relief in the following cases:

"(1) The agency action, or the statute or rule and regulation on which the agency action is based, is unconstitutional on its face or as applied;
"(2) the agency has acted beyond the jurisdiction conferred by any provision of law;
"(3) the agency has not decided an issue requiring resolution;
"(4) the agency has erroneously interpreted or applied the law;
"(5) the agency has engaged in an unlawful procedure or has failed to follow prescribed procedure;
"(6) the persons taking the agency action were improperly constituted as a decision-making body or subject to disqualification;
"(7) the agency action is based on a determination of fact, made or implied by the agency, that is not supported by evidence that is substantial when viewed in light of the record as a whole, which includes the agency record for judicial review, supplemented by any additional evidence received by the court under this act; or
"(8) the agency action is otherwise unreasonable, arbitrary or capricious."

Interpretation of statutes is a question of law; thus, to the extent statutory interpretation is required in this case, our review is unlimited. City of Wichita I, 274 Kan. at 924.

Interdepartmental Transfers

The City's internal auditor from 1994 to 2001, Jeanne Hernandez, testified that the various operating departments of the City, including the water department, shared services for the sake of efficiency. The data center fully costs itself, and then those charges are allocated to the user department for those services. This transaction occurs as a journal entry in the financial accounting system where it is an allocation of those expenses to the water department. The City argues that BOTA erred in concluding that the following four categories of interdepartmental transfers were taxable:

"Interdepartmental Transfers Tax Data Center Charges $37,692 PBX Instrument Charges $ 5,256 Long Distance Pagers $ 1,728 Photocopy Charges $ 972"

Data center charges were characterized as payments for professional services such as billing, accounting, training, personnel, and payroll and for purchases of equipment or other tangible personal property by the City.

The PBX instrument charges are the instrument charges for phones, actual phone lines, and equipment for the water department. The long distance pagers charges were allocations for pager and long distance services. The photocopy charges are accumulated by the data center's dictionary stores and its operation and allocated to the individual departments. Any equipment purchased in connection with these charges is purchased by the data center, and the cost is transferred to the water department.

Some of the expenses constitute a monthly, recurring charge, which is not recalculated each month and is simply an automated journal entry in the accounting system that transfers the expense to the water department. Some charges, like photocopying and long distance services are not automated charges and are calculated each month based on actual use. Money does not change hands, as the water department has an account number in the accounting system to which the expenses are charged. As the water department does not have its own separate bank account, the money collected from customers, i.e., the receipts from selling and furnishing of water, are deposited into the City's bank account. The expenses attributable to the water department are then noted as accounting debits and credits.

When the allocations to the water department are made, the bundle of costs for the data center charges are classified in the following categories: equipment charges, including software application fees for software such as the payroll and billing software utilized by the water department; replacement reserves for future purchases of equipment; license fees; personnel; training services; and strategic planning. When asked if the Revenue Department's audit made any effort to segregate these costs based on their taxability, Hernandez responded that the Revenue Department took out all of the labor services from the interdepartmental transfers but did not make an effort to segregate any of the other costs listed.

BOTA concluded that the interdepartmental transfers constituted taxable sales:

"62. The Board finds that the subject `interdepartmental transfers' as they are referred to by the parties constitutes sales of tangible personal property or services. Although the consideration was recorded by journal entry, the Board finds that there was an exchange of tangible personal property for a consideration.
"63. The Board finds that implicit in K.A.R. 92-19-72 is the fundamental assumption that the initial purchase by the single legal entity is subject to sales tax or that all the various departments are independently exempt from sales tax. Administrative rules and regulations must be appropriate, reasonable, and not inconsistent with the law to be valid. Pemco, Inc. v. Kansas Department of Revenue, 258 Kan. 717, 720, 907 P.2d 863 (1995). To interpret K.A.R. 92-19-72 to allow a city to purchase property and services

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