N. Border Pipeline Co. v. S.D. Dep't of Revenue, #27152

CourtSupreme Court of South Dakota
Writing for the CourtZINTER, Justice
Citation2015 S.D. 69
Docket Number#27152,#27166
Decision Date05 August 2015

2015 S.D. 69




August 5, 2015

#27152, #27166-a-SLZ



Davenport, Evans, Hurwitz & Smith, LLP
Sioux Falls, South Dakota

Attorneys for appellee.

South Dakota Department of Revenue
Pierre, South Dakota

Attorneys for appellant.

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ZINTER, Justice

[¶1.] Northern Border Pipeline Company operates an interstate pipeline business that provides transportation services to natural gas owners who desire to ship their gas. The South Dakota Department of Revenue (Department) assessed Northern Border for use tax on the value of the shippers' gas that the shippers allowed Northern Border to burn as fuel in compressors that moved the gas through the pipeline. The assessment was affirmed following an administrative hearing, but the circuit court reversed, holding that a tax exemption applied. The Department appeals, arguing that the exemption did not apply. By notice of review, Northern Border raises a number of additional issues, including the contention that the burning of the shippers' gas was not a taxable "use" by Northern Border. We conclude that there was no taxable "use" by Northern Border because the gas was owned by the shippers.

Facts and Procedural History

[¶2.] Northern Border operates an interstate natural gas pipeline that extends from Monchy, Saskatchewan, through South Dakota, to North Hayden, Indiana. The Federal Energy Regulatory Commission (FERC) regulates interstate pipeline businesses. Under the federal regulatory scheme, Northern Border is a "transportation-only" pipeline, meaning that it cannot own the gas it transports in the pipeline. See infra ¶ 14. Northern Border is also bound by the terms of its FERC tariff. The tariff identifies the transportation services that Northern Border can offer and the rules under which it provides those services to shippers, the owners of the gas.

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[¶3.] Northern Border is authorized to provide different kinds of transportation services. For each type of service, the shipper designates the quantity of gas it desires to be transported through the pipeline. The gas is then delivered to Northern Border at a receipt point and returned to the shipper at a delivery point. No gas enters the pipeline in South Dakota.

[¶4.] Pressure is required to move the gas through the pipeline. To maintain pressure, gas is continuously routed through compressors located at stations along the pipeline. At each compressor station, the gas is compressed and then returned to the pipeline. There are three compressor stations in South Dakota.

[¶5.] Although nearly all of the gas routed through the compressors returns to the pipeline, some of the shippers' gas is burned as fuel to operate the compressors. The gas burned to fuel the compressors is part of what is known as "company use gas."1 Northern Border does not buy company use gas from shippers. Pursuant to the tariff, shippers must allow their gas to be burned as a condition of receiving Northern Border's pipeline transportation services. However, shippers retain title to the gas throughout the transportation process.

[¶6.] The Department audited Northern Border's business activities for the period from July 2007 through December 2010. The Department issued a certificate of assessment for use tax on the value of the shippers' gas that was burned in the

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compressors.2 Northern Border contested the assessment and requested an administrative hearing. Following a hearing, an administrative law judge issued a proposed decision affirming the assessment. The proposed decision was adopted by the Department Secretary, and Northern Border appealed to the circuit court. The circuit court reversed the assessment. The court ruled that Northern Border's burning of the shippers' gas was exempt from use tax under SDCL 10-46-55, which exempts "[t]he provision of natural gas transportation services by a pipeline."

[¶7.] The Department appeals the circuit court's exemption ruling. By notice of review, Northern Border challenges the tax, raising the following four issues:3

Whether Northern Border's burning of the shippers' gas was subject to use tax under SDCL 10-46-2.

Whether the imposition of use tax was pre-empted by federal law.

Whether the imposition of use tax interfered with interstate commerce.

Whether the assessment was erroneous due to factual and legal errors.


[¶8.] The Department argues that the circuit court erred in holding that the pipeline-transportation-services exemption applied to the burning of shippers' gas.

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"To be exempt, the activity must first be taxable." Magellan Pipeline Co., LP v. S.D. Dep't of Revenue & Regulation, 2013 S.D. 68, ¶ 36, 837 N.W.2d 402, 411, reh'g denied (Oct. 22, 2013) (Konenkamp, J., dissenting). See also N. Border Pipeline Co. v. Comm'r of Revenue, Nos. A08-0309, A08-0310, 2009 WL 173959, at *4 (Minn. Ct. App. Jan. 27, 2009) (concluding in a similar pipeline-compressor-gas case that "a court naturally determines whether the use tax applies before it determines whether an exemption applies. A thing can be exempted from a tax only if it is initially among the class of taxable things."). Therefore, we first consider whether the activity was a taxable event; i.e., whether Northern Border's burning of the shippers' gas was subject to use tax under SDCL 10-46-2.4

[¶9.] "'Whether a statute imposes a tax under a given factual situation is a question of law reviewed de novo[,] and thus no deference is given to any conclusion reached by the Department of Revenue or the circuit court.'" Magellan, 2013 S.D. 68, ¶ 7, 837 N.W.2d at 404 (quoting TRM ATM Corp. v. S.D. Dep't of Revenue & Regulation, 2010 S.D. 90, ¶ 3, 793 N.W.2d 1, 3). "Statutes [that] impose taxes are to be construed liberally in favor of the taxpayer and strictly against the taxing body."

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Butler Mach. Co. v. S.D. Dep't of Revenue & Regulation, 2002 S.D. 134, ¶ 6, 653 N.W. 2d 757, 759 (quoting Robinson & Muenster Assocs., Inc. v. S.D. Dep't of Revenue, 1999 S.D. 132, ¶ 7, 601 N.W.2d 610, 612). The Department bears the burden of proving the imposition of a tax. Sioux Valley Hosp. Ass'n v. State, 519 N.W.2d 334, 335 (S.D. 1994).

[¶10.] SDCL 10-46-2 imposes use tax "on the privilege of the use, storage, and consumption in this state of tangible personal property purchased for use in this state at the same rate of percent of the purchase price of said property as is imposed pursuant to chapter 10-45." There are two requirements for taxability under this statute. First, there must be "use, storage, and consumption in this state of tangible personal property[.]" SDCL 10-46-2. Second, the tangible personal property must be "purchased for use in this state[.]" Id.

[¶11.] In this case, we may assume without deciding that the Department proved taxability under the first requirement. There is no dispute that natural gas was "tangible personal property," see SDCL 10-46-1(16),5 and the gas was "consumed" in Northern Border's compressors.6 The dispositive question is whether the Department also proved taxability under the second requirement.

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[¶12.] Under the second requirement, the tangible personal property must be "purchased for use in this state[.]" SDCL 10-46-2 (emphasis added). In this case, Northern Border must be deemed to have "purchased" the gas.7 A purchase includes "any transfer, exchange, or barter, conditional or otherwise, in any manner or by any means whatsoever, for a consideration." SDCL 10-46-1(9). Here, the tariff required shippers to allow their gas to be burned in exchange for Northern Border's transportation service. Thus, there was an exchange of power over the gas for consideration.

[¶13.] The Department also argues that Northern Border's burning of compressor gas was a "use" within the meaning of the second requirement because Northern Border "consumed" the gas to operate the compressors.8 But unlike the

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first requirement that specifically triggers tax liability for "consumption," there is no "consumption" language in the second requirement of SDCL 10-46-2. More importantly, the word "use" in the second requirement is specifically defined by statute. A taxable "use" must involve "the exercise of right or power over tangible personal property . . . incidental to ownership of that property . . . ." SDCL 10-46-1(17) (emphasis added). Therefore, the question is whether Northern Border's "exercise of right or power over" the gas was "incidental to [Northern Border's] ownership of that property." See id.9

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[¶14.] We conclude that Northern Border did not burn the shippers' gas incidental to Northern Border's ownership. This conclusion is compelled under the tariff, federal law, and the evidence. Under the tariff and federal law, Northern Border did not own—indeed, it was prohibited from owning—the gas it burned in the compressors. Instead, the shippers retained title to and ownership of the gas throughout the entire transportation process. Northern Border...

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