Honorable George H. Sheppard
Comptroller   of Public Accounts
Austin, Texas

Dear Sir:                                        Opinion No. O-4025
                                                 Re: Gas Production Tax Claim
                                                      against Canadian River Gas
                                                      Company - determination       of
                                                       “:~-?arkct value” of natural
                                                      I,&:; w~.~erArticle 7047b,
                                                      l>rior to May I, 1941,

                  We are in receipt         of your I<:lt<:r ~1 S&~iilber           23, 1941, which
reads    as follows:

                 “We have recently made an investigation           of the
          books and records of the Canadian River Gas Company.
          This company is the producer of gas which supplies
          through affiliates  the gas used in Amarillo      and Dalhart,
          Texas;   Denver and Colorado Sprin!;s,     Colora~~l I; an(l.,
          one-fourth   of the requirements  of tli<! gin:: ISI C;licago.

                  “Reports   to this office for the month of July 1941
          sho,w that eighty-nine    per cent of all gas handled by
          pipelines in the Panhandle area was exported from Texas
           to other States; and that the owners of the pipelines pro-
          duced eighty-=four per cent of all gas carried by said pipe-
           lines, buying only sixteen per cent of their requirements
          f,roio other producers.

                   “This compnay admits a probable liability under
          Method     I of about $28,000 without penalty and interest.

                    “‘I am attaching copy of auditor’s             report for your
          study and consideration.           Please     refer     to your  Opinion
          Non O-633 dated April 26, 1939 and advise me as to your
          opinion of tllc cool, c-i ~~~;~ti~~~~‘    1.~)I::;.: in determining    this
          co~~npany's     liabiliry t,,,.J't Ai,tic  It:, '!..47b   prior LOMay I,
          1941; also, t;le c,orrcc:t ,.,~~thwi to u:jc under this law as
          amended by House Jill NO. 6.”

                   IlllClcr tlic facts :!rc:;cnt:~:r: in t?,i!;, Ir,i!::,r !~~:,;r~~r’,~:<!r
                                                                                          ~.vit~;~~
                                                                                                 the
report    of Mr    J. I~!<:i::un Crvxil al!a<~I~,:~,~!t(l(:r~~:(,~, ;J:~J\~L
                                                                          a,,I: l~i:: l;~,c following
                                                                            .      .




Honorable      George   H. Sheppard,   page 2 (No. o-4025)



question:

               What is the correct method to use in determining
         this company’s   liability under Article 704713 prior to
        May 1, 1941; also, the correct method to use under this
        law as amended by House Bill No. 8?

                Since receiving your letter of September 23 above set out,
we have released Opinion No. O-3516 addressed           to you written by Mr.
Cecil C. Rotsch, October 16, 1941, wherein the determination          of market
value of natural gas under Article       II of House Bill 8 as enacted by the
47th Legislature,    1941, being Article    704713, as amended, is discussed
at length.   The writer is advised by Mr. Nelson Brown of your depart-
ment that this opinion answers the question submitted by your letter
above set forth with reference     to the correct method to use in deter-
mining the liability of the Canadian River Gas Company subsequent to
May 1, 1941, under House Bill No. 8, above mentioned.          Therefore,   this
opinion will be confined to the correct method to use in determining
the liability of Canadian River Gas Company prior to May 1, 1941.

               The material part of the statute in question, which is
House Bill 547, Chapter 73, page 111, Acts 1931, 42nd Legislature,
amended by House BiIl’8,    Chapter 495, page 2040, Acts 1936, 3rd
Called Session, 44th Legislature,   all of which prior to its amend-
ment by Article II of House Bill 8 as ehaeted by the 47th Legisla-
ture, was codified as Article  704713 of Vernon’s  Annotated Civil
Statutes of Texas, reads as follows:

                   “Sec. 1 (a) That from and after the date herein
            fixed, every person engaging or continuing within this
            State, in the business of producing and saving in paying
            quantities, for sale or for profit, any natural gas, in-
            cluding casinghead gas, from the soil or waters of this
            State, and

                   “(b) Every person who imports natural gas into
            this State and thereafter sells the same in intrastate
            commerce     in this State, the tax to be imposed on the
            first sale; (provided, however, that if any gas is imported
            into this State from another state, in which latter State
            a severance,    occupation or excise tax is imposed, the
            person importing such gas shall not be required to pay
            another~ tax thereon under the provisions     of this Act),

                   “(c) Are hereby declared to be ‘producers’ and
            engaged in the business     of producing natural gas with-
            in this State and shall make quarterly    on the 25th day
            of January, April, July and October each year, a report
            to the Comptroller,   . . . .”
Honorable   George   H. Sheppard,    page 3 (NO. O-4025)




               “Set, 3, A tax shall be paid by each such producer
        on the amount of gas produced and saved within this State,
        and on gas imported into the State, upon the first sale there-
        of in intrastate commerce   upon the following basis:

               “A tax equivalent to three per cent (3%) of the market
        value of the total amount of gas produced and saved within
        this State, or sold, if imported into this State, at the actual
        market value thereof, as and when produced.       ,, . .”

               On April 26, 1939, we released Opinion No. O-633 addressed        to
you and written by Cecil Rotsch, a member      of this department,  wherein we
discussed  the “place where market value should be determined       in taxing na-
tural gas under Article  704713” prior to its amendment by the 47th Legislature.
We held in this opinion that the tax levied by Article   704713 was a “severance
tax”.   We quote from said opinion as follows:

               “We believe that this tax is what is soiiletimes      referred
        to as a ‘severance   tax,’ and if that is true it is reasonable    to
        believe that the legislature  intended to charge the tax immediately
        upon the gas being severed from the earth.        The Louisiana Natural
        gas tax act, which is almost identical with the Texas statute we
        are considering,   was held to be a ‘severance     tax’ in the case of
        Gulf Refining Co. v. McFarland,      154 La. 251, 97 SOU. 433.      In 57
        Corpus Juris 538 ‘severance      tax’ is defined as follows:

               ” ‘Severance  tax. An excise tax upon the privilege  of
        severing,  or upon the right to sever the natural resources
        from the soil; a tax upon the natural resources   from the soil.’

                “We should look at this tax from a practical,stand-
        point, and see how it operates.     If we charge this tax on
        the basis of the higher market value at the place of sale
        seven miles away instead of on the basis of the lower
        market value at the well, then all the operator has to do
        in order to escape the higher tax would be to sell and con-
        vey its ‘compressor    stations’ and seven mile pipe line to
        another concern, and sell its gas to this other concern at
        3 cents at the mouth of the well, and let this other concern
        compress    the gas and transport it seven miles    and resell
        it at 3; cents.   The legislature  is presumed   to have known
        the actual conditions the act was to apply to when it passed
        it; and it intended for the law to operate in a practical
        manner.     We think it intended for the tax to be paid on the
        basis of the market value at the well.”

               Further   quoting    from   Opinion   No. O-633:
                                                                                    -    .




Honorable   George    H. Sheppard,     page 4 (No. o-4025)




               “Usually   the price paid by the purchasing   pipe
        line company is a proper criterion     on which to figure
        market value, but it could be a producer and a pur-
        chaser would enter into a contract for a price less
        than the market value or more than the market value
        for reasons known only to themselves,      and such a
        price in those cases should not be taken by the
        Comptroller    as market value.   He should be governed
        by ‘the actual market value,’ which may change from
        time to time.

                 “Our answer to your inquiry is that under the
        facts of the case in question you should charge the
        natural gas tax, provided for in Article               7047&b, on
        the basis of the actual market value at the well, and
        not on the basis of the actual market value at the place
        of the :firtst?s&i+e lif~~tKat’~‘p~cei$&wtiy from the~we&l;!~and you
        are advised.;th&.if      .M,~il~s~.ha,~..~~io;:.l~t.~alue      gt:~.t@we.te:ll
        ‘y&  .my    d+=rrrpi,w- +~gk:e‘L’         &l&&+;;f:(t~     we:~~~~<~&j&g the
         actual m&rk&%&+& ~~ere,3he+e!             is ‘$rmn.rke t~~aa&,:$educting
         the;;c~~t-,of,,t~~,th~‘*~S:~t~mr$r~k,t.             :     > ~,~,;
                                                                        :, ~:

               We  believe that this opinion, which we expressly   approve,
fully answers the question submitted by you. You will note that in the
last four lines of the above quotation from the opinion we advise you as
follows:  “and you are advised that if the gas has no market value at
the well you may determine     its market value at the well by taking the
actual market value where there 1s a market and deducting the cost of
taking the gas to that market.”

                  We believe from the facts set forth in your letter and the
attached report of Mr. Brown that acting under this opinion method six
as set forth on page 2 of the report of Mr. Brown would be the proper
i-?BthorI to follow in determining    the tax liability of Canadian River Gas
C~...>any under Article     704713 prior to May 1, 1941, however we will
discuss    the proposition  further.

                As we understand the report sent to us by Mr. Brown,
Canadian River Gas Company is a part of an intricate corporate struc-
ture consisting   of a maze of corporations     the ownership of all of which
can ultimately   be traced to the same interests and these interests      sub-
stantially control the production,    transportation  and ultimate sale of the
major portion of all gas taken from the Panhandle gas field.        These
inter-woven    corporations   operate under contracts with themselves      re-
sulting in the sale of gas from the Panhandle field at prices ranging
from net cost to seven or eight cents per thousand cubic fee.        We fur-
ther understand from Mr. Brown’s report that the result of this control
of the production,   transportation  and ultimate sale of practically   all of
the gas produced in the Panhandle field is that sc~me independent well
operators   must sell their gas for as low as one-half     cent per thousand
.       -




    Honorable   George   H. Sheppard,   page 5 (No. o-4025)




     cubic feet by virtue of the fact that they have no market and no trans-
    portation system to dispose of such gas. Assuming          that these facts are
     true  and could be sustained to the satisfaction   of a jury we are con-
     strained to the belief that same would justify a finding that there is
    actually no established    market value at the well in this field as is
    usually the case in oil and gas fields in Texas.      In fact such has been
    judicially  determined   in the case of Consolidated    Gas Utilities Corpora-
     tion v. Thompson and Texoma Natural Gas Company v. Thompson,              re-
    ported in 14 Fed. Supp. 318, wherein the court in speaking of gas pro-
    duced in the Panhandle gas field for light and fuel purposes says the
    following on page 324 of the opinion:

                   “As to gas for these uses, there is not, there
            never has been, a real market in the field, for except
            for a small quantity consumed in operating wells and
            plants, gas for this use is not sold in the field,  It is
            transported  on contracts  to distant points for delivery
            at the burner tips. The commission’s      proration order
            was therefore based not upon market demand in the field,
            but upon the amount required by plaintiffs and other pipe
            lines for supplying their customers    at distant points,”

                   Therefore   in view of the facts before us and in view of this
    decision,  and, assuming that the fact that there is no market value for gas
    at the well in the field in question can be established, we will discuss the
    question presented from such standpoint.

                   In the case of Atchison T. & S. F. Ry. Co, v. Nation and
    Slavens, 92 S. W. 823, the court of Civil Appeals sets out the rule for
    determining   market value where there is no market value at the particular
    place in question.   The following is a quotation from said case:

                    “The rule is well settled that where the question
             is what was the value of property at a particular   place
            and there was no market value there, proof may be given
             of such value at other places with the cost of transporta-
            tion in order to enable the jury  to deduce the value at the
             place in question.”   Citing Sutherland on Damages    (2nd
            Ed.), Section 445.

                    Again in the case of Kerr v. Blair, 105 S. W. 548, the court
    in discussing   the proposition of determing the market value of rice at a
    particular   place when it was shown that there was no’market    value at
    that place says the following:

                    “The above testimony would show that the
             rice was in the shock to be threshed by defendant, and
            if they failed to thresh it as they contracted to do, plain-
            tiff’s damages would be measured       by reference to its mark-
            et value as threshed at that place or at the nearest place
             where it had a market value.     If the evidence showed it
            had a market value at Bay City, a few miles distant, it
            was sufficient to afford a basis for measuring      damages.”
                                                                               8.
                                                                               -     .




Honorable   George    H. Sheppard,      page 6 (No. O-4025




               In the case of Dale Oil & Refining Company v. the City of
Tulia, 25 S. W. (2d) 671, the court in determining the market value of oil
has the following to say:

               “Where   there has been no sale of personal pro-
        perty or a commodity    of a given kind in the particular
        place involved, then its mark& vlaue may be shown by
        proving such value at the nearest market and adding
        thereto the costs of transportation.”

                Having determined     that there is no market value for gas at
the well in the Panhandle gas field the gross receipts of the producer less
the cost of getting the gas to market, whatever that ultimate market may
be, seems to us to be the basis upon which to determine            the market value
of gas at the well for purposes of taxation under Article          7047b.  Arriving
at this conclusion   the question is then presented whether or not the tax
levied under Article    7047b would constitute a tax on property outside
the State of Texas or wguld result in a burden on inter-state           commerce
and hence become repugnant to the Constitution          of the United States.
We do not believe that this would be the result simply because of the
fact that the Comptroller     in determining   the market value at the well
would have to ascertain     the ultimate sale price of the gas in other states
and the cost of its transportation     thereto by virtue    of the fact that a sub-
stantial portion of the gas produced is transported         and ultimately sold in
Northern and Eastern and in some cases Western             States.

               In the case of American  Manufacturing    Company v. City of
St. Louis, 250 U. S. 459, which was a case in which the taxpayer manu-
factured furniture in St. Louis part of which went into storage in New
York before being s.old in that State. The court held that such sales in
another state were exempt from the local occupation tax, and that that
tax was not on sales, and that the tax did not consti~tute a burden on
interstate commerce.

               In the case of Hope Natural Gas Company v, Hal~l, by the
Supreme Court    of Appeals of West Virginia, reported in 135 S. E. 582,
the court, in construing an occupation tax on among other things the produc-
tion of natural gas, the statute providing:

               “The meansure    of this tax is the value of the
        entire production in this state, regardless    of the place
        of sale or the fact that deliveries  may be made to
        points outside the state.”

held, that the sale price necessarily  included the cost of delivery saying
that such sale price would not reflect the worth of the commodity      in the
State, but the worth within the State plus the cost of transportation.

                 In the Hope Natural     Gas Company    case,   supra,   the court
in the opinion    says the following:
Honorable   George    H. Sheppard,    page 7 (NO. O-4025




                “In Wallace v. Hines, 253 U. S. 66, 40 Sup. Ct. 435,
         (64 L. Ed. 782), the Supreme Court  Said:

                “‘?~‘The only reason for allowing a state to look
         beyond its borders when it taxes the property of foreign
         corporations    is that it may get the true value of the
         things within it; when they are a part of an organic
         system of wide extent, that giires them a value above
         what they otherwise would possess.       The purpose is
         not to expose the heel of the system to a mortal dart --
         not, in other words, to open to taxation what is not
         within the state.’

                 “By parity of reasoning,    we can as well say that
         the only reason for permitting      consideration  of the price
         plaintiff receives  for delivering    gas through its trans-
         mission system to another state is to get the true value
         of the gas within the state before it enters into inter-
         state commerce,     and that purpose is not to open to
         taxation interstate  commerce     itself.”

                The Hope Natural Gas Company case, supra, involved a
state of facts quite similar    to the facts presented in this situation, that is,
the chief business    of the plaintiff in error was the productian and purchase
of natural gas in West Virginia and the continuous and uninterrupted             trans-
portation of this through pipelines in Pennsylvania          and Ohio, where it is
sold, delivered and consumed.         The corporation     owned 3 178 producing
wells located in 25 counties of West Virginia,         from which it-took in the
year ending June 30, 1925, more than twenty-five           billion cubic feet of gas.
Most of this passed into interstate      commerce      by continuous movement
from the wells.     We are confronted with practically         the same situation
here.   Practically  all of the production of gas from the Panhandle field
is controlled by the intricate corporate      structure     as above  set out and
a major portion of this production is transmitted          through transmission
lines all controlled by the same interests       to the various markets in other
states.

                In the case of Cumberland    Pipeline Company v, Common-
wealth, by the Court    of Appeals of Kentucky, reported in 15 S. W..(Zd) 280-286,
which was a case involving a license or franchise      tax on those engaged in
the production of crude petroleum in the State of Kentucky which tax provided
for the payment annually of one per cent of the market value of all crude
petroleum   produced and further provided in Section 1 thereof that the State
Tax Commission      must find the market value from monthly reports showing
sales of such crude petroleum and from such other reports and information
as it may secure    and further providing that the Commission     should make an
appropriate   allowance for the cost of transportation    from the producing
wells to the market.     It was held that the value of petroleum at the wells
should be ascertained     from the evidence of the market value after the oil
Honorable   George    H. Sheppard,     page 8 (No.          o-4025)



had completed its journey through the channels of commerce       and had
been sold in the market.     The following is a quotation from page 284
of the opinion in this case:

               “It requires   that the value at the wells should
        be ascertained   from the evidence of the market value
        after the oil has completed its journey through the
        channels pf a c,ommerce and has been sold in the ,market.
        It is but a mea$g adopted and prescribed      to find the mar-                       .
        ket value of the oil at the well where it was produced.
        There is seldom,    if ever, a market at the place of pro-
        ducti~on.    Thor product   ~,:,lu:;t bc   ca.rris::l   to th:: :Ilarkct:i,   T;le




                 While Article  7047b does not provide a method for de-
termining market value ,as was provided in the Kentucky statute as
above shown, we believe that such method is but the adoption of the
rule of !~a..~to be used in determining  the market value at a particular
place W~ICZILh:rc is no market value at that place.    In fact on page 284
of the opinion in the Cumberland Pipeline case, supra, the court in
effect lays down this rule as follows:

                “The act requires  the state tax commission
        to resort to the same sources for evidence that would
        naturally and necessarily   be selected to establish the
        fact of market value if the Act were silent upon that
        subject.   The method is not a new one, but conforms     to
        the legal rules of evidence for the ascertainment    of
        market value.    22 C. J. 1 151, p, 187; 35 Cyc. 638;
       ‘Woerman     v. McKinney-Guedry    Co., 174 Ky. 521, 192
        S. W. 684.

                “The market value of a commodity        is its sell-
        ing price in the usual and ordinary course of business,
        but, if there be no market at a particular      place at
        which it is desired to fix the market value, then the
        market value is taken at the nearest point available,
        with adjustments     to care for the cost of transportation
        to that market.    Campbellsvllle     Lumber Company v.
        Bradlee    & Wiggins,    96 Ky. 494, 29 S. W. 313; Log
        Mountain Coal Co. v. White Oak C. Co., 163 Ky. 842,
         174 S. W. 721. The plain mandate of the act of 1918
        is that the tax commission      shall find the market value
        at the place of production by taking the actual sales
        as reported from the pipeline companiss,         and such
         other evidence thereof as may be available,       and de-
        ductlng therefrom      the carriage   charges.  The result
         reached in that way is the market value of the oil
         at the well.   (Underscoring     ours)
_.      -




     Honorable   George   H. Sheppard,     page 9 (No. o-4025)




                   Further quoting from           the opinion in the case of Cumberland
     Pipeline Company v. Commonwealth,            supra, on page 285 thereof, we find the
     following:

                        “In its final analysis,       the tax is measured by
             the market value of the product at the places of production.
             It is quite true that the value is ascertained           by taking
             evidence of sales in another state after the article has
             been carried in interstate          commerce,      but the use of such
             evidence is not forbidden.           It is not put ‘apart in a kind of
             civil sanctuary,’ where the state may not venture for facts
             relevant and important in the administration               of its tax laws.
             Davis v. C. C. C. &St. L. R. Co., 217 U.S.               157, 30 S. Ct.
             463, 54 L. Ed. 708, 27 L. R. A. (N. S.) 823, 18 Ann. Cas.
             907; Baltic Mining Co. v. Mass,             213 U. S. 68, 34 S. Ct. 15,
              58 L. Ed. 127. It is not possible to find the value of mineral
             products at the mine where there is no market, except by
             taking the value at the neare,s.t market and deductine  deducting the
             cost of transportation.         Interstate commerce        jis not affected
             or burdened by the use thus made of evidence resulting from
             transactions      therein.
                               therein,     There is no basis for the contention
             that the tax on the producer is invalid because the amount
             of the investment        is ascertained     by considering     incidents,
             facts, or results flowing from interstate commerce.                   Amer-
              ican Mfg.
                    Mf     C
                           Go.           Louis
                                v. St. Louis.     250 U.U S.
                                                           S 460.
                                                              460 39 S. Ct. 522, 63
             L. Ed. 1084.
             L.        Ipd84o*zthe
                                In the Hall case, 102 W. Vi. 272, 135 S. E.
              582, affirmed 274 U      U.S. 285, 47 S. Ct. 639, 71 L. Ed. 1049,
             the producer and carrier           of natural gas were the same
              corporation,     and the act levied the tax at the well based on
              the entire porduction wherever            sold. As the carrier was
             also the producer,         the result was that the selling price
              corresponded       closely to the gross receipts,        and the act
             was susceptible        to the construction      that the gross receipts
             for the gas produced, including the interstate transportation,
             was subject to the tax. The Supreme Court of Appeals of
             West Virginia construed the act to exclude the cost of trans-
             portation by limiting the power to tax to the place of produc-
              tion. The kentucky Act of 1918 expressly              required the cost
              of transportation       to be given proper weight, and applies by
              its terms to the producer alone.”             (Underscoring      ours)

                      Let us take by way of analogy a party in Texas who is desirous
     of selling a piece of antique furniture which he owns and let us assume for the
     purpose of this analogy that the only market for such an article is in New York
     City.   The party in Texas is the owner of a moving van into which he places the
     piece of furniture and transports     same to New York where it is ultimately sold.
     We believe that in determining    the market value of this piece of furniture that
     same would be the ultimate sale price less the cost of transporting       it to New
     York, taking into consideration    all of the incidental costs of such transportation.
Honorable   George   H. Sheppard,   page lo (No. O-4025)




                From a thorough study of the cases hereinabove     referred  to
and the report on the operations of Canadian River Gas Company which you
have submitted to us, we are of the opinion and you are therefore advised
that the correct method to use in determining  the tax liability of Canadian
River Gas Company under Article 704713 of the Revised Civil Statutes of
Texas prior to May 1, 1941, is method six as contained in the report of
Mr. Brown on page 2 thereof, which method as we understand it, is as
follows:

                 Take the gross receipts  received for the gas
        at its ultimate wholesale destination,   that is, at the
        first sale, where there is an established,    bona fide,
        market, and subtract therefrom     all costs of trans-
        portation and allow in addition thereto eight per cent
        return on invested capital the remaining figure being
        the value of the gas at the well.

                The eight per cent allowance above as we understand it, is
an arbitrary figure set up by Mr. Brown, which he considers   a reasonable
return on the investment,  but, of course, whether same is reasonable  or not
would be a matter for judicial determination.

                Trustingthat    theiforegtiing   fully answers   your;inq~utry,-we
are

                                                            Yours   very   truly

                                                     ATTORNEY       GENERALOFTEXAS




                                                     BY
                                                            Douglas    E. Bergman
                                                                       Assistant

DEB:db:ps
