  .

               THEA'ITORNE=Y                   GENERAL
                            OF TEXAS
                        Aua~xw,   -hCXAS    7e711




                                    June 10, 1974


The Honorable Robert S. Calvcrt            Opinion No. H-     323,
Comptroller  of Public Accounts
State Finance Building                     Re: Entitlement to gas production
Austin, Texas                              tax refund under Articles. 1. 045
                                           and 3. 01, Taxation-General,   V. T. C. S.

Dear Mr.   Calvert:

        Your:opinion    request requires us to determine whether a particular
gas producer   is entitled to a refund of overpayment of the gas production
tax imposed by Article 3.01, Taxation- General, V. T. C. S. which imposes
a tax on the production of gas equal to I 112% of its market value when
produc’ed.

         The Supreme Court ‘has interpreted the term, “market value” to
mean the price at which the producer sells his gas. W. R. Davis, Inc.
v. State,    180 S. W. 2d 429 (Tex. 1944). The price at which gas can be
sold in interstate commerce,     however,  is subject to regulation by the
Federal Power Commission, (FPC) under the Federal Natural Gas Act,
L5 u. s. c., Sec. 717, et seq. The FPC usually permits a seller of gas
to collect an increased rate as provided in his gas sales contract, but
subject to its final review and approval.    Until the rate is fixed by the
FPC. a producer of gas does not know for certain the market value of
his product and, as a result, cannot determine how much productian tax
is owed under Article 3.01.

         The Comptroller   has solved this problem by requiring producers
to pay the production tax on the basis of the temporary rate permitted by
the FPC subject to later adjustment upon a final determination    by that
body.   If the FPC subsequently lowers the applicable rate, the tax will
also be lower, and the taxpayer will be entitled to a credit or refund.
If the rate is raised, a tax deficiency results.  See Article 1. DA, Taxation-




                                     p. 1491
The Honorable    Robert S. Calvert      page 2    (H-323)




General,    V. T. C. S. and Attorney   General   Opinions H-172 (1973) and
ww-477     (1958).

         Your opinion request concerns the application for refund of an
overpayment    of the gas production tax submitted ‘by Dorchester    Gas
Producing Company (Dorchester).         From November 7, 1959 to October
1, 1970, Dorchester     sold gas to Northern Natural Gas Company (Northern)
pursuant to, a gas sales agreement between the parties.       The rates
established in the agreement     were collected subject to final approval by
the FPC, and they provided the basis upon which Dorchester        computed
the gas production tax it owed. On September 18, 1970, the FPC issued
Opinion No. 586 in which it determined the just and reasonable rates for
Dorchester’Q      sale of gas to Northern; this opinion has since been upheld
in final appellate proceedings.     The opinion reduces the rate that Dorchester
can charge Northern for the gas sold during the period in question from
that provided in the agreement between the parties and requires Dorchester
to refund all amounts collected in excess of the approved rate.

        While Dorchester and Northern have computed and reported to the
FPC the amount to be refunded, the actual refund has not yet been made.
Instead Dorchester     and Northern have entered into an “exploration  fund
agreement” performance       b1y which,; Dorchester would serve as a substi-
tute for its obligation to make a refund.   This agreeme’nt’: has been submit-
ted to the FPC for approval, and it does not become effective until approval
is granted.

          Under the agreement’s  terms, Dorchester would retain the amount
it id required to refund to Northern and would assume any income tax
liability that results.  Dorchester would expend this money in a gas ex-
ploration and development program subject to Northern’s approval.        Any
gas reserves    developed under the program would be owned by Dorchester
but dedicated for sale to Northern under contracts reflecting price, quality,
and other conditions prevailing at the time of discovery.    The price of the
gas sold to Northern as a result of the exploration agreement would be
discounted in an amount, up to 125% of the amount required to be refunded
by Dorchester,    the discount to be payable solely out of 25% of Dorchester’s




                                        p. 1492
The Honorable     Robert   S. Calvert   page 3    (H-323)




net working interest income from the gas dedicated to Northern.          The
discount would be regularly deducted by Northern from the monthly
payments it would make to Dorchester under the applicable contracts.
If any of the original refund amount remains unspent at the termination
of the exploration agreement,      it must be paid directly to Northern.
Before the agreement is to become effective,       the FPC must approve it,
Dorthester    must acquire a suitable bond indemnifying.Northern      against
any liability, .that might result, and Northern must obtain a favorable
Internal Revenue Service ruling as to the tax consequences of the agre-
ement.           ,,:


         With reference  to Dorchester’s  application for a refund, you ask
four questions.    You. first ask whether in this situation there has been a
“final determination”   as referred to in Article 1. 045 (F)(l), Taxation-
General,   V. T. C. S., which provides:

                     Notwithstanding any provision of any other Article
                of this Title, when any administrative      proceeding before
                any local, state, or federal regulatory agency or judicial
                proceeding arising therefrom,       results in a final deter-
                mination which affects the amount of tax liability imposed
                by any Article of this Title,. such final determination      shall
                be, reported to the Comptroller     within sixty (60) days after
                becoming final, with a statement of the reasons for the
                difference   in tax liability, in such detail as the Comptroller
                may require.     [emphasis added]

        In Attorney General Opinion H-172 (1973) we said that a final deter-
mination in a rate proceeding before the FPC occurs when the amount of
refund has been agreed to by the parties and approved by the Commission
or. in the absence of agreement,  has been ordered by the Commission.

        In Dorchester’s case the rate it can charge for the gas sold to
Northern during the period in question has been established by the FPC
in Opinion No. 586, and that opinion has been upheld in final appellate
proceedings.   Because the rate fixed in the opinion is lower than what
was actually charged, Dorchester is required to make a refund to Northern.
The parties have agreed upon the amount that must be refunded and
the form of payment and, as required by the opinion, have submitted a petition




                                        p. 1493
The Honor able Robert S. Calvert      page 4    (H- 323)




seeking FPC   approval   of their agreement.

         But the FPC has not yet granted its approval.     The opinion states
at pgs. 33-34 that any amount to be refunded shall be retained subject
to further order of the Commission directing disposition and that the
proceedings    shall remain open for such further action~as may be necessary
with respect to individual cases.     Thus, while the applicable rate has been
finally determined,    the amount of refund required of Dorchester    and the
form of payment have not yet been approved.       Until FPC   approval   is
granted, or some other disposition is ordered, we do not believe that a,
final determination    affecting Dorchester’s gas production tax liability, as
contemplated by Article 1. 045, has yet occurred.

        Your second question is whether Dorchester would be entitled to
a refund of gas production taxes if the exploration agreement is ultimately
approved by the FPC.        When the contract price charged by a gas producer
is denied by the FPC and the producer is required to refund the disallowed
portion to its customers,    then under Article I...&%, -the production tax paid
by reason of the disallowed portion of the contr,act pric,e should be refunded
to the producer or allowed as a credit in subsequent tax r.epnrts.      You ask
whether performance     of the gas exploration agreement by Dorchester      would
have the same tax consequences under Art. l.llA as would a refund.

         Under the terms of the exploration agreement the full amount’of ,the
refund will be retained as income by Dorchester.       Dorchester will not,
however,   have unrestricted use of,this fund; it will be obligated to expend
the money, subject to Northern’s approval,    in a search for new gas
reservea.    Any reserves discovered till, be owned by Dorchester     but dedi-
cated for sale to Northern at a discount.

         There can be no doubt that this arrangement will be more beneficial
to Dorchester    than having to pay the refundable amount directly to Northern.
Under it, Dorchester’s     search for new reserves  is subsidized by Northern.
At the same time we must assume that the exploration agreement is also
of substantial benefit to Northern; otherwise Northern would not have agreed
to it in lieu of a direct refund.  The agreement provides Northern with an
opportunity to secure future supplies of gasat a discount, an opportunity




                                      p. 1494
The Honorable    Robert   S. Calvert   page 5       (H-323)




apparently   of considerable   value to Northern.

         But regardless  of which party has the better end of the bargain,     it
can hardly be argued that approval of the agreement by the FPC would give
Dorchester   the benefit of the full contract price originally   charged Northern
and upon which production taxes were paid. Instead FPC approval will
further confirm that a portion of the original price has been disallowed and
that as a result Dorchester has had to assume new obligations with respect
to this money.    The gas exploration agreement is in effect simply an
alternative  method of making the required refund which has been proposed
by Dorchester    and accepted by.Northern.     If approved by the FPC, Dorchester
will not be relieved of its obligation to make a refund-but will be permitted
to do so in a manner other than direct repayment.        In these circumstances
we believe Dorchester    would be entitled to a refund of the gas production
taxes it paid on the amount charged Northern in excess of the rate fixed
by the FPC.

         Your third question is whether the taxpayer would still be entitled
to a refund of g,as production taxes if, in lieu of a direct refund, the FPC
approved an exploration agreement similar to that submitted by Dorchester
but without the provision for a discount on future sales in the event new
production is obtained.    The absence of a discount provision would not
change the fact that the original contract price has been disallowed by
the FPC, that a lower rate has been established,       and that as a result the
producer /taxpayer is required to refund that portion of the contract price
charged in excess of the approved rate.     Even without a discount provision,
the exploration agreement is nevertheless      an alternative method for making
the required refund under which the producer loses unrestricted        use of the
refund amount and assumes substantial new obligations with respect to it.
In this situation the amount of the refund can no longer be considered part
of the price received for the gas sold and accordingly the taxpayer ,would
be entitled to a refund of the gas production taxes paid on this amount.

        Your final question is whether the taxpayer is entitled to a refund
of gas production taxes whenever the FPC fixes the rate lower than the
contract price even though the taxpayer is never required to make a refund




                                       p. 1495
The Honorable    Robert   S. Calvert    page 6    (H-323)




or do anything llse’in order to repay the amount overcharged.         In this,
situation, even though a lower   rate has been established,   the taxpayer has
been permitted to retain the full contract  price free of restriction.     In
effect he has been permitted a higher price for the gas sold and therefore
should have to pay production taxes calculated on the basis of this higher
amount.    In our opinion he would not be entitled to a refund.    The gas pro-
duction tax imposed by Article 3. 01 is based on the price actually received,
not the rates established by the FPC.

                                   SUMMARY

                    A, final determination in a rate proceeding
                before the Federal Power Commission occurs
                when the amount of refund has been agreed to
                by the parties and approved by the Commission          or,
                in the absence of agreement,    has’been ordered
                by the Commission.

                    A taxpayer is entitled to a refund of gas pro-
                duction taxes if the FPC establishes a rate lower
                than the contract price and requires him to make
                a refund of the amount overcharged,      even though
                he is permitted to satisfy this obligation through
                a gas exploration agreement with or without a
                discount provision.    Article 1.11A , Taxation-General,
                V. T. C. S.

                                                 Very truly yours,




                                                 Attorney   General   of Texas




                                        p. 1496
    .   .
,

        The Honorable   Robert   S. Calvert    page 7   (H-323)




    DAVID M. KENDALL,            Chairman
    Opinion Committee




                                              p. 1497
