BEFORE THE OFFICE OF TAX APPEALS

STATE OF ALASKA

IN THE MATTER OF:

Municipality of Anchorage d/b/a Anchorage Municipal Light & Power

As 43.55 Gas Production Tax and AS 43.57 Conservation Tax Tax Periods 11/96 to 12/97

Case No. 42-OTA-2000

In this case, the Municipality of Anchorage d/b/a Anchorage Municipal Light and Power (ML&P), appeals the denial of its claim for a refund of AS 43.55 gas production taxes and AS 43.56 conservation taxes that ML&P paid from November 1996 through December 1997 on gas produced from ML&P's interest in the Beluga gas field. ML&P used the gas to generate electricity.

ML&P claims it is exempt from the gas production and conservation taxes under AS 29.71.030 because the taxes at issue do not expressly tax municipalities. Alternatively, ML&P contends that it is exempt from the gas production tax under Alaska Constitution Article IX, § 4, and AS 29.45.030 because that tax is a tax on municipal property.

This case is appropriate for resolution by summary judgment because the material facts are not in dispute. A hearing for the purpose of oral argument on the cross motions for summary judgment was held on July 27, 2002.

Ellen Toll, Assistant Attorney General, and Brain Timblin, Appeals Officer, represented the Department of Revenue ("DOR"). John Andrew Leman of the law firm, Kemppel, Huffman & Ellis, P.C., represented ML&P.

1. In December 1996, the Municipality of Anchorage, d/b/a/ Municipal Light & Power (ML&P), purchased a one-third interest in Beluga Gas Field leases from Shell Oil Company. ML&P acquired Shell's one-third interest in eleven State of Alaska oil and gas leases and two federal leases.
2. ML&P sold some of the gas to third parties, and used some of the gas internally as fuel to generate electricity. During the 1996 to 1997 tax period ML&P internally used approximately 18 to 25 percent of its monthly gas production to generate electricity and sold the rest. ML&P sells electricity to consumers and to the Municipality of Anchorage.
3. The Municipality of Anchorage is a municipal corporation and unified home rule municipality organized under the laws of the State of Alaska. ML&P is a department of the Municipality of Anchorage. The Anchorage Assembly granted final approval to close the purchase of Shell's interest in the Beluga oil and gas leases in November 1996.
4. As a regulated public utility, ML&P also had to get approval from the Regulatory Commission of Alaska (RCA) to purchase Shell's interest in the Beluga leases. The RCA approved ML&P's purchase of Shell's Beluga filed interests by orders issued in October and November 1996.
5. Because the Shell/ ML&P transaction involved state leases, it required approval by the Department of Natural Resources ("DNR"). On May 8, 1997 DNR approved the transfer of the leases to ML&P, effective January 2, 1997.
6. DNR's approval of the transfer of Shell's interest in leases to ML&P included certain conditions. DNR required, as a condition of approval, that ML&P pay AS 43.56 oil and gas property taxes and that ML&P pay AS 43.55 production taxes and AS 43.57 conservation taxes on the portion of its Beluga production that ML&P sold to third parties.
7. DNR's decision approving the transfer of oil and gas interests to ML&P left for future consideration the issue of whether ML&P would pay AS 43.55 production taxes and AS 43.57 conservation taxes on gas that ML&P used internally.
8. Beginning with January 1997 production, ML&P has consistently reported and paid production and conservation taxes on all production, including gas that ML&P used internally.
9. On December 15, 1999, ML&P filed a Claim for Refund for that portion of AS 43.55 and AS 43.57 taxes previously paid on the share of gas production used by ML&P to generate electricity at its Beluga power plant. The claim covered tax periods from November 1996 through December 1999. The basis for the refund claim was that ML&P is exempt from AS 43.55 and AS 43.57 taxes under the provisions of Alaska Constitution Article IX, Sec. 4 and AS 29.71.30.
10. Since filing the December 15, 1999 Claim for Refund, ML&P has paid each subsequent month's production taxes, but has protested and claimed a refund for those taxes paid on production internally used and not sold to third parties.
11. On March 28, 2000 the Department of Revenue ("DOR") denied ML&P's claim for a refund of $310,644.56 for the tax periods November 1996 through December 1997 and advised that the refund claim for later periods would be held in abeyance pending audit. ML&P filed a Request for Informal Conference to contest the denial on April 24, 2000.
12. On December 13, 2000 DOR issued an Informal Conference Decision denying ML&P's refund claim for November 1996 through December 1997 on the grounds that ML&P is not exempt from AS 43.55 and AS 43.57 taxes.

ML&P's liability for the 1996 taxes is no longer at issue. ML&P conceded in its reply brief that it is not entitled to a refund of taxes for gas produced in November and December 1996 because Shell was the owner of record of the gas, and the producer until DNR approved the assignment of Shell's interests to ML&P effective January 2, 1997. DOR is entitled to summary judgment denying the requested refund with respect to 1996 taxes.

This case presents a question of first impression concerning the meaning of, and interaction between, the gas production / gas conservation taxes and statutes providing that municipalities are exempt from taxes.

AS 43.55.016(a), the Gas Production Tax, provides in pertinent part:

1. There is levied upon the producer of gas a tax for all gas produced from each lease or property in the state, less any gas the ownership or right to which is exempt from taxation.

"[O]wnership or right to which is exempt from taxation" is defined in AS 43.55.900(13) as "any ownership interest of the federal government or the state.

DOR contends that the gas production tax, and the similarly worded conservation tax, AS 43.57, expressly apply to ML&P because ML&P, as the owner of a 33% interest in the Beluga oil and gas leases is "the producer" and the producer must pay tax on "all gas produced" except for gas owned by the state or federal government. DOR argues that ML&P is seeking an additional exemption for municipally owned gas that the legislature never intended when it explicitly provided exemptions for state and federal gas.

ML&P claims immunity from the gas production and conservation taxes based on two Alaska statutes addressing taxation of municipalities and a provision of the Alaska Constitution. ML&P contends that its strongest claim for a refund is found in AS 29.71.030, which provides:

ML&P contends that it is exempt under AS 29.71.030 from the gas production and conservation taxes because the legislature has not expressly provided in AS 43.55 and AS 43.57 that municipalities are taxable.

Alternatively, ML&P argues that even without AS 29.71.030, the municipality is still exempt from AS 43.55 and AS 43.57 taxes under Alaska Constitution Article IX, Sec. 4 and AS 29.45.030. ML&P relies on the following portion of Alaska Constitution Article IX, § 4:

ML&P's alternative argument also relies on AS 29.45.030, which states in pertinent part:

1. municipal property, including property held by a public corporation of a municipality, or state property, except that

1. a private leasehold, contract, or other interest in the property is taxable to the extent of the interest.

DOR contends that Art. IX, § 4 and AS 29.45.030 do not exempt ML&P from gas production taxes because they provide municipalities with an exemption from property taxes only and the gas production tax is not a property tax. ML&P argues that Article IX, Sec. 4 and AS 29.45.030 are not limited to property taxes but apply to general taxes on real and personal property owned by a municipality, which includes the gas production tax because it is the functional equivalent of a property tax.

The independent judgment standard of review applies when, as in this case, the Administrative Law Judge must interpret and apply the law to undisputed facts and DOR's specialized knowledge and experience are not especially probative as to the meaning of the statutes at issue.

This analysis begins with ML&P's alternative argument based on Art. IX, § 4 and AS 29.45.030 because the constitutional provision and its history provide a useful framework for considering the meaning and application of the various statutes at issue. Another reason for addressing ML&P's alternative argument first is that there is some precedent concerning the meaning of the constitutional provision and the statute exempting municipal property from taxation.

ML&P makes two arguments concerning the constitutional provision concerning taxation of state and local government. The first contention is that Art. IX, § 4 provides independent constitutional protection to municipalities from all taxation of their real and personal property but allows the legislature to provide by law for exceptions to tax immunity. The second contention is that Art. IX, § 4, applies to the gas production tax.

I agree with ML&P on the first point. As ML&P points out, the records of the Alaska Constitutional Convention indicate that the framers intended state and local government to be exempt from taxation unless the legislature affirmatively provided by law for exceptions to the general rule of tax immunity. The intent of the framers is evident in the following commentary on the tax exemption provision by the Committee on Finance and Taxation of the Constitutional Convention:

The second part of ML&P's argument, that Art. IX, § 4 exempts municipalities from taxes other than property taxes is not so persuasive. While I agree with ML&P that the language of Art. IX, § 4 is broad enough to encompass taxes other than property taxes, we are not writing on a blank slate with respect to the meaning of the constitutional provision. ML&P's position is inconsistent with cases from Alaska and other jurisdictions that have interpreted and applied similar constitutional provisions.

In Kotzebue Lions Club v. City of Kotzebue, 955 P. 2d 921 (Alaska 1998), the Alaska Supreme Court held that the second clause of Article IX, § 4, which prohibits taxation of the property of charitable or non-profit organizations, does not grant the charity a tax exemption from a sales tax. In that case the Lions Club challenged the city's ordinance applying a sales tax to charitable gamin. The Supreme Court upheld the tax, rejecting the city's argument that Art. IX, § 4 exempted charitable organizations from any form of tax, not just property taxes:

The Club also argues that since the Club is a charitable

955 P.2d at 922, n.1.

ML&P argues that the decision in Kotzebue Lions Club has limited applicability in this case because the Lion's Club is a private organization which, unlike a local government, is presumptively taxable unless there is an express exemption from tax. ML&P suggests that the Alaska Supreme Court would construe Art IX, § 4 to more broadly protect municipalities from tax. But ML&P's attempt to distinguish the Lions Club decision is not very compelling given the fact that in purchasing oil and gas leases and becoming a natural gas producer, ML&P is participating in a commercial activity just like a private corporation, not acting in a governmental capacity. Given the context of the tax dispute in this case, there is no reason to think that the Alaska Supreme Court would read Art. IX, § 4 more broadly than it did in Kotzebue Lions Club to exempt ML&P from taxes other than property taxes.

In addition, as DOR points out, Kotzebue Lions Club is in accord with the rule in most other jurisdictions that a municipality's immunity from taxation extends only to ad valorem property taxes. 16 McQuillan Mun.Corp. § 44.57 (3d Ed. 1994.)

But ML&P argues that even if the constitutional exemption and AS 29.45.030 apply only to property taxes, the AS 43.55 production tax is the functional equivalent of a property tax on natural gas for purposes of determining a municipality's immunity from taxation. It is true, as ML&P argues, that in some respects the gas production tax is like a property tax. But DOR's position that the AS 43.55 production tax is not a property tax is supported by long-standing authority and is more persuasive.

As DOR points out, when Alaska courts have considered the issue they have held that a production tax is an excise or a privilege tax, not a property tax. Territory of Alaska, by Olson v. Hawkins, 9 Alaska 573 (D. Alaska Terr.1939) (Mining license tax was an excise tax not a property tax); Liberati v. Bristol Bay Borough, 584 P. 2d 1115, 1121 (Alaska 1978) ("A severance tax is a tax upon the taking or extracting of a resource."). California courts have also held that an oil production tax is a privilege or occupation tax, not a property tax. McAdams Oil Co. v. City of Los Angeles, 89 P. 2d 729, 732 (Ca. App. 1939) ("A tax on persons engaged in producing oil from the ground based on the quantity of the product thus produced is a privilege or occupational tax and not a property tax.") See also, Local Government in Mineral Development, 28 Rocky Mtn. Mineral Institute221, 280 (1982) ("Severance taxes have been broadly defined as excise taxes imposed for the privilege of severing natural resources from the soil.")

In Brunton v. Superior Court of Los Angeles County, 124 P. 2d 831 (Ca. 1942), a municipal flood control district claimed it was exempt from a statute imposing fees for the privilege of drilling for oil pursuant to a clause in the California constitution providing that "property such as may belong to the United States, This State, or to any county or municipal corporation shall be exempt from tax." The California Supreme Court rejected that argument:

124 P.2d 831, 834. ML&P's claim to production tax exemption under Art. IX, § 4 and AS 43.29.030 is very similar to the argument that the California Supreme Court rejected in Brunton and I reject it in this case for the same reasons.

Based on the authorities discussed above, I conclude that Art. IX, § 4 of the Alaska Constitution and AS 29.45.30 provide an exemption from property taxes only and the AS 43.55 production tax is not a property tax.

ML&P's primary argument is that AS 29.71.030 grants ML&P tax immunity unless the legislature expressly waives that immunity in a particular tax statute and AS 43.55 does not do so because it does not mention municipalities.

DOR contends that AS 29.71.030 and AS 43. 55.016 can be read in harmony. DOR argues that AS 43.55.016 does expressly tax ML&P because it expressly taxes a producer on "all gas produced" except for state or federal gas. DOR argues that the legislative history of AS 43.55 establishes that the legislature intended to exempt only state and federal gas from taxation.

DOR contends that when the legislature defined the term "ownership or right to which is exempt from taxation" as "any ownership interest of the federal government or the state," it intended to limit the exemption from production taxes to interests owned by the state or federal government. Finally, DOR contends that if the two statutes cannot be harmonized, then the specific tax statute prevails over the general municipal statute, which DOR characterizes as a mere rule of construction.

The crux of this case is the interaction between AS 29.71.030 and AS 43.55.016 (a). Because this case presents a question of first impression, the duty of the Administrative Law Judge "is to adopt the rule of law that is most persuasive in light of precedent, reason, and policy.' "

The issue of whether ML&P is exempt from paying the oil and gas production tax is not only an issue of first impression, it is a difficult question. ML&P and DOR. both offer reasonable interpretations of the statutory language, and some precedent and valid policy considerations that support their conflicting positions.

I agree with ML&P on several points. First, I agree that the legislative history of AS 43.55 does not show legislative intent to tax municipalities. The 1973 amendment which defined the phrase "ownership or right to which is exempt from taxation" as federal or state interests was intended to clarify that state and federal royalty interests are not subject to tax but that privately held royalty interests are subject to tax. The legislative history does not support an inference that the definitional language in AS 43.55900(13) was intended to be an exclusive list of tax exemptions for the gas production tax that would preclude an exemption for gas owned and produced by a municipality.

In fact, there is no evidence that the legislature even considered the issue of exempting ownership interests of a municipality in 1973 when it adopted the definition of exempt interests, or at any time since the production tax was enacted in 1955. The reason that the legislature failed to consider whether municipalities should have to pay oil and gas production taxes is that it was a non-issue. No municipalities were involved in the production of oil or gas until recently.

I also agree with ML&P that AS 29.71.030 is not merely a "rule of construction". AS 29.71.030 is not in Title I of the Alaska Statutes with other rules of construction. Instead it is found in the "General Provisions" section of Title 29 with statutes that address the powers and relationships of municipalities. More important, AS 29.71.030 reads like a substantive rule rather than a rule of construction:

(Emphasis supplied.)

In addition, there is considerable merit to ML&P's argument that AS 43.55.016 does not "expressly" tax municipalities according to how the courts have applied the concept of "express" in determining whether a statute waives state immunity. Alaska Housing Finance Corp. v. Salvucci, 950 P.2d 1116 (Alaska 1997). (Alaska Whistleblower Act does not expressly subject state employers to punitive damage awards.)

However, there is a fatal flaw in ML&P's argument that AS 29.71.030, properly applied, immunizes or exempts ML&P from the production tax. The fundamental problem is that ML&P's position on tax immunity overlooks the critical fact that producing oil and gas, the activity taxed by the production tax, has historically been a strictly private sector commercial activity. When ML&P purchased Shell's Beluga field interests, ML&P stepped into the shoes of an oil and gas company.

ML&P concedes that without AS 29.71.030, there would be little question that AS 43.55.016 applies to ML&P since ML&P is a gas producer. The pivotal question in this case is whether AS 29.71.030 requires a different result because the term "municipality" or "political subdivision" doesn't appear in the gas production statute. The answer is "no".

There is a logical and compelling explanation for the absence of any reference to municipalities in the gas production statute. The legislature has not specifically addressed taxation of municipalities that are producers because there were none until recently. No municipality was producing oil or gas in 1955 when the production tax was enacted or in 1973 when AS 43.55 was amended to define exempt interests.

Still, ML&P argues that AS 29.71.030 exempts ML&P from the gas production tax unless and until the legislature amends AS 43.55 to explicitly make municipal producers taxable. But requiring the legislature to amend the production tax statute to explicitly tax municipalities upon learning that a municipality has gone into the commercial business of producing oil and gas is impractical, at best.

More important, ML&P offers no reason to conclude that if the legislature had specifically considered the question, the legislature would not have decided that ML&P should pay production taxes like any other producer. Historically, the framers of Alaska Constitution Art. IX, § 4 and subsequent legislatures have expressed a policy preference for taxing government activity that is the same as private commercial activity. The Committee on Finance and Taxation of the Constitutional Convention commented that an exception to tax immunity "might be appropriate if a government engaged in what is normally a private business". Subsequently, when the legislature addressed the question of exceptions to the general property tax exemption for municipalities, the legislature decided that where a municipality leases its property to private parties, the leasehold interest is fully taxable.

Although courts in Alaska have apparently not addressed the effect of a statute conferring a general tax exemption for municipalities when a municipal entity engages in commercial activity that is taxable under another statute, the Oregon Supreme Court has addressed the question and decided that the activity was taxable. In Western Generation Agency v. Department of Revenue, 959 P.2d 80 (Ore. 1998), a utility formed by a city utility and a people's utility district argued that it was exempt from property tax on its electrical generating facility under a statute providing that all city property is exempt from taxation except as provided by law. The Department of Revenue argued that the property was taxable under another statute that specifically taxed in the same manner as private property any property owned, used or controlled by a people's utility district. The Court determined that the property was taxable, at least to the extent that the joint operating agreement vested control in the enterprise to the people's utility district.

ML&P does not offer any legislative history that sheds light on the meaning or intent of AS 29.71.030. But it is clear that when the legislature enacted AS 29.71.030 in 1972, the legislature was not concerned with whether municipalities were taxable as producers under AS 43.55 because no municipality was producing oil or gas at that time.

It also stands to reason that in adopting AS 29.71.030, the legislature intended to adopt the doctrine of inter-governmental tax immunity. This is at least implicit in ML&P's argument. The doctrine of inter-governmental tax immunity has been the subject of much litigation in recent years, primarily in the federal courts. Recent decisions demonstrate that the courts have restricted application of the immunity doctrine. In determining tax status in recent cases, courts have examined the nature of the government entity and the activity being taxed and have refused to apply the immunity doctrine where the government instrumentality is not so closely connected to the government that the tax can be considered a tax on the government itself or where the activity can be characterized as private commercial activity. See, e.g. United States v. New Mexico, 455 U.S. 720 (1982); Indiana Dep't of State Revenue v. Farm Credit Servs. Of Mid-America, 734 N.E. 551 (Ind. 2002).

Here, the nature of the activity at issue, the production of natural gas, is unarguably a traditionally private business activity that is not closely related to the governmental functions or operations of the Municipality of Anchorage. In fact, requiring ML&P to pay production taxes on the gas that it produces and uses to generate electricity has no demonstrable effect whatsoever on municipal operations or the municipal budget because before ML&P began producing its own gas, it paid the production taxes on the gas that it purchased from Beluga producers as part of the purchase price of the gas. Under the circumstances, ML&P fails the modern test for application of the tax immunity doctrine.

For the foregoing reasons, I conclude that ML&P is taxable under AS 43.55 and AS 43.57.

This is the hearing decision of the Administrative Law Judge under AS 43.05.465 (a). Unless reconsideration is ordered, this decision will become the final administrative decision 60 days from the date of service of this decision. A party may request reconsideration in accordance with AS 43.05465(b) within 30 days of the date of service of this decision.

When the decision becomes final, the decision and the record in this appeal become public records unless the administrative law judge has issued a protective order requiring that specified parts of the record be kept confidential. AS 43.05.470. A party may file a motion for a protective order, showing good cause why specific information in the record should remain confidential, within 30 days of the date of service of this decision.