The Louisiana Third Circuit Court of Appeal ruled that an oil producer, Avanti Exploration, LLC, properly remitted severance tax based on the full amounts of its gross receipts received from its first purchasers for crude oil sold at its leases and thus that no severance tax was due on the downward price adjustments in its crude oil sales contracts. Avanti has served as a test case for dozens of similar cases currently pending before the Louisiana Board of Tax Appeals.
The issue before the Court was the proper application of La. R.S. 47:633(7)(a), which requires that the higher of either gross receipts or posted field price be used to calculate severance tax. The Court noted throughout its decision that there was no traditional posted price in the field, “which is apparently a practice that has been in disuse for many years,” and thus, Avanti’s gross receipts are determinative of the severance tax.
At issue were Avanti’s contracts with two of its first crude oil purchasers. Each contract contained a negotiated price formula to establish the sales price to be paid to Avanti for the oil it sold to the purchaser at the lease site. The price formulas began with published, oil market center prices for the month of production and made various positive and negative adjustments, including a final price differential, to arrive at a lower price to be paid for the crude oil being sold at the lease.
Following an audit, the Louisiana Department of Revenue took issue with the “adjustments” to price in Avanti’s sales contracts, specifically the final price differential, and contended that Avanti had impermissibly reduced its gross receipts, and thus its severance tax liabilities, by subtracting transportation costs that were not allowed since it sold its oil on the lease and did not itself transport the oil. In other words, the Department asserted that Avanti improperly took a transportation deduction by hiding it in the pricing formula as an un-named deduction. According to the Department, “Avanti and its purchasers conspired to manipulate Avanti’s tax liability by taking a producer’s transportation deduction and hiding it in the pricing formula.”
The Third Circuit rejected the Department’s position. The court held that Avanti did not take a deduction for the transportation costs paid by its first purchaser to move the oil from the lease. Rather, the costs of transportation incurred by the oil purchasers were an element of the negotiated price in an arms-length transaction between Avanti and its first purchasers and thus just another fluctuating overhead expense in the cost of doing business.
In so holding, the Court also rejected as “illogical” the Department’s attenuated argument that the differential for transportation or other costs used in the pricing formula was a “thing of value” to Avanti that could be added back to the gross receipts from its sales of oil for the purpose of determining severance tax due.
The court upheld the use of the price formula in the contracts between Avanti and its first purchasers for determining the sales price subject to severance tax (i.e., “the taxable value of oil”) and also ruled that the contracts constituted arms-length transactions. Moreover, the court seemed to reject the Department’s de facto use of market center index prices without adjustment to calculate severance tax. In addressing this issue, the court first concluded that, in unilaterally adding back the pricing differentials/deductions from the pricing formulas, the Department did in fact “use the large market center indices to calculate the severance tax owed.” In rejecting the Department’s method for calculating price, the court relied heavily on Robinson v Mantle Oil & Gas, where the First Circuit held that “a market center price for a field 130 miles away could not be used as a posted field price.”
Ultimately, Avanti was able to show in this case that it paid severance tax on the full amount of its gross receipts in sales to the first purchasers of its oil, and that there were no material issues of fact or law preventing summary judgment in Avanti’s favor. This decision is helpful to oil producers in Louisiana not only on severance tax issues, but also on royalty issues under State Leases, where the Office of Natural Resources has been taking the same position as the Department in these tax cases.