A group of natural gas marketing and distribution companies and out-of-state municipalities have asked the United States Supreme Court to reverse a December 2013 Kansas Supreme Court decision upholding ad valorem taxation of natural gas purportedly stored in—or transported through—Kansas.  The case was set in motion in 2009 when the Kansas Division of Property Valuation concluded that common carriers were holding natural gas owned by out-of-state entities in Kansas storage facilities or interstate gas pipelines passing through the state.  Kansas then assessed ad valorem taxes against each out-of-state taxpayer owning gas purportedly stored in the state using an allocation formula adopted from FERC-approved tariffs.

The taxpayers protested, arguing that they stored no gas in Kansas.  Rather, each purchased gas outside of Kansas, delivered it into one of four interstate pipelines at a point outside of Kansas, and received delivery of an equivalent amount of gas outside of Kansas.  Between a given taxpayer’s delivery of gas into a transmission pipeline in one location and withdrawal of an equivalent amount of gas in some other location or at some other time, the taxpayer’s gas would be stored in the interstate pipeline’s storage or transportation systems—perhaps in Kansas and perhaps not.

According to the taxpayers, the Dormant Commerce Clause imposes a bright-line prohibition on state taxation of a potential taxpayer whose sole connection with the taxing state is through a common carrier like an interstate pipeline.  The Kansas Supreme Court rejected this argument, holding that the bright-line rule announced in Quill Corp. v. N. Dakota, 504 U.S. 298 (1992), should be limited to sales and use tax cases and thus did not prevent Kansas from assessing an ad valorem tax.

Having rejected the taxpayers’ bright-line argument, the court turned to the four-part Dormant Commerce Clause test announced in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).  Under the Complete Auto test, Kansas’s ad valorem tax would not run afoul of the Dormant Commerce Clause if (1) it applies to an activity with a “substantial nexus” to the state, (2) it is fairly apportioned, (3) it does not discriminate against interstate commerce, and (4) it is fairly related to services or benefits provided by the taxing state.  The taxpayers argued that Kansas’s ad valorem tax violated the first and fourth prongs because the taxpayers have no Kansas facilities or employees and because they did not control or possess the gas in Kansas.  Rather, it was the common carriers operating the interstate pipelines that comingled the taxpayers’ gas and determined where the gas was stored and transported.  The Kansas Supreme Court rejected this argument too, concluding that there is “axiomatically” a substantial nexus between Kansas and gas stored in Kansas.  Similarly, the court rejected the taxpayers’ federal due process challenge, concluding that the taxpayers’ ownership of natural gas in Kansas under contracts with common carrier pipeline companies constitutes sufficient contacts with Kansas to satisfy the Due Process Clause.

Both holdings appear to presuppose that a given taxpayer’s gas was actually stored in Kansas.  It is unclear how the court reconciled these holdings with its own statement that a given taxpayer’s gas may or may not have been stored in, or transported through, Kansas.  In the Oklahoma case the court relied on in support of its holding—In re Assessment of Personal Property Taxes, 234 P.3d 938 (Okla. 2008)—the taxpayers delivered gas into a pipeline knowing that one of two possible storage locations was in Oklahoma.  The Kansas Supreme Court’s opinion gives no indication as to whether the out-of-state taxpayers had similar notice that their gas was likely to be stored in the taxing state.

Having declined to hear the 2008 Oklahoma case, the United States Supreme Court now faces another opportunity to define the scope of potentially wide-ranging ad valorem taxation implications for businesses using common carriers to move tangible goods through, or store them in, many states. For SALT practitioners, this is a certiorari petition worth monitoring.