Aug 17, 2015
From KPMG TaxWatch
The South Dakota Supreme Court recently addressed whether a pipeline company that transported natural gas for others was liable for use tax on the value of the gas that was burned as fuel during the transportation process. The taxpayer, an interstate pipeline, transported gas owned by third parties. Under the federal regulatory scheme for pipeline companies, the taxpayer was a transportation-only pipeline, meaning that it was not allowed to own the gas it transported. Moving natural gas through a pipeline required pressure. To maintain this pressure, gas was continuously routed through compressors located at various points along the pipeline. At each station— of which there were three in South Dakota— gas was compressed and returned to the pipeline. However, some of the gas was burned as fuel to operate the compressors. The taxpayer did not purchase or pay for the gas that was burned; rather, the shippers had to allow a certain amount of gas to be burned as a condition of receiving transportation services. Following an audit, the Department assessed use tax on the value of the shippers’ gas that was burned in the compressor. The taxpayer contested the assessment. After a circuit court ruled that the gas qualified for an exemption (as a pipeline transportation service), the Department appealed.
South Dakota’s high court observed at the outset that for an exemption to apply, an activity must first be taxable. Thus, the court first considered whether the burning of the shippers’ gas was subject to tax. Under South Dakota law, use tax is imposed on the use, storage, and consumption of tangible personal property purchased for use in South Dakota. It was undisputed that the natural gas was tangible personal property that was consumed in South Dakota in the compressors. Thus, the key question was whether the gas had been “purchased for use in [South Dakota].” After holding that there was consideration for the transaction because the shippers had to provide the gas to obtain transportation services, the court addressed whether a taxable use occurred. For purposes of this analysis, the court looked to a statutory definition of “use” that defined the term as “exercising rights or powers over property incidental to ownership” of that property. The court concluded that the taxpayer could not burn the shippers’ gas incidental to its ownership of the gas because it did not own the gas. In fact, it was prohibited from owning the gas under federal regulations, and the shippers retained title to and ownership of the gas at all times. Because the taxpayer did not own the gas, the court concluded that use tax could not be imposed under precedents established in earlier court cases. Two justices dissented—primarily with the majority’s holding that the definition of “use” requires ownership of the underlying property. Please contact Nicole Kirk at 612-305-5420 with questions on North Border Pipeline Co. v. S.D. Dep’t of Revenue.
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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.