Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
-
Upload
paul-masters -
Category
Documents
-
view
223 -
download
0
Transcript of Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
1/67
IN THE SUPERIOR COURT FOR THE STATEOF ALASKATHIRD JUDICIAL DISTRICT AT ANCHORAGESTATE OF ALASKA, DEPARTMENT OFREVENUE, TAX DIVISION,
Appellant,v.
CONOCOPHILLIPS ALASKA, INC.,A ellee.
JAN 18 2011.
Case No.: 3AN-I0-05484 CIOAH Case No. 07-0565-TAX
APPEAL FROM THE OFFICE OF ADMINISTRATIVE HEARINGS,CHIEF ADMINISTRATIVE LAW JUDGE TERRY L. THURBON, PRESIDINGBRIEF OF APPELLEE, CONOCOPHILLIPS ALASKA, INC.
Leon T. Vance (Alaska BarNumber 8309096)Faulkner Banfield, P.C.One Sealaska Plaza, Suite 202Juneau, Alaska 99801(907) 586-2210
By: t,.-.. - r . . ( j ~ ....Leon T.Vance
Filed in the Superior Courtin Anchorage, Alaskaon January , 2011.
B y : - : : : - - : - ~ ~ _ - : - - - : : : : - __Clerk of the Superior Court
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
2/67
i
TABLE OF CONTENTS
TABLE OF CONTENTS ..................................................................................................... ITABLE OF AUTHORITIES ............................................................................................. IIICONSTITUTIONAL PROVISIONS, STATUTES, COURT RULES, ORDINANCESAND REGULATIONS PRINCIPALLY RELIED UPON ................................................ VINTRODUCTION ............................................................................................................... 1JURISDICTIONAL STATEMENT .................................................................................... 1ISSUES PRESENTED FOR REVIEW ............................................................................... 2STATEMENT OF THE CASE ........................................................................................... 2STANDARD OF REVIEW ................................................................................................. 2ARGUMENT ....................................................................................................................... 3
I. The OAH Properly Determined that the Make-Whole Premium Must Be Included in theCalculation of the Cost-Of-Capital Allowance ........................................................................... 3
A. Statement of the Case ................................................................................................... 31. Background ............................................................................................................... 32. Course of Proceedings .............................................................................................. 9
B. Argument ...................................................................................................................... 91. Framework of Statutes and Regulations ................................................................... 92. DOR Must Follow the Requirements of Its Own Regulation ................................. 123. As a Factual Matter, the Make-Whole Premium Was an Ordinary and NecessaryTransportation Expense .................................................................................................... 154. As a Matter of Law, the Make-Whole Premium Was an Ordinary and NecessaryExpense ............................................................................................................................. 175. The OAH Correctly Determined that DORs Interpretation of the Regulation WasNot Supported by a Reasonable Basis .............................................................................. 26
II. The OAH Correctly Determined that the Administrative Fee Paid for Facilitating anExchange Serving No Purpose for CPAI Was Not Compensation for Quality Differentials ... 27
A. Statement of the Case ................................................................................................. 271. Background ............................................................................................................. 272. Course of Proceedings ............................................................................................ 34
B. Argument .................................................................................................................... 351. The OAHs Decision Cured the Factual Mistakes in DORs Decision .................. 352. As a Matter of Law, the Administrative Fee Is Not Compensation for QualityDifferentials ...................................................................................................................... 38
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
3/67
ii
3. There Was No Reasonable Basis for DORs Erroneous Interpretation of ItsRegulation ......................................................................................................................... 44
CONCLUSION ................................................................................................................. 48
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
4/67
iii
TABLE OF AUTHORITIES
Cases
B. Forman Co., Inc. v. Commissioner of Internal Revenue, 453 F.2d 1144 (2d Cir.), cert.denied, 407 U.S. 934 (1972) .......................................................................................... 19
Button v. Haines Borough, 208 P.3d 194 (Alaska 2009) .................................................. 44
Commissioner of Internal Revenue v. Heininger, 320 U.S. 467 (1943) ...................... 15, 25
Commissioner of Internal Revenue v. Pacific Mills, 207 F.2d 177 (1st Cir. 1953) ..... 21, 25
Commissioner of Internal Revenue v. Polk, 276 F.2d 601 (10th Cir. 1960) ...................... 25
Deputy v. DuPont, 308 U.S. 488 (1940) ............................................................................ 19
Gulf Oil Corp. v. State, Department of Revenue, 755 P.2d 372 (Alaska 1988) ................... 19
Northwest Medical Imaging v. State, 151 P.3d 434 (Alaska 2006) .................................... 3
State v. Dyncorp, 14 P.3d 981 (Alaska 2000) ............................................................... 3, 19
State of Alaska, Department of Revenue v. Atlantic Richfield Company, 858 P.2d 307(Alaska 1993) ........................................................................................................... 13, 14
Sun Oil Company v. Commissioner of Internal Revenue, 562 F.2d 258 (3d Cir. 1977),cert. denied, 436 U.S. 944 (1978) .................................................................................. 20
Unocal Corp. v. Kaabipour, 177 F. 3rd 755 (9th Cir.), cert. denied, 528 U.S. 1061(1999) ............................................................................................................................... 5
Welch v. Helvering, 290 U.S. 111 (1933) .................................................................... 19, 21
Statutes
AS 43.05.280 ..................................................................................................................... 48
AS 43.05.405 ................................................................................................................. 9, 35
AS 43.05.430 ....................................................................................................................... 9
AS 43.05.435(2) ................................................................................................................ 17
AS 43.05.465(a). .................................................................................................................. 2
AS 43.05.480 ....................................................................................................................... 2
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
5/67
iv
AS 43.05.499(6) ....9, 35
AS 43.55.011 ................................................................................................................... 7, 9
AS 43.55.150 ............................................................................................................. 7, 9, 33
AS 44.62.560 ....................................................................................................................... 2
AS 44.62.570(b) .................................................................................................................. 2Regulations
15 AAC 55.151(b) ................................................................................................. 33, 35, 44
15 AAC 55.180 ........................................................................................................ 7, 10, 33
15 AAC 55.191 .............................................................................................................. 7, 34
15 AAC 55.191(a)..10
15 AAC 55.191(b).8, 10, 11, 24
15 AAC 55.191(o).....34
15 AAC 55.195 ........................................................................................................ 8, 11, 24
15 AAC 55.196(d) ......................................................................................................... 8, 11
Computation of a Cost-of-Capital Allowance under 15 AAC 55.196, IncorporatingDepreciation and Return on Invested Capital for Marine Vessels and Improvements(November 21, 2002) (ROI Regulation) .......................................................... 8, 11, 12
Other Authorities
Donald J. Weidner, Synthetic Leases: Structured Finance, Financial Accounting and TaxOwnership, 25 Iowa J. Corp. L. 445 (2000) .................................................................... 5
John C. Murray, Off-Balance Sheet Financing: Synthetic Leases, 32 Real PropertyProbate and Trust Journal 193 (1997)........................................................................ 5, 20
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
6/67
v
CONSTITUTIONAL PROVISIONS, STATUTES, COURT RULES,
ORDINANCES AND REGULATIONS PRINCIPALLY RELIED UPON
Alaska Statute 43.05.435
The administrative law judge shall hear all questions de novo under AS43.05.405 - 43.05.499. The administrative law judge shall
(1) resolve a question of fact by a preponderance of the evidence or, if adifferent standard of proof has been set by law for a particular question, bythat standard of proof;
(2) resolve a question of law in the exercise of the independent judgment ofthe administrative law judge;
(3) defer to the Department of Revenue as to a matter for which discretionis legally vested in the Department of Revenue, unless not supported by areasonable basis.
Alaska Statute 43.05.465(a)
Within 180 days after the record on the appeal is closed, the administrativelaw judge shall issue a decision in writing. Unless reconsideration isordered under (c) of this section, the decision under this subsection is thefinal administrative decision.
Alaska Statute 43.05.480(a) and (c)
(a) Judicial review by the superior court of a final administrative decisionmay be had by a party to the appeal under AS 43.05.405 - 43.05.499 byfiling a notice of appeal in accordance with the applicable rules of courtgoverning appeals to that court in civil matters.
****
(c) Appeals under this section are reviewed under AS 44.62.560 and 44.62.570.
Alaska Statute 44.62.570(b)
Inquiry in an appeal extends to the following questions: (1) whether theagency has proceeded without, or in excess of jurisdiction; (2) whether
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
7/67
vi
there was a fair hearing; and (3) whether there was a prejudicial abuse ofdiscretion. Abuse of discretion is established if the agency has notproceeded in the manner required by law, the order or decision is notsupported by the findings, or the findings are not supported by the
evidence.
Alaska Statute 43.55.011(a) and (b) (2003 Version)
(a) There is levied upon the producer of oil a tax for all oil produced fromeach lease or property in the state, less any oil the ownership or right towhich is exempt from taxation. The tax is equal to either the percentage-of-value amount calculated under (b) of this section multiplied by theeconomic limit factor determined for the oil production of the lease orproperty under AS 43.55.013.
(b) The percentage-of-value amount equals 15 percent of the gross valueat the point of production of taxable oil produced from the lease or property.
Alaska Statute 43.55.150(a) (2003 Version)
(a) For the purposes of AS 43.55.011 - 43.55.150, the gross value shall becalculated using the reasonable costs of transportation of the oil or gas. Thereasonable costs of transportation shall be the actual costs
Alaska Administrative Code 15 AAC 55.151(b) (2003 Version)
The gross value at the point of production for a producer's oil or gas mustbe calculated as follows:
(1) a destination value must be determined for the oil or gas
(2) except as otherwise provided under (i) of this section, the producer'sreasonable costs of transportation under 15 AAC 55.180 and 15 AAC55.191 must be subtracted from the destination value determined under (1)
of this subsection;
(3) if oils of different qualities or oil and NGLs are commingled, the valuecalculated under (2) of this subsection must be adjusted for anyconsideration paid or received for quality differentials, regardless ofwhether prescribed by a filed tariff;
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
8/67
vii
Alaska Administrative Code 15 AAC 55.180(a) (2003 Version)
(a) Except as provided in (b) of this section, the reasonable cost of
transportation is the actual cost of transportation as determined in 15 AAC55.191(a) and (b), if the actual costs incurred are ordinary andnecessary transportation expenses.
Alaska Administrative Code 15 AAC 55.191(a), (b) and (o) (2003
Version)
(a) Reasonable costs of transportation are the ordinary and necessary costsincurred to transport the oil or gas from the point of production to the salesdelivery point .
(b) Actual costs of transportation allowable for purposes of 15 AAC55.180(a) are
****
(3) if transportation of oil is by a vessel that is owned or effectively owned,in whole or in part, by the producer of that oil, the producer's actual cost forthat transportation, which is the sum of
(A) voyage and port costs incurred with respect to that transportation, asprovided in (j) of this section;
(B) the positioning cost, amortized over 36 months, for that vessel;
(C) depreciation of the vessel as calculated by the producer for financialaccounting purposes and used for reporting income and expenses toshareholders and owners, or as provided in 15 AAC 55.195(a) , (b), (c), (f),or (h) or 15 AAC 55.196, as applicable; and
(D) an amount that, when added to the amount of depreciation allowed
under (C) of this paragraph, will provide a reasonable return on theacquisition cost, as provided in 15 AAC 55.195(a) , of the vessel over itsexpected useful life as used for financial accounting purposes and used forreporting income and expenses to shareholders and owners, or on theadjusted shipyard cost or invested capital as provided in 15 AAC 55.195(b),(c), (f), or (h) or 15 AAC 55.196, as applicable;
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
9/67
viii
****
(o) A producer shall report any reimbursed costs to the department.Reimbursed costs are not allowable as actual costs of transportation under
this section.
Alaska Administrative Code 15 AAC 55.195(b) (2003 Version)
For a vessel or LNG transportation facility placed in service on or afterJanuary 1, 1995, and before January 1, 2002, a cost of capital allowancewill be allowed as provided in 15 AAC 55.196 for oil or gasproduced on or after January 1, 2002.
Alaska Administrative Code 15 AAC 55.196(a) and (d) (2003 Version)
(a) Except if 15 AAC 55.195(a) applies, for oil or gas produced on or afterJanuary 1, 2003, a cost of capital allowance that consists of depreciationand a return on invested capital will be allowed under this section for avessel owned or effectively owned by the producer .
****
(d) A cost of capital allowance under this section must be calculated usingthe methodology set out in the department's publication Computation of aCost-of-Capital Allowance under 15 AAC 55.196, IncorporatingDepreciation and Return on Invested Capital for Marine Vessels andImprovements, dated November 21, 2002 and adopted by reference.
State of Alaska Department of Revenue Tax Division Computation of a
Cost-of-Capital Allowance under 15 AAC 55.196 Incorporating
Depreciation and Return on Invested Capital for Marine Vessels and
Improvements, November 21,2002 (incorporated by 15 AAC 55.196(d))
(2003 Version)
Introduction
This publication sets out the methodology to be used by producers incomputing the cost-of-capital allowance for marine vessels andimprovements under 15 AAC 55.196. This methodology provides forseparately computing a cost-of-capital allowance for each individual vessel,including improvements to that vessel, to which 15 AAC 55.196 applies.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
10/67
ix
Computation of an allowance is performed using a series of input schedulesand calculation tables that are generally organized on a calendar year basis.The input schedules consist of information supplied by the producer. The
calculation tables utilize the information in the input schedules to derive theallowance. In all schedules and tables, unless otherwise specified, each rowcorresponds to a calendar year. The rows are set out in chronological orderstarting with the earliest year to which the schedule or table in questionapplies. The columns are organized by category of data or computation,which are described below in the Instructions for Input Schedules andInstructions for Calculation Tables.
The input schedule and calculation table forms are set out following theinstructions. An illustrative example is also provided.
****
Instructions for Input Schedules 3-1 through 3-6Expected Future Schedules
The entries for this table are schedules, to be submitted for the year forwhich the tax is calculated, showing the producer's various expected futurepost-service cash flow events for the vessel, for each future year. Theseitems include depreciation (Input Schedule 3-1), post-service CCF deposits(Input Schedule 3-2), CCF withdrawals (Input Schedule 3-3), otherrevenues and expenditures with after-tax benefits cash flows (InputSchedule 3-4), other revenues and expenditures with non-taxable cashflows (Input Schedule 3-5), and other revenues and expenditures withtaxable cash flows (Input Schedule 3-6). A new schedule is submitted eachyear. For any subsequent year for which the tax is calculated, if theproducer believes future cash flows will be different than those previouslyused for these years in previous calculations, the producer shall changethese entries for the year being calculated and future years. The entry forthe year being calculated is the amount actually incurred by the producer. Ifthe actual amount is not known at the time the tax is due the producer shallsubmit an amended schedule when the actual amount is known.
****
Input Schedule 3-5: Other Revenues and Expenditures- Non-Taxable CashFlows
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
11/67
x
These include the producer's anticipated amounts of other non-taxablerevenues and expenditures associated with the vessel, including cash flowsassociated with sale/leaseback agreements, or synthetic leases. Examplesare the purchase price of a vessel paid to the producer by a lessor who
intends to lease the vessel back to the producer, or the re-purchase pricepaid by the producer at the end of the lease, if the proceeds or theexpenditures are not taxable or deductible for tax to the producer. Theamount for any year is entered as the revenues minus the expenditures.
Input Schedule 3-6: Other Revenues and Expenditures- Taxable Cash FlowEvents
This shall include the producer's anticipated amounts of other taxablerevenues and expenditures associated with the vessel, including cash flows
associated with sale/leaseback agreements, or synthetic leases. Examplesare the lease payments associated with sale/leaseback agreements, orsynthetic leases. The amount for any year is entered as the revenues minusthe expenditures.
****
APPENDIX: Example
Following is an example of using the methodology described in thispublication to calculate the cost-of-capital allowance. The example containsboth a hypothetical set of inputs, and the calculations that would result fromthose inputs. An Excel spreadsheet with this example is available from thedepartment.
The example is predicated on the following hypothetical set of circumstances:
I. Pre-Service
1. A vessel with a capitalized basis of $120 million begins useful life in 2003.
****
III. Expected Future Schedules
****
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
12/67
xi
5. The vessel is subject to a synthetic lease, where the producer will sell thevessel to a lessor in 2003 for $100 million, lease it back for ten years for $6million per year, and buy the vessel back in 2012 at the original sales price.Input Schedule 3-5 shows the sale and re-purchase transactions, assuming
these are not taxable transactions to the producer.
6. Input Schedule 3-6 shows the above-mentioned lease payments,assuming the lease payments are tax deductible to the producer.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
13/67
1
INTRODUCTION
The Department of Revenue (DOR) appeals from a decision of the Office of
Administrative Hearings (OAH), which correctly determined that DOR had erred in
two distinct decisions it had made concerning the calculation of the production tax on oil
paid by ConocoPhillips Alaska, Inc. (CPAI) for 2003. The production tax is calculated
by taking the sales price of the oil at the point of disposition and deducting from it
various costs incurred in transporting it to the point of disposition in order to arrive at the
value upon which the tax is based. On the first issue, DOR incorrectly determined that
part of the consideration an affiliate of CPAI paid to acquire a tanker used to transport oil
to market was not an allowable element to include in the calculation of the deductible
transportation expenses. On the second issue, DOR incorrectly determined that an
administrative fee CPAI earned for facilitating an oil exchange transaction that provided
no benefit to CPAI was compensation for degradation of that oil, and therefore reduced
CPAIs deductible transportation expenses. In both instances the OAH carefully reviewed
the facts and controlling law and, applying the appropriate standard of review and
alternative standards of review, determined that there was no legal or reasonable basis for
DORs decisions. The OAHs decision should be affirmed.
JURISDICTIONAL STATEMENT
Appellee is satisfied with Appellants Jurisdictional Statement.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
14/67
2
ISSUES PRESENTED FOR REVIEW
1. Even though the relevant regulation required lease payments paid in
installments over time to be included in the Cost-of-Capital Allowance calculation, DOR
determined that a lower one-time payment substituting for those lease payments should
not be included in that calculation. Did the OAH correctly determine that it was not
necessary to defer to that decision?
2. DOR determined that a contract administration fee due whether or not oil was
degraded somehow constituted consideration for degradation of oil. Did the OAH
correctly determine that it was not necessary to defer to that decision?
STATEMENT OF THE CASE
Appellee will present the Statement of the Case in the appropriate argument
sections.
STANDARD OF REVIEW
The decision the OAH issued in its capacity as the Office of Tax Appeals, not the
DORs Informal Conference Decision, is the final administrative decision in this
matter.1 Judicial review of the OAHs decision is governed by AS 43.05.480, which
provides that the review of the final administrative decision occurs under AS 44.62.560
and .570.2 Under AS 44.62.570(b), the scope of review of the OAHs decision is limited:
1 AS 43.05.465(a).2 AS 43.05.480(c).
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
15/67
3
(1) whether the agency has proceeded without, or in excess of jurisdiction;(2) whether there was a fair hearing; and (3) whether there was a prejudicialabuse of discretion. Abuse of discretion is established if the agency has notproceeded in the manner required by law, the order or decision is not
supportedby the findings, or the findings are not supported by theevidence.3
In practical terms, that means that in reviewing the OAHs decision this Court should
apply the substantial evidence test to questions of fact and the substitution of
judgment standard to questions of law.4
ARGUMENT
I. THE OAH PROPERLY DETERMINED THAT THE MAKE-WHOLEPREMIUM MUST BE INCLUDED IN THE CALCULATION OF THE COST-
OF-CAPITAL ALLOWANCE
A.Statement of the Case1. Background
Polar Tankers, Inc., is a subsidiary of ConocoPhillips Company, as is the taxpayer
here, CPAI. In 2001, Polar Tankers, then a subsidiary of Phillips Petroleum Company,
took possession of a new tanker, the Polar Endeavour.5 In order to finance the
acquisition of the tanker, Polar Tankers sold the Polar Endeavourto Arctic Funding
Limited Partnership for the sum of $205,000,000, and simultaneously leased the vessel
back from Arctic Funding for a term of 10 years.6 Under the terms of the lease, Polar
3
In this context, the term agency must be read to mean the OAH, because its decisionis the final administrative decision under review.4State v. Dyncorp, 14 P.3d 981, 985 (Alaska 2000);Northwest Medical Imaging v. State,151 P.3d 434, 438 (Alaska 2006).5 [R. 253].6 [R. 480, 494, 520].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
16/67
4
Tankers was to pay to Arctic Funding periodic rental payments, totaling approximately
$14.8 million per year, during the term of the lease, and at the end of the term it was
required to repurchase the vessel from Arctic Funding by payment of the initial
acquisition cost.7 Phillips Petroleum guaranteed Polar Tankers payment obligations
under the lease.8 The lease granted Polar Tankers the right to repurchase the vessel at any
time during the lease term by paying the initial financed acquisition cost plus a Debt
Yield-Maintenance Premium, along with other amounts not at issue.9
Arctic Funding, meanwhile, sold ten-year promissory notes in the principal
amount of $198,850,000 to various investors in order to fund its purchase of the vessel.10
Arctic Funding was to pay the noteholders semi-annual interest payments, funded by
Polar Tankers periodic rental payments, and then would pay the principal sum when the
notes became due in 2011.11 In the event that Polar Tankers exercised its early repurchase
right under the lease, Arctic Funding was required to pay the noteholders the principal
sum plus a Make-Whole Premium.12 The Make-Whole Premium was based on the
difference between: a) the present value of the expected future cash flows under the notes
(the underlying principal amount plus the remaining scheduled interest payments at the
7
[R. 292, 520, 543-44].8 [R. 566].9 [R. 542].10 [R. 399].11 [R. 478].12 [R. 413].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
17/67
5
time of the termination) discounted at governmental note yield rates prevailing at the time
of the repurchase; and, b) the underlying principal amount.13
That financing technique is called a synthetic lease transaction. The primary
advantage of structuring the financing in that manner is that although the Lessee (here,
Polar Tankers) was required to treat the synthetic lease as a financing transaction for
federal income tax purposes, it was permitted to treat the synthetic lease as an operating
lease for the purposes of financial reporting under Generally Accepted Accounting
Principles (GAAP).14
That meant that on the consolidated balance sheet of first Phillips
Petroleum Company and then ConocoPhillips Company (Polars parent companies) the
lease expense during a specific time period was reported as an operational expense for
that period, but the gross financed acquisition cost was not directly reported on the
balance sheet as a debt obligation, though it was disclosed generally in the Notes to
Consolidated Financial Statements and elsewhere in the financial reporting.
15
13 [R. 415, 834].14See Unocal Corp. v. Kaabipour, 177 F. 3rd 755, 765-66 (9th Cir.), cert. denied, 528U.S. 1061 (1999); Donald J. Weidner, Synthetic Leases: Structured Finance, Financial
Accounting and Tax Ownership, 25 Iowa J. Corp. L. 445, 447 (2000); John C. Murray,Off-Balance-Sheet Financing: Synthetic Leases, 32 Real Property, Probate and TrustJournal 193, 194 and 196 (1997). The term synthetic refers to the blended treatment the synthesis of the same transaction under IRS and GAAP standards. Weidner, 25Iowa J. Corp. Law at 449.15 [R. 706, 739, 753, 754].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
18/67
6
In August 2002, ConocoPhillips Company was created by a merger between
Phillips Petroleum Company and Conoco, Inc..16 After the merger was completed
ConocoPhillips was carrying more debt than it deemed desirable, and it adopted the
reduction of debt as an important part of its business plan.17 In January 2003 the
Financial Accounting Standards Board (FASB) issued Interpretation No. 46:
Consolidation of Variable Interest Entities.18 In summary, for ConocoPhillips, FASB
Interpretation No. 46 meant that by virtue of its guaranty of Polar Tankers payment
obligations under the synthetic lease, ConocoPhillips was required to report the
acquisition cost of the Polar Endeavouras debt on its consolidated balance sheet.19 The
advantage of a synthetic lease over traditional financing therefore disappeared, and the
addition of the cost of the Polar Endeavour, and other similarly financed assets, further
increased ConocoPhillipss reported debt, making debt reduction even more imperative.20
In December 2003, as part of ConocoPhillipss company-wide program of retiring
synthetic leases and similar financing arrangements affected by Interpretation No. 46,
Polar Tankers exercised its right to repurchase the Polar Endeavourfrom Arctic
Funding.21 As required under the lease agreement, Polar Tankers paid the initial
acquisition cost, $205,000,000, plus the Debt Yield-Maintenance Premium of
16
[R. 697].17 [R. 695].18 [R. 744, 753, 754].19 [R. 758, 762, 796-97, 806-07].20 [R. 758].21 [R. 253, 758, 797, 806-07].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
19/67
7
$34,156,402, along with other costs not at issue.22 That terminated Polar Tankers
obligation to pay periodic rental payments of approximately $14.8 million per year for
the seven years remaining on the lease, a total of over $100 million.23 The Debt Yield-
Maintenance Premium was defined as the amount of the Make-Whole Premium to be
paid by Arctic Funding to the noteholders according to the terms of the Arctic Funding
Note Purchase Agreement.24 That amount, as noted above, was calculated by taking the
difference between the present value of the expected future cash flows under the note,
discounted at then-current governmental note yield rates, and the principal amount to be
repaid under the note.25
Under AS 43.55.011 and .150, the value of the crude oil on which the production
tax at issue here is paid is calculated by deducting from the eventual sales price (or
equivalent) the reasonable costs of transportation incurred in getting the crude oil to a
market.
26
Under 15 AAC 55.180, reasonable costs of transportation include the actual
costs of transportation as calculated in 15 AAC 55.191, if they are ordinary and
22 [R. 253, 542, 823, 824, 834].23 [R. 292, 520, 542].24 [R. 498]. Polar therefore actually paid the Debt-Yield Maintenance Premium toArctic Funding, which in turn paid that amount to its noteholders as the Make-WholePremium. Because the Informal Conference Decision and the Office of Administrative
Hearings decision refer to Polars payment to Arctic Funding as the Make-WholePremium, this brief will do so as well.25 [R. 415-16, 841].26 The production tax statutes and regulations have been amended extensively since 2003.Unless otherwise noted, citations to the production tax statutes and regulations in thisbrief will refer to those statutes and regulations as they existed in 2003.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
20/67
8
necessary transportation expenses. Under AS 15 AAC 55.191(b)(3), the actual costs of
transportation allowed include depreciation and an amount that when added to
depreciation will provide a reasonable return on acquisition cost as provided in 15
AAC 55.195.
Under 15 AAC 55.195(b), the reasonable return calculation includes a cost of
capital allowance. Under 15 AAC 55.196(d), the cost of capital allowance must be
calculated using the method set forth in the DOR publication the regulation adopts by
reference: Computation of a Cost-of-Capital Allowance under 15 AAC 55.196,
Incorporating Depreciation and Return on Invested Capital for Marine Vessels and
Improvements (November 21, 2002) (ROI Regulation).27 The ROI Regulation
specifically recognizes synthetic lease transactions as a common financing mechanism
and demonstrates how they should be accounted for generally.28 In particular, the ROI
Regulation on the input schedules for Other Revenues and Expenditures Taxable Cash
Flow Events, provides:
This shall include the producers anticipated amounts of other taxablerevenues and expenditures associated with the vessel, including cash flowsassociated with sale/leaseback agreements, or synthetic leases. Examplesare the lease payments associated with sale/leaseback agreements, orsynthetic leases.29
27 [R. 837].28 [R. 843, 844, 850, 870].29 [R. 850].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
21/67
9
2. Course of ProceedingsCPAI, the taxpayer here, included in that input schedule the $34,156,402 Make-
Whole Premium in its calculation of the Cost-of-Capital Allowance.30 The Tax Division
disallowed that input, thus reducing the Cost-of-Capital Allowance.31 CPAI appealed that
disallowance within the Department of Revenue.32 The Department of Revenue upheld
the disallowance in an Informal Conference Decision, concluding that the Make-Whole
Premium was not an ordinary and necessary expense of marine transportation.33 Under
AS 43.05.430, CPAI appealed that decision to the OAH, acting in its capacity as the
Office of Tax Appeals.34 The OAH ruled that as a matter of law the Make-Whole
Premium was an ordinary and necessary expense and that DORs decision to disallow
that payment in the calculation of the Cost-of-Capital Allowance was not supported by a
reasonable basis.35 DOR sought reconsideration, which the OAH denied, and DOR
appealed the OAHs decision to this Court.36
B. Argument1. Framework of Statutes and Regulations
The tax at issue is the oil production tax imposed under AS 43.55.011(b) on the
gross value at the point of production of taxable oil. Under AS 43.55.150, the gross
30 [R. 286].31
[R. 291-92].32 [R. 323, 327].33 [R. 255].34 [R. 364-65]. See AS 43.05.405 and .499(6).35 [R. 72-75].36 [R. 1].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
22/67
10
value at the point of production must be calculated by deducting from the price at the
point of disposition the reasonable costs of transportation incurred in moving the oil to
the place of disposition. In the case of crude oil CPAI produces on Alaskas North Slope
and disposes of at refineries on the west coast, the oil is transported through the Trans-
Alaska Pipeline System from the North Slope to Valdez, and then by tanker from Valdez
to the west coast. Whether CPAI or its parent company charters tankers or owns the
tankers, the tankers are an essential element of transporting the crude oil to market.
In general, therefore, the costs incurred in acquiring the tankers that transport the
crude oil are ordinary and necessary expenses of transportation under 15 AAC
55.180(a) and 191(a). If a taxpayer obtains the tanker by chartering it from an
independent third party, the actual charter costs are deductible expenses.37 With respect
to tankers owned by the taxpayer or an affiliated company, however, the regulations
require the calculation of the allowable deduction in the following manner:
(3) if transportation of oil is by a vessel that is owned or effectively owned,in whole or in part, by the producer of that oil, the producer's actual cost forthat transportation, which is the sum of
(A) voyage and port costs incurred with respect to that transportation ;
(B) the positioning cost, amortized over 36 months, for that vessel;
(C) depreciation of the vessel ; and
(D) an amount that, when added to the amount of depreciation allowedunder (C) of this paragraph, will provide a reasonable return on the
37 15 AAC 55.191(b)(2).
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
23/67
11
adjusted shipyard cost or invested capital as provided in 15 AAC 55.195(b).38
Under 15 AAC 55.195(b), the amount to be combined with depreciation to provide
a reasonable return is defined to include a cost of capital allowance as provided in 15
AAC 55.196. And 15 AAC 55.196(d), in turn, specifically incorporates into the
regulation the ROI Regulation:
A cost of capital allowance under this section must be calculated using themethodology set out in the department's publication Computation of a Cost-of-Capital Allowance under 15 AAC 55.196, Incorporating Depreciation
and Return on Invested Capital for Marine Vessels and Improvements,dated November 21, 2002, and adopted by reference.
The Informal Conference Decision acknowledges that the ROI Regulation demonstrates
that DOR specifically recognizes synthetic leases as valid tanker financing arrangements
whose elements are to be included in the calculation of the cost-of-capital allowance.39
At multiple points in the calculation process the ROI Regulation directs taxpayers
to enter into the input schedules expenditures associated with the vessel, including cash
flows associated with sale/leaseback arrangements, or synthetic leases.40 In particular,
in Input Schedule 3-6: Other Revenues and Expenditures Taxable Cash Flow Events,
the regulation provides:
This shall include the producers anticipated amounts of other taxablerevenues and expenditures associated with the vessel, including cash flows
associated with sale/leaseback agreements, or synthetic leases. Examples
38 15 AAC 55.191(b)(3) (emphasis added).39 [R. 253].40 [R. 844, 850 (emphasis added)].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
24/67
12
are the lease payments associated with sale/leaseback agreements, orsynthetic leases.41
Indeed, the ROI Regulation specifically includes an example of a vessel financed through
a synthetic lease:
III. Expected Future Schedules
****
5. The vessel is subject to a synthetic lease, where the producer will sell thevessel to a lessor in 2003 for $100 million, lease it back for ten years for $6million per year, and buy the vessel back in 2012 at the original sales price.Input Schedule 3-5 shows the sale and re-purchase transactions, assumingthese are not taxable transactions to the producer.6. Input Schedule 3-6 shows the above-mentioned lease payments,assuming the lease payments are tax deductible to the producer.42
2. DOR Must Follow the Requirements of Its Own RegulationDORs regulations therefore specifically recognize expenses associated with
synthetic leases as ordinary and necessary expenses constituting part of the reasonable
costs of transportation that can be deducted in the calculation of the taxable value of oil.
And the ROI Regulation specifically directs taxpayers to input on Schedule 3-6 cash
flows associated with synthetic leases, without excluding cash flows that terminate
the lease payment cash flow, such as the Make-Whole Premium.43 Here, had Polar
Tankers continued making the lease payments under the terms of the lease for seven more
years in an amount in excess of $100 million dollars, DOR acknowledged that those cash
flows properly would be included in the cost-of-capital allowance calculation under the
41 [R. 850 (emphasis added)].42 [R. 870].43 [R. 850].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
25/67
13
ROI Regulation.44 There is no basis in the regulation for excluding from that calculation
the one-time cash flow of roughly $34 million associated with the same lease that Polar
Tankers paid under the terms of the lease as a substitute for the allowable cash flow of
over $100 million paid over time.
Thus, the ROI Regulation itselfrequires the inclusion of the Make-Whole
Premium in the cost-of-capital calculation. The Make-Whole Premium was incurred as a
result of the early repurchase of the Polar Endeavour under the terms of the synthetic
lease. It undeniably was an expenditure associated with the vessel, and more particularly
a cash flow associated with the synthetic lease. Under the terms of the ROI Regulation,
that cash flow must be accounted for in the cost-of-capital calculation, specifically in
Input Schedule 3-6. DOR is not free to ignore the plain language of its own regulation.45
In theAtlantic Richfieldcase, DOR wrote a regulation addressing the deductibility
under an income tax of interest paid on the construction of an oil pipeline. The regulation
permitted the deduction of all interest paid as a result of the construction of the pipeline,
and did not limit the deductibility to a portion of the interest attributable to debt secured
only by the pipeline itself; that is, even if assets of a parent company, as well as the
financed pipeline itself, were used to secure the debt, the regulation still would permit the
deduction of all interest paid. DOR argued that its decision nevertheless to apportion the
44 [R. 255] (Semiannual lease payments were includable in determining the cost-ofcapital allowance under 15 AAC 55.196.). See also [R. 254].45State of Alaska, Department of Revenue v. Atlantic Richfield Company, 858 P.2d 307,310 (Alaska 1993).
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
26/67
14
deduction to reflect only interest associated with debt secured by the pipeline itself was
consistent with the statute and therefore should be upheld.46 The Alaska Supreme Court
disagreed, and, even though it was applying a rational basis standard of review, ruled
that DOR was bound by the plain language of the regulation as it had written it:
The regulation does not indicate that interest expense deductions are limitedin any way other than that the money be borrowed from a third party for thepurpose of constructing TAPS.
****The regulation as written, however, cannot be reasonably read to allow theuse of an apportionment formula.47
Here, too, DOR cannot ignore its own regulation. The regulation authorizes the
inclusion of all cash flows associated with the synthetic lease and does not limit the types
of cash flows in any way. However DOR might speculate about scenarios where it would
need to limit the regulation despite its lack of express limitations, there is no valid
concern here.48 The ROI regulation specifically uses lease payments as an example of
properly included cash flow, and DOR acknowledged the lease payments of more than
$100 million here would have been allowed. The Make-Whole Premium of some $34
million substituted for and terminated those undeniably allowable payments; it is equally
undeniably allowable. Whether other expenses would be deductible is not at issue. The
ROI regulation cannot reasonably read to exclude a cash flow associated with the lease
46Id. at 309-10.47Atlantic Richfield Company, 858 P.2d at 310.48 Appellants Brief at 19.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
27/67
15
that serves as the functional equivalent of the allowable lease payments. As it was in
Atlantic Richfield,DOR is bound by the regulation it wrote.
3. As a Factual Matter, the Make-Whole Premium Was an Ordinary andNecessary Transportation Expense
In addition, although the OAH ruled that the Make-Whole Premium was an
ordinary and necessary expense as a matter of law, that determination essentially is one
of fact:
Whether an expenditure is directly related to a business and whether it isordinary and necessary are doubtless pure questions of fact in most
instances.49
As such, the OAHs determination is reviewed under the substantial evidence standard,
and there is no question that the decision was supported by substantial evidence.
The OAH carefully and properly reviewed the Lease Agreement, under which
Polar Tankers had the obligation to fulfill the terms of the agreement in one of two
relevant ways:
1) It could make the semi-annual lease payments for the full ten years of the Lease
Agreement, which in 2003 would have required making payments of over $100
million, and then repurchase the vessel for $205 million at the end of the lease
term;50 or,
2) With proper notice, it could repurchase the vessel for $205 million before the
end of the lease term, pay a Make-Whole Premium, which in 2003 was an amount
49Commissioner of Internal Revenue v. Heininger, 320 U.S. 467, 475 (1943).50 [R. 520].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
28/67
16
of about $34 million, and terminate the Lease Agreement and obligation to make
lease payments (over $100 million remaining to be paid in 2003).51
Either course of action would fulfill Polar Tankers obligations under the terms of the
Lease Agreement, but one or the other was required. That is, Polar Tankers had the right
to terminate the obligation to pay $100 million in lease payments over seven more years,
but, to do so it had the obligation to pay the $34 million Make-Whole Premium. That was
not a penalty, but a negotiated, alternative form of payment of the consideration
required by the contract. Polar Tankers could elect to pay a larger nominal sum in
installments over time, or a smaller nominal sum at one time, but its contractual
obligation to pay one way or the other was clear.
The synthetic lease agreement itself clearly was ordinary, as DOR itself adopted a
regulation addressing such arrangements, and there is no question that the lease payments
required under it were necessary. Likewise, even though Polar did not have to exercise its
right to early termination and repurchase option, if it did so, there is no question that
under the express terms of the Lease Agreement the payment of the Make-Whole
Premium was required as a substitute for the lease payments and, therefore, necessary.
Substantial, undisputed evidence established that as a factual matter, as well as a legal
matter, the Make-Whole Premium was an ordinary and necessary expense.
51 [R. 542].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
29/67
17
4. As a Matter of Law, the Make-Whole Premium Was an Ordinary andNecessary Expense
If the issue is viewed as a legal one instead of a factual one, then in the exercise of
its independent judgment this Court still must conclude that the Make-Whole Premium
was an ordinary and necessary expense. First, contrary to DORs arguments, to the extent
the determination whether an expense is ordinary and necessary is a legal one, it is not
one involving DORs specialized expertise. Under AS 43.05.435(2), therefore, the OAH
correctly reviewed the issue using its independent judgment, and this Court can do so as
well.
The OAH focused on the issue as one of contract interpretation requiring no
deference to DOR, and correctly concluded that under the terms of the Lease Agreement
the Make-Whole Premium was both an ordinary and a necessary payment:
Once the repurchase option was exercised, the obligation to pay the $34.2million make-whole premium arose and was no more avoidable than the
obligation to pay the $205.0 million repurchase price itself.52
And, as discussed above, the consequence of making the $34 million payment was to
terminate the obligation to make over $100 million of lease payments over the next seven
years, lease payments that DOR acknowledged were allowable ordinary and necessary
expenses:
The use of synthetic leasing is not an unusual form of financing and semi-annual lease payments based on 6.85% interest on the notes would havebeen allowable if paid through the remaining term of the lease.
****
52 [R. 73].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
30/67
18
The company could have left the lease in effect and included thesemiannual lease payments in the ROI model, but it chose otherwise.
****Semiannual lease payments were includable in determining the cost-of
capital allowance under l5 AAC 55.196.53
But there is an additional reason why the OAH properly concluded that this legal
issue did not require deference to DORs interpretation. Contrary to DORs argument, the
determination whether an expense is ordinary and necessary is not an issue requiring the
exercise of DORs expertise, and DOR did not in fact use any special expertise to analyze
the issue. DORs brief does not point to any particular specialized analysis DOR
conducted; rather, it points to the Internal Revenue Code and legal and standard
dictionaries as justification for DORs interpretation.54 Nor could it point to any such
application of specialized expertise, for the Informal Conference Decision itself based its
analysis upon a United States Supreme Court decisions interpretation of ordinary and
necessary business expenses in the context of the federal income tax.55 Because DOR
relied on federal case law, not its own specialized knowledge and experience, the OAH
did not owe the DORs interpretation any deference, and neither does this Court:
Because the outcome of this case rests solely on the application ofestablished federal law to undisputed facts, it cannot be said that "theanswer depends on the particularized experience or knowledge of theadministrative personnel." Therefore, acting as the functional equivalent ofa court of original jurisdiction, the Office of Tax Appeals correctly
concluded that it owed no special deference to the decision reached by the
53 [R. 254-55].54 Appellants Brief at 11-12.55 [R. 254-55].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
31/67
19
department.56
Under federal case law, ordinary expenses are those that can be expected in a
particular business, even if they are not routinely incurred:
Ordinary has the connotation of normal, usual, or customary. To be sure, anexpense may be ordinary though it happen but once in the taxpayer'slifetime. Yet the transaction which gives rise to it must be of common orfrequent occurrence in the type of business involved.57
Necessary expenses are those that are appropriate and helpful to a business, without
any requirement that they be absolutely essential.58 In essence:
The test for determining deductibility [as an ordinary and necessarybusiness expense] is whether a hard-headed businessman, under thecircumstances, would have incurred the expense.59
There is no doubt that the payment of the Make-Whole Premium satisfies the tests
applied by the federal courts. The synthetic-lease arrangement was normal and customary
in the acquisition of tankers, as DOR acknowledged, and some form of alternative
payment upon early termination of the lease was normal and customary in such
arrangements and similar financing arrangements:
The lease is the most important document in characterizing the financingtransaction as a synthetic leasing transaction. This document willcommonly include a provision for the payment of a stipulated
56
Dyncorp, 14 P.3d at 984 (quoting Gulf Oil Corp. v. State, Department of Revenue,755 P.2d 372, 378 n.19 (Alaska 1988)).57Deputy v. DuPont, 308 U.S. 488, 495 (1940) (citations omitted).58Welch v. Helvering, 290 U.S. 111, 113 (1933).59B. Forman Co., Inc. v. Commissioner of Internal Revenue, 453 F.2d 1144 (2d Cir.),cert. denied, 407 U.S. 934 (1972).
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
32/67
20
termination fee in the event of early termination or abandonment of thelease .60
The contractual provision allowing for the early repurchase plainly was an
appropriate and helpful one, as Polar Tankers saw fit to ensure its inclusion in the Lease
Agreement, and the exercise of the that option was, too. For sound business reasons,
Polar Tankers parent company, ConocoPhillips, had made the reduction of debt a
priority for 2003.61 Moreover, the adoption of Financial Accounting Standards Board
Interpretation Number 46 in early 2003 meant that ConocoPhillips was required to report
synthetic leases on it is financial statements:
During 2003, the company adopted Financial Accounting Standards BoardInterpretation No. 46 (FIN 46), Consolidation of Variable InterestEntities, for synthetic leases and other financing structures. This resultedin increasing the companys total debt from $19.8 billion at the end of 2002to $22.6 billion as of the beginning of 2003.62
As result of the financial accounting change, therefore, it was even more important
for ConocoPhillips to reduce debt, and the change eliminated the feature that made
synthetic leasing an attractive financing option. ConocoPhillips therefore elected to
60 John C. Murray, Off-Balance Sheet Financing: Synthetic Leases, 32 Real PropertyProbate & Trust Journal 193, 213-14 (1997). See also Sun Oil Company v. Commissionerof Internal Revenue, 562 F.2d 258, 260 (3d Cir. 1977), cert. denied, 436 U.S. 944 (1978)
(sale and leaseback arrangement, similar to a synthetic lease, allowed early terminationupon repurchase of property at price based on present value of outstanding rentalpayments plus an amount sufficient to ensure the lessor/lender a return of 5 percent perannum over the term of the investment).61 [R. 695].62 [R. 758].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
33/67
21
eliminate debt associated with synthetic leases and other Variable Interest Entities,
including the Arctic Funding synthetic lease for the Polar Endeavour.63
ConocoPhillipss officers believed that the elimination of debt by terminating the
synthetic lease and paying the associated cash flows was appropriate and helpful to its
business.64 That determination essentially is controlling:
the payment was thought by the taxpayer's officers to be beneficial, and weshould be slow indeed, even if we were inclined, which we are not, toquestion the soundness of their judgment.65
The Make-Whole Premium was incurred for the appropriate and helpful purpose of
eliminating debt; it was a necessary expense.
Most importantly, not only did hard-headed business people conclude that the
early repurchase of the vessel and the associated cash flow of the Make-Whole Premium
made sense, their decision objectively was reasonable. If Polar Tankers decided simply to
maintain the Lease Agreement through its entire life, in 2003 Polar Tankers faced the
certain payment of some $14.8 million per year for seven more years, over $100 million
in total (as well as the repurchase expense of $205 million in 2010). If it instead elected
to repurchase the vessel in 2003 (paying the $205 million repurchase expense then) and
incur the expense of the Make-Whole Premium, some $34 million, it was certain that it
would terminate the obligation to pay over $100 million over the next seven years. At the
63 [R. 806-07].64 [R. 695, 758, 797, 806-07].65Commissioner of Internal Revenue v. Pacific Mills, 207 F.2d 177, 180 (1st Cir. 1953). Seealso Welch v. Helvering, 290 U.S. 111, 113 (1933).
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
34/67
22
time, it was impossible to know for certain which option ultimately would be the better
one financially, but it was an eminently sensible and reasonable decision to decide to pay
$34 million dollars in 2003 rather than over $100 million over the next seven years. The
Make-Whole Premium was an ordinary and necessary business expense and should be
included in the in the Cost-of-Capital Allowance calculation.
The early termination of the Lease Agreement and the payment of the Make-
Whole Premium eliminated lease payments that DOR acknowledges were allowable
ordinary and necessary expenses, so the Make-Whole Premium plainly is an allowable
ordinary and necessary expense. DOR nevertheless attempts to make a further distinction,
arguing that the payment of the Make-Whole Premium was not directly required to
provide marine transportation of oil.66 That strained parsing overlooks the purpose of all
payments associated with the synthetic lease: the acquisition of the means of marine
transportation, a tanker. Costs that are appropriate and helpful to the acquisition of the
tanker are necessary costs of marine transportation. There are many different business
considerations that will determine whether a producer charters or owns tankers, and how
it finances the acquisition of tankers, but the fundamental nature of the expense remains
that of acquiring a tanker essential to marine transportation.
It is true that Polar Tankers did not need to collapse the synthetic lease to transport
its oil, but in order to transport its oil it did need the tanker subject to that lease. And, to
66 [R. 255]; Appellants Brief at 12.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
35/67
23
fulfill its obligations under that lease, it either had to make lease payments for seven more
years, a total of over $100 million, or it had to pay the Make-Whole Premium of $34
million. No less than the unquestionably allowable lease payments themselves, the
payment of the Make-Whole Premium assured the acquisition of a tanker to transport
CPAIs oil from the TAPS Terminal across the ocean to market. As were the lease
payments, it was an ordinary and necessary expense of obtaining marine transportation.
DOR also argues that the Make-Whole Premium was not similar to other costs
specifically allowed under the regulations, such as voyage and port costs. But that
argument fails to acknowledge that the regulations recognize several distinct types of
types of costs as part of the reasonable costs of transportation. Voyage and port costs
indeed are one type of direct cost incurred on specific voyages. But the regulations also
specifically recognize indirect costs that although not tied to a specific voyage
nevertheless are essential to marine transportation, the acquisition costs of the vessel
itself:
(3) if transportation of oil is by a vessel that is owned or effectively owned,in whole or in part, by the producer of that oil, the producer's actual cost forthat transportation, which is the sum of
(A) voyage and port costs incurred with respect to that transportation ;
(B) the positioning cost, amortized over 36 months, for that vessel;
(C) depreciation of the vessel ; and
(D) an amount that, when added to the amount of depreciation allowedunder (C) of this paragraph, will provide a reasonable return on the
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
36/67
24
adjusted shipyard cost or invested capital as provided in 15 AAC 55.195(b).67
In order to acquire the vessel used in marine transportation, Polar Tankers either
had to make the lease payments for seven more years, at a cost of over $100 million, or it
had to pay $34 million in 2003 and terminate the obligation to make the lease payments.
The two types of payments were equally required under the Lease Agreement, and were
equally unavoidable. Both types of payments were ordinary and necessary expenses.
And DORs attempt to dismiss the Make-Whole Premium as a penalty also is
unavailing. First, the arms-length contract provided two clear choices: pay over $100
million in rental payments over seven years, or pay $34 million in 2003, terminating the
obligation to make further rental payments. There was no penalty, just a rough
equalization of the values of the two options. Polar was free to make either choice
without penalty, but the parties from the beginning attempted to ensure the financial
impact on the parties of each of the two choices was roughly equivalent (recognizing of
course, that the accurate prediction of future economic conditions is impossible).
But, even if characterized as a pre-payment penalty, the Make-Whole Premium
still was an allowable ordinary and necessary expense. The federal courts repeatedly have
allowed various legal expenses, penalties and fines paid to governmental entities as
ordinary and necessary business expenses, so long as they were a normal part of a
business and were not incurred in bad faith. For example, the United States Supreme
67 15 AAC 55.191(b)(3) (emphasis added).
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
37/67
25
Court ruled that the legal fees incurred in the unsuccessful defense of a mail fraud claim
were ordinary and necessary business expenses.68 The Tenth Circuit determined that
penalty interest imposed on a tax deficiency was a deductible ordinary and necessary
business expense because the circumstances of the taxpayers business made accurate
reporting difficult and deficiencies therefore were to be expected.69 And the First Circuit
ruled that the taxpayers payment of a fine to the federal government to settle a charge of
violation of price controls was an ordinary and necessary expense.70 The payment here
was not a penalty, but characterizing it as such does not render it any less of an ordinary
and necessary expense.
Finally, there is no merit in DORs complaint that the OAHs Decision opens the
door to the allowance of all manner of improper costs.71 The OAH dealt with the specific
cost before it: a payment of a smaller lump sum in place of a larger sum due over the
course of the next seven years that DOR acknowledged was an allowable cost under the
ROI Regulation. DORs extrapolated examples simply were not at issue, and the OAH
carefully limited scope of its ruling:
This is not to say that all synthetic lease- or other agreement-driven costs,under all circumstances, must be considered "ordinary and necessary"transportation costs. Taxpayers necessarily must accept the tax
68
Heininger, 320 U.S. at 471-72.69Commissioner of Internal Revenue v. Polk, 276 F.2d 601, 603 (10th Cir. 1960)(livestock inventories were inherently difficult to value, making errors in reportinginventory value, and therefore penalties, a usual part of that business).70Pacific Mills, 207 F.2d at 181.71 Appellants Brief at 19-20.
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
38/67
26
consequences of their business judgments, whether those consequencesincrease tax liability or decrease it. Under these particular circumstances,the department also must accept the tax consequences of the taxpayer'sexercise of business judgment .72
Neither CPAI nor any other taxpayer can argue that the decision upholding this plainly
allowable expense opens the door to the allowance of a laundry list of questionable
expenses. There is no reason for this Court to defer to DORs own decision, which was
not supported by a reasonable basis, because DOR might have a reasonable basis to
disallow other types of expenses not at issue.
5. The OAH Correctly Determined that DORs Interpretation of theRegulation Was Not Supported by a Reasonable Basis
Finally, though DOR barely acknowledges it, the OAH had an alternative basis for
its decision. The OAH correctly ruled that the ordinary and necessary expense analysis
did not require a deferential standard of review, but it analyzed the decision under that
standard, too. Using that standard, the OAH correctly concluded that DOR did not have a
reasonable basis for its decision.73
The OAH recognized that there was no meaningful distinction between the Make-
Whole Premium and the lease payments for which it served as a substitute. DOR
acknowledged that the lease payments were ordinary and necessary expenses, as was the
repurchase payment of $205 million. The Make-Whole Premium arose from the same set
of contractual obligations, and there is no reasonable basis for concluding it, too, was not
72 [R. 75].73 [R. 74-75].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
39/67
27
ordinary and necessary. Under the Lease Agreement, as of 2003 the total consideration
for the purchase of the Polar Endeavourconsisted of either: (1) seven more years of
lease payments, totaling over $100 million, plus the $205 million repurchase cost in
2010; or (2) the payment of the $34 million Make-Whole Premium, plus the $205 million
repurchase cost. There is no reasonable basis for concluding that although parts of the
total consideration for the vessel (the lease payments and the repurchase cost) are
ordinary and necessary expenses, the alternative consideration required by the very same
agreement (the Make-Whole Premium) is not. As the OAH noted in its order denying
reconsideration, it is unreasonably inconsistent for DOR to concede that the repurchase of
the Polar Endeavouris an ordinary and necessary transportation expense, but a portion of
the contracted repurchase price, the Make-Whole Premium, is not.74 The OAH properly
concluded DORs decision was not supported by a reasonable basis.
II.THE OAH CORRECTLY DETERMINED THAT THE ADMINISTRATIVEFEE PAID FOR FACILITATING AN EXCHANGE SERVING NO PURPOSE
FOR CPAI WAS NOT COMPENSATION FOR QUALITY DIFFERENTIALS
A.Statement of the Case1. Background
CPAI produces oil on the North Slope and transports it to Valdez through the
Trans-Alaska Pipeline System (TAPS). During 2003, CPAI diverted some of its oil
from the TAPS to Williams Alaska Petroleum, Inc., for use in its refinery near Fairbanks,
under the terms of three different contracts entered into by predecessors of CPAI with
74 [R. 1].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
40/67
28
various Williams companies or their predecessors. Two of the contracts were sales
contracts. One sales contract was entered into in 1998 between Phillips Petroleum
Company (then the owner of only a relatively small interest in producing Alaska North
Slope Units75) and Mapco Alaska Petroleum, Inc. (a predecessor of Williams); it will be
referred to as the Phillips Sales Contract.76 During 2003, Williams purchased from
CPAI 3,020,006 barrels of crude (approximately 8,300 barrels per day) under the Phillips
Sales Contract.77 The second sales contract was entered into between BP Oil Supply
Company and Williams Energy Marketing & Trading Company in December 1999 and
later assigned to a predecessor of CPAI; it will be referred to as the BP Sales
Contract.78 During 2003, Williams purchased 1,817,726 barrels of crude from CPAI
under the BP Sales Contract (approximately 6,600 barrels per day).79
The third contract is the only one at issue. Unlike the first two, it is not a sales
contract, but an exchange contract. In December 1999, at the same time it entered into the
BP Sales Contract, BP Oil Supply Company entered into an agreement with Williams
Energy Marketing & Trading Company for the use of oil at Williamss refinery near
75 [R. 1197, 1201].76 [R. 1208-09].77 [R. 227].78 [R. 1210-11].79 [R. 228].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
41/67
29
Fairbanks, which will be referred to as the Exchange Agreement.80 The parties
described the Exchange Agreement this way:
It is the intent of BP and Williams to exchange equal quantities of ANS inwhich BP shall deliver a minimum of zero (0) and a maximum of 160,000barrels per day daily average per month of ANS from TAPS at the[Williams Refinery] and, subsequent to processing, BP shall receive backfrom Williams the equal volume delivered.81
The barrels returned after processing would be returned to the TAPS by BP. The
consideration for the exchanged barrels consisted of two components:
The exchange differential paid by Williams to BP shall be equal to anyquality bank degradation charges per barrel as assessed by the TAPSquality bank administrator. Williams also agrees, in addition to qualitybank assessments, to pay an administration fee of $0.0275 per exchangebarrel.82
During 2003, CPAI provided Williams with 50,071,788 exchange barrels under the
agreement, an average of over 137,000 barrels per day.83
The Williams Refinery in Fairbanks was not able to make products from the entire
chain of components in the crude stream. It therefore distilled from the crude stream
some of the lighter hydrocarbon components, which it used to make refined petroleum
products, and then returned for redelivery to the TAPS the residue stream consisting
primarily of heavier hydrocarbon components.84 As of 1999, the Williams Refinery had
80 [R. 1212-13].81 [R. 1212-13 at 2]. See also [R. 208].82 [R. 1212-13 at 2]. See also [R. 208].83 [R. 228].84 [R. 1222].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
42/67
30
a throughput capacity of 210,000 barrels of crude per day.85 It would consume
approximately 64,000 barrels per day in making refined products, and would return
approximately 146,000 barrels per day of residue to TAPS.86 Williams purchased
approximately 57,000 barrels of crude per day from the State of Alaska, which the State
had taken as its royalty share, royalty-in-kind (RIK) barrels.87 At the time, Williams
was the sole purchaser of the States RIK barrels.88 Williams obtained the remainder of
its throughput needs, approximately 150,000 barrels per day, from other TAPS shippers,
through a combination of small purchases and other agreements.
In particular:
Williams rents crude oil from several TAPS shippers and returns to thepipeline the residual oil after removing the lighter components used tomake petroleum products.89
BP entered into the Exchange Agreement in December 1999 as it was closing its
acquisition of Atlantic Richfield Company.90 The Exchange Agreement did not
commence until the effective date of the acquisition of Atlantic Richfield Company, and
it expressly was conditioned on the consummation of the merger:
The obligations of BP Oil Supply Company (BP), a wholly ownedindirect subsidiary of BP Amoco, plc (BPA), under this agreement areexpressly conditioned on the prior satisfaction of each of the followingconditions:
85
[R. 1222].86 [R. 1222].87 [R. 1222].88 [R. 1220].89 [R. 1222].90 [R. 1212-13 at 1, 1218].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
43/67
31
(a) The proposed acquisition of Atlantic Richfield Company (ARCO) byBPA is approved by the Federal Trade Commission (FTC), and theacquisition is completed; and(b) the FTC does not disapprove the terms of this agreement.91
In 2003, after the merger had been completed and the Exchange Agreement had
taken effect, Williams no longer had to rent crude oil from various TAPS shippers.
Instead, it could purchase approximately 57,000 RIK barrels per day from the State, still
as the sole purchaser of the States RIK share, and small additional amounts such as the
8300 barrels per day it purchased from CPAI under the Phillips Sales Contract and the
6600 barrels per day it purchased from CPAI under the BP Sales Contract.92 It could
fulfill the remainder of its needs, up to 160,000 barrels per day, through the Exchange
Agreement, without purchasing or renting additional barrels from other shippers. The
only charges Williams incurred under the Exchange Agreement were the Quality Bank
degradation charge reimbursements and the administrative fee.
The Quality Bank degradation charges were incurred by CPAI solely as a result of
the Exchange Agreement. The Quality Bank is a mechanism for addressing the fact that a
barrel of oil exiting the pipeline at the TAPS Terminal in Valdez is made up of a
combined crude stream that may have come from multiple sources contributing crude oil
of varying quality, and that along the route of the TAPS oil may have been removed from
or returned to the crude stream with various impacts on the quality of the combined
91 [R. 1212-13 at 1, 209-10]. The BP Sales Contract contained the same provision. See[R. 1210-11 at 1].92 [R. 1237, 1239, 1243, 1253, 1255, 1257].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
44/67
32
stream.93 The entity taking possession of the barrel of crude may have contributed crude
to the combined stream that was of a higher or lower quality than that of the combined-
stream barrel it ultimately receives.94 The Quality Bank imposes a charge on shippers
who degrade the combined crude stream by contributing crude of lower quality to the
combined stream, whether on the North Slope or at a point downstream, such as
downstream from the Williams Refinery near Fairbanks.95 The charges are used to
compensate shippers who have contributed a higher quality stream of crude than that of
the combined stream they ultimately received.96
Under the Exchange Agreement, CPAI removed from the TAPS barrels of crude
of a certain quality for delivery to Williams, accepted from Williams an equal volume of
residue barrels of a reduced quality and then returned to the TAPS the reduced quality
residue barrels. As it therefore reduced the quality of the combined TAPS stream, CPAI
was assessed Quality Bank degradation charges. CPAI paid those degradation charges
along with its other Quality Bank obligations, identified and segregated the charges
related to the Exchange Agreement barrels from the other Quality Bank transactions and
billed Williams for reimbursement of those degradation charges.97 Williams paid those
93 [R. 1265].94 [R. 1265].95 [R. 1265].96 [R. 1265].97 [R. 228-29].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
45/67
33
amounts to CPAI, reimbursing CPAI for the Quality Bank charges it paid solely as a
result of exchanging barrels with Williams under the Exchange Agreement.
The administrative fee was the only other charge Williams incurred for receiving
up to 160,000 barrels of crude oil per day (and actually receiving some 137,000 barrels
per day in 2003) to help it meet its throughput requirements.98 The fee provided CPAI
some compensation for the administrative effort it expended in undertaking the
mechanics of exchanging 137,000 barrels per day (when, in contrast, it was selling to
Williams only about 11% of that amount, some 14,900 barrels per day) and conducting
the complicated tracking and sorting required to obtain reimbursement for Quality Bank
charges it incurred solely because of the exchange for which it received no other
compensation.99
In implementing the requirement in AS 43.55.150(a) that the taxable value of the
oil be determined by taking into account the reasonable costs of transportation, 15
AAC 55.151(b) (emphasis added) requires accounting for Quality Bank charges and
payments:
(b) The gross value at the point of production for a producer's oil mustbe calculated as follows:
(1) a destination value must be determined for the oil ;(2) except as otherwise provided under (i) of this section, the producer'sreasonable costs of transportation under 15 AAC 55.180 and 15 AAC
98 [R. 228].99 [R. 227-29].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
46/67
34
55.191 must be subtracted from the destination value determined under (1)of this subsection; (3) if oils of different qualities or oil and NGLs are commingled, the valuecalculated under (2) of this subsection must be adjusted for any
consideration paid or received for quality differentials .
And, under 15 AAC 55.191(o):
A producer shall report any reimbursed costs to the department.Reimbursed costs are not allowable as actual costs of transportation underthis section.
2. Course of ProceedingsConsistent with those regulations, CPAI reported both the Quality Bank
degradation charges it incurred as a result of the Exchange Agreement and the offsetting
reimbursements from Williams, so that the Quality Bank charges associated with the
Exchange Agreement simply had no impact on the calculation of CPAIs production
tax.100 Because the administrative fee was distinct from the Quality Bank reimbursement
and had nothing to do with transportation of CPAIs oil, however, CPAI did not report
the administrative fee as compensation for quality differentials or a reimbursed
transportation cost.101
The Tax Division on audit determined that the administrative fee should be offset
against CPAIs other Quality Bank expenses, reducing CPAIs deductible transportation
costs.102 CPAI appealed that determination within the Department of Revenue.103 In the
100 [R. 314].101 [R. 314].102 [R. 315].103 [R. 323, 335-36].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
47/67
35
Informal Conference Decision, the Department of Revenue upheld the reduction in
transportation expenses, ruling that the administrative fee was additional consideration
received for the degradation of crude oil under 15 AAC 55.151(b)(3).104 CPAI appealed
that decision to the OAH, acting in its capacity as the Office of Tax Appeals.105 The
OAH ruled that as a matter of law the administrative fee was not consideration for quality
differentials and DORs determination that it was was not supported by a reasonable
basis.106 DOR sought reconsideration, which the OAH denied, and DOR appealed the
OAHs decision to this Court.107
B. Argument1. The OAHs Decision Cured the Factual Mistakes in DORs Decision
The Administrative Fee arose from the Exchange Agreement, which was a unique
agreement for an unusual transaction. Fundamentally, DORs erroneous determination
that the Administrative Fee constituted additional compensation for the degradation of
exchanged oil was based on its faulty understanding of facts surrounding the Exchange
Agreement. For example, on Audit, the Tax Division based its determination on the
factually incorrect basis that the Exchange Agreement was an agreement for the sale of
oil:
ConocoPhillips also receives an additional "administrative fee" of $.0275per barrel from Williams per their sales contract.
104 [R. 270].105 [R. 242, 246]. See AS 43.05.405 and .499(6).106 [R. 80-83].107 [R. 1].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
48/67
36
****The term "administrative fee" is not truly representative of the additionalpayment made by Williams, since it based on the number of barrels soldtoWilliams and not based on any administrative expenses for managing the
contract. This is part of the full consideration being received, which wasnegotiated as additional payment under the contract terms for sales toWilliams. The $.0275 per barrel more accurately reflects revenue to offsetthe quality bank expenses for this sale to Williams, since it is included onthe invoice for quality bank reimbursement due.108
But, of course, the Exchange Agreement was not a contract for the sale of oil. Williams
received and returned an equal volume of oil.109 The returned barrels were of a lower
quality than the barrels delivered, but there was an exchange, not a sale, of oil.
The Informal Conference Decision did not perpetuate that factual error, but it
founded its analysis on equally faulty and fundamental factual errors. DOR erroneously
described the exchange transaction this way:
After processing the crude, Williams returned to TAPS degraded oil that itno longer needed. The owners of the crude being shipped through TAPSreceived compensation for the degradation of the common stream inaccordance with calculations of the TAPS quality bank administrator. Theowners, including ConocoPhillips, also received an additional fee of$.0275 for each barrel of ANS that William degraded and returned toTAPS.110
DOR thus erroneously suggests that through the Quality Bank process all shippers
received compensation from Williams for crude degradation. But that is not true. The
Quality Bank process imposed degradation charges on ConocoPhillips, not Williams.
108 [R. 314-15 (emphasis added)].109 [R. 1212-13 at 2]. See also [R. 208].110 [R. 270 (emphasis added)].
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
49/67
37
ConocoPhillipspaidthose charges into the Quality Bank; it did not receive them, as DOR
states. It alone then obtained reimbursement from Williams under the terms of the
Exchange Agreement. Williams had no direct contact with the Quality Bank or any other
shipper. And, contrary to DORs erroneous assertion, the shippers in general did not
receive an additional fee of $.0275 per barrel from Williams. Williams paid the
administrative fee to ConocoPhillips alone, under the terms of the Exchange Agreement.
The OAHs decision, unlike DORs decision, is based on a correct understanding
and statement of the factual circumstances of the exchange transaction. As a factual
matter, CPAI exchanged barrels of crude with Williams; it did not sell barrels of crude to
Williams. As a factual matter, CPAI, not Williams, was assessed Quality Bank charges,
and CPAI, not Williams, paid the Quality Bank charges to the other shippers; with
respect to this transaction, CPAI did not receive any Quality Bank compensation. As a
factual matter, Williams reimbursed CPAI, and only CPAI, for the Quality Bank charges
CPAI paid as a result of Williamss actions. As a factual matter, Williams paid that
reimbursement to CPAI, and only CPAI, because only CPAI played any role in the
exchange and the Quality Bank charges it produced. And, as a factual matter, under the
terms of the Exchange Agreement the administrative fee was due not as a result of quality
differentials, but as a result of the exchange itself:
Under the plain terms of the exchange agreement, if hypotheticallyWilliams, instead of removing its target products from the input stream ormixing the stream with lesser quality oil, returned back to the TAPS oil ofthe same quality, ConocoPhillips Alaska would still be entitled to collectthe per-barrel administrative fee. Payment of the administrative fee is
-
8/4/2019 Alaska v. ConocoPhillips, 3AN-10-05484 CI, (Alaska 2011) ConocoPhillips' Brief
50/67
38
contingent upon exchanging barrels, not upon degradation of the quality ofoi1 so exchanged.111
DORs determination that the administrative fee was additional consideration for
quality differentials was based on an incorrect factual foundation. In contrast, because it
was based on the correct facts, there was substantial evidence supporting the OAHs
essentially factual determination that:
In short, the TAPS quality bank assessment payments are consideration forquality differentials; the [administrative] fee is consideration foradministration of the contract.112
This Court should affirm that det