Powerex Corp. II v. Dept. of Rev.

30 September 17, 2012 No. 4

IN THE OREGON TAX COURT

REGULAR DIVISION

POWEREX CORP.,

Plaintiff,

v.

DEPARTMENT OF REVENUE,

Defendant.

(TC 4800)

Plaintiff (taxpayer) appealed Defendant (the department)’s assessment of

tax, and the department’s position that revenues from taxpayer’s electricity sales

are sales of tangible personal property and that the revenues from such sales can

be sourced in Oregon and included in the numerator of the Oregon sales factor

used for apportionment of taxpayer’s income. Taxpayer argued that electricity is

other than tangible personal property and that because the greatest portion of

the costs of its income producing activity related to the sales of electricity were

incurred at its office and trading location in Canada, the revenue from taxpayer’s

sales of electricity cannot be sourced in Oregon under ORS 314.665(4). Ruling for

taxpayer, the court found that given the nature of electricity, and the positions of

the MTC and other UDITPA states, the sale of electricity is a sale other than a

sale of tangible personal property.

Trial was held September 12 and 13, 2011, in the court-

room of the Oregon Tax Court, Salem.

Eric J. Coffill, Morrison & Foerster LLP, Sacramento,

argued the cause for Plaintiff (taxpayer) pro hac vice.

Marilyn J. Harbur, Senior Assistant Attorney General,

Department of Justice, Salem, argued the cause for Defen-

dant (the department).

Decision for Plaintiff rendered September 17, 2012.

HENRY C. BREITHAUPT, Judge.

I. INTRODUCTION

This matter is before the court after a trial. Certain

facts have been stipulated by the parties. The tax at issue

is the corporate income tax and the years at issue are the

years ending March 31, 2002, March 31, 2003, and March 31,

2004.

Cite as 21 OTR 30 (2012) 31

II. FACTS

Plaintiff (taxpayer) is a company headquartered in

Vancouver, British Columbia. Plaintiff is wholly owned by

British Columbia Hydro and Power Authority, a Provincial

Crown Corporation (BC Hydro). Taxpayer sells electricity,

generated by BC Hydro, at wholesale to many customers. In

some cases, the sales contracts specify a contractual point

of delivery that is within Oregon, typically at a substation

that is part of a large transmission system. The electricity

delivered in such cases is further transmitted to users, most

of whom are not in Oregon.

The court finds as a matter of fact, based on the tes-

timony and other record made in this case, that the majority

of the costs incurred by taxpayer in carrying on the income

producing activity of its wholesale electricity sales business

are incurred in British Columbia. That record includes evi-

dence from taxpayer as to direct costs incurred in British

Columbia in connection with the sales in question and an

absence of evidence from Defendant Department of Revenue

(the department) that direct costs of performance of the

transactions giving rise to the transactions in question

occurred at any other location.

Taxpayer also sells natural gas at wholesale. Again,

the contractual delivery point for some of those sales is in

Oregon. However, the record establishes that none of the

actual purchasers of natural gas sold by taxpayer are located

in Oregon. Rather, the natural gas is sold by taxpayer and

further transmitted from the contractual point of delivery to

the ultimate user.

The department has asserted that the revenues

from the electricity sales of taxpayer are sales of tangible

personal property. If that is the case, the revenues from such

sales could be sourced in Oregon and included in the numer-

ator of the Oregon sales factor used for apportionment of

the income of taxpayer depending on the application of other

statutory rules relating to the location of the purchaser. See

ORS 314.665(2).1

1

All references to the Oregon Revised Statutes (ORS) are to the 2001 edition.

32 Powerex Corp. II v. Dept. of Rev.

Taxpayer argues that electricity is other than tan-

gible personal property. Based on that position, taxpayer

further argues that because the greatest portion of the

costs of the income producing activity related to the sales of

electricity are incurred at its office and trading location in

Canada, the revenue from the sales of electricity cannot be

sourced in Oregon under ORS 314.665(4).

Taxpayer accepts the conclusion of the department

that natural gas is tangible personal property. However, as

to the natural gas, taxpayer points out that all purchasers

of such gas involved in this case are located outside the state

of Oregon. The record does not disclose directly whether the

purchasers are the ultimate end users of the gas covered

by the sales agreements. However, the record supports an

inference that those who purchase gas from taxpayer sell

the gas on to others. Taxpayer argues that because the

location of its purchaser is outside Oregon, its sales of gas

cannot be considered to have occurred in this state under

ORS 314.665(2).

III. ISSUES

Given the finding of the court as to the proportion

of the income producing activity occurring in Oregon with

respect to taxpayer’s sales of electricity, the issues for deci-

sion are:

(1) Is the sale of electricity the sale of tangible personal

property or a sale other than a sale of tangible personal

property?

(2) Are taxpayer’s sales of natural gas made in Oregon

or at the location of the ultimate user of the natural gas?

If, but only if, electricity is tangible personal property, the

same issue exists as to taxpayer’s sales of electricity.

IV. ANALYSIS

The trial in this matter was very interesting, pri-

marily because of the testimony of two distinguished phys-

icists regarding the nature of electricity, a question which

has engaged scientists for over 100 years and which, accord-

ing to the department’s expert witness, is not yet resolved.

Cite as 21 OTR 30 (2012) 33

The nature of electricity is of interest here because

of the wording of the Uniform Division of Income for Tax

Purposes Act (UDITPA), a statute drafted in the second

half of the twentieth century and adopted in Oregon shortly

afterwards.2 The nature of electricity is important here only

because UDITPA distinguishes between sales of tangible

personal property and all other sales.

For sales of tangible personal property, the reve-

nue from the sale is sourced to Oregon in all cases where

the property is delivered or shipped to a purchaser within

Oregon. ORS 314.665(2). For all other sales, revenue is

sourced to Oregon only when a greater proportion of the

income producing activity associated with the sale is per-

formed in Oregon than in any other state. ORS 314.665(4).

As noted above, the court finds that the greatest proportion

of income producing activity related to the sales of electric-

ity at issue here occurs in Canada.

The court is of the opinion that the proper resolution

of the first issue in this case, the nature of electricity, is to

be informed by the testimony of the experts as to the nature

of electricity, the position of the Multistate Tax Commission

(MTC) for the years at issue here and the decisions of tribu-

nals in other states that have adopted UDITPA.

A. The Nature of Electricity

The testimony of the experts is relevant to a con-

sideration of the statutory language regarding “tangible

personal property,” that is “delivered or shipped” without

regard to the “f.o.b. point or other conditions of the sale.”

ORS 314.665(2). Tangible personal property must be not

only “property” but also “tangible” and subject to being

“delivered or shipped,” and potentially be loaded “free on

board.”

The testimony of taxpayer’s expert witness sup-

ports a finding that electricity does not involve the trans-

fer of something that is tangible or a “thing” that is deliv-

ered to a purchaser. Rather, according to that testimony,

the transmission of electricity involves transmission of a

2

Oregon’s version of UDITPA is codified at ORS 314.605 to 314.675.

34 Powerex Corp. II v. Dept. of Rev.

force occurring by reason of the operation of “virtual pho-

tons,” which have no mass. Importantly, the testimony of

taxpayer’s expert established, and the department’s witness

agreed, that the sale of electricity is not the transfer of elec-

trons from the seller to the buyer. There are as many elec-

trons in the relevant system after the point of transmission

of energy to the purchaser as before.

The expert witness for the department did not con-

test any of the conclusions or positions of the expert witness

for taxpayer. Rather, the witness for the department simply

opined that taxpayer’s witness had chosen the wrong level

of description for the problem at hand. This expert merely

concluded that the question was to be differently analyzed

when considering sales of electricity on the power grid—his

viewpoint—as opposed to the level of particle physics—the

viewpoint of the expert for taxpayer.

The problem with the approach of the witness for

the department is that there is no indication in the statute

that the answer to the question of whether a sale is of tangi-

ble property changes depending on the level of analysis. The

court therefore can give no credit to the ultimate conclusion

of the witness for the department. However, because the wit-

ness for the department agreed with the scientific analysis

of the witness for taxpayer, the court concludes that on this

score taxpayer has prevailed on the question of whether,

more probably than not, the sale of electricity is a sale other

than one of tangible personal property.3 The court concludes

that in selling electricity, a seller provides to the purchaser

a force and not an item of property.

The court also considers it important that the dis-

cussion by the experts of the nature of electricity reveals

that the characteristics of electricity do not fit at all well

into the general framework found in ORS 314.665(2).

Recall that this statute talks of property that is “delivered

or shipped.” The statute also contemplates that the prop-

erty is of a type as to which a shipping term of “f.o.b.” could

be applied. Finally, paragraph (b) of subsection (2) of ORS

3

“More probably than not” may be the best anyone can do on these funda-

mental questions as to the nature of the world and the matter and forces found in

this world.

Cite as 21 OTR 30 (2012) 35

314.665 addresses property that could be shipped “from an

office, store, warehouse, factory, or other place of storage in

this state.”

Although it may go too far to conclude that all tan-

gible personal property must be capable of being shipped

from such locations, this language is used in a way that

suggests that the tangible personal property with which the

subsection is concerned would be capable of such shipment

from such a location. The court cannot comfortably imag-

ine shipping electricity “f.o.b.” or otherwise from any of the

locations mentioned in the statute. Nor did the testimony

of either expert witness in this case suggest that electricity

could be considered to be of such a character. The conclusion

that taxpayer’s expert established is that electricity is a phe-

nomenon in which virtual photons transmit force—not mat-

ter. Transmitters of force with no mass do not, in the opinion

of the court, come within the legislative understanding of

tangible personal property.

B. Position of the MTC

The treatment of gross receipts in the sales fac-

tor is, of course, a function of the provisions of UDITPA as

adopted in Oregon. As such, courts in Oregon pay particu-

lar attention to the views of the MTC and sister states that

have adopted provisions of UDITPA or are members of the

Multistate Tax Compact which itself contains the provisions

of UDITPA. Atlantic Richfield Co. v. Dept. of Rev., 300 Or

637, 717 P2d 613, on rehearing, 301 Or 242, 722 P2d 727

(1986); Twentieth Century-Fox Film v. Dept. of Rev., 299

Or 220, 700 P2d 1035 (1985). For the years at issue, the

MTC Corporation Income Tax Audit Procedures Guideline

Manual specified that electricity was to be treated as intan-

gible personal property. The department argues that the

MTC has altered its position to “neutral” on the matter. The

department relies for this position on material that is not

in the trial record and that, on its face, indicates that the

change may have only been proposed for discussion. The

behavior of the department in this regard is inconsistent

with both the rules of evidence by which it is bound and

basic principles of logic. For the years at issue a major insti-

tution in the effort to achieve uniformity among the states

36 Powerex Corp. II v. Dept. of Rev.

following UDITPA principles has accepted that electricity is

intangible in nature.

C. Case Law of Other UDITPA States

The question of the nature of electricity for purposes

of apportionment of income under UDITPA has only been

considered in two cases. Those cases are Appeal of PacifiCorp,

Cal St Bd of Equal, No 90027, 2002 Cal Tax LEXIS 469

(Sept 12, 2002) and EUA Ocean State Corporation et al., v.

Commissioner of Revenue, No C258405-406, 2006 Mass Tax

LEXIS 35 (Apr 24, 2006).

In PacifiCorp the tax administrative tribunal of

a state neighboring this one—one with a long history of

leading the way in issues of taxation of interstate business

operations—concluded that the sale of electricity was the sale

of a service and not the sale of tangible personal property.

The decision of the tribunal is well reasoned and included

consideration of testimony from the same expert witness

who appeared on behalf of the department in this case.4 The

court considers this opinion to be especially important as

well because the record in this case indicates that many of

the sales of electricity in the western United States occur in

the north-south corridor that includes the states of Oregon

and California. Consistency in treatment of electricity in

these two states is therefore of particular importance.

In EUA Ocean State, a tax tribunal of another

UDITPA state considered at length evidence very similar to

the evidence presented to this court and concluded, in a well

reasoned manner, that electricity was similar to heat, light

and sound and as such was not tangible. This conclusion is

consistent with the views of taxpayer’s expert witness on

the nature of electricity as a force conductor that transmits

energy to a purchaser as opposed to a “thing” with mass

that is transferred to a purchaser.

Cases from other jurisdictions have been cited to

the court. The department has also relied on a commercial

summary of the positions of states as to how electricity is

4

Indeed, the report of this witness presented in this case was essentially the

same report submitted in the PacifiCorp proceeding.

Cite as 21 OTR 30 (2012) 37

treated. There are obvious errors in this summary and the

department has not provided the court with detailed analysis

of the material in the summary or information that would

assist the court in determining the authoritative validity of

this summary.

Several cases upon which the department relies are

sales tax cases in which electricity is treated as subject to

tax. The department states its position as “a sale is a sale is

a sale.” The court declines to accept the department’s invita-

tion to decide important matters based on euphemistic con-

clusions based on no analysis or consideration of parallel tax-

ation regimes. It is enough to observe that a definition used in

determining the base for taxation cannot, without much more

than what the department provides, be used in the apportion-

ment of the base of a separate and distinct tax regime.

D. Conclusion as to Electricity

The record in this case fully supports the conclusion

that the sale of electricity is a sale other than a sale of tangi-

ble personal property. That conclusion rests not only on the

testimony and material submitted by the expert witnesses

as to the nature of electricity but also, given the positions

of the MTC and other UDITPA states, on considerations of

uniformity and consistency in the application of UDITPA

provisions to taxpayers generally and this taxpayer in

particular.5

E. Treatment of Sales of Natural Gas

The other issue presented in this case is the proper

treatment of receipts from the sale of natural gas in the

computation of the sales factor computation for taxpayer for

one of the years at issue. The parties agree that natural gas

5

The department has asserted that it has a long held administrative position

that electricity is tangible personal property. It is not clear that there is such a

long held policy and the attempts by the department to articulate that conclusion

have met with difficulties addressed in previous summary judgment proceedings

in this case. See Powerex Corp. v. Dept. of Rev., 20 OTR 338 (2011); Powerex Corp.

v. Dept. of Rev., TC No 4800 (Dec 17, 2010). In any case, the court’s conclusion

is based on the statute, the factual record in this case and the considerations

that must go into construing a uniform law. Even if the department had properly

articulated its position on this question, that position could not trump the conclu-

sion of this court based on the factors the court has considered.

38 Powerex Corp. II v. Dept. of Rev.

is tangible personal property. Therefore, the proper treat-

ment of the receipts from the sale of the natural gas depends

upon ORS 314.665 and its directive that receipts are Oregon

receipts when tangible personal property is “delivered or

shipped to a purchaser * * * within this state.”

The position of the department is that because the

contractual point of delivery of the natural gas in question is

a location in Oregon, the sales are Oregon sales for purposes

of computing the sales factor. Taxpayer points out that all

of the customers who purchase natural gas from taxpayer

are located in other states and do not use the natural gas in

Oregon. Taxpayer argues that the statute should be inter-

preted as employing an ultimate destination rule such that

the “interim” nature of what may be called delivery of the

natural gas to a contractually agreed upon point in Oregon

is not determinative.

The position of the department can be stated to be

that where delivery of tangible personal property is made

to a purchaser, the statute applies if the delivery point is in

Oregon. The focus of the department is on the place of deliv-

ery. The position of taxpayer can be stated to be that where

a purchaser is located outside Oregon, the statute dictates

that the sale is not an Oregon sale. The focus of taxpayer is

on the place where the purchaser is located.

For the year at issue, there is no question that the

purchaser under the contract is not located in Oregon. The

parties did not spend much effort in providing to the court

the details of the gas transactions. However, from the record

provided it appears that the gas in question is being trans-

mitted over interstate pipelines that are, or function as, com-

mon carriers. The delivery point under the sales contracts

in question is at a market center or hub that functions in an

overall coordinated transmission system for natural gas that

has developed in connection with changes in federal policy

regarding interstate gas transmission. The gas in question

is not consumed at the market hub point of delivery but is

transferred to an ultimate user in another location.

It appears that although the statutory provisions of

UDITPA have been construed by some states in the fashion

urged by the department and in some states in the fashion

Cite as 21 OTR 30 (2012) 39

urged by taxpayer, most courts that have addressed the

issue have adopted an ultimate destination rule rather than

a state of delivery rule. Jerome R. Hellerstein and Walter

Hellerstein, 1 State Taxation ¶ 9.18 [1][a]. In particular, in

cases where delivery by a seller is to a common carrier for

further shipment an ultimate destination approach is fol-

lowed.6 This is so even though the MTC takes the position

that a sale is completed at the delivery point, even though

the product is then subject to further shipment by the

purchaser.

The purpose of the sales factor in apportionment

is to recognize the contribution of the market state to the

income producing process. Hellerstein, 1 State Taxation at

¶ 8.06[2]. On the facts of this case that purpose is clearly

best served by looking beyond the point of contractual deliv-

ery where the purchaser is located in another state. This

is especially so in cases such as this one where the “deliv-

ery” is a transfer of title within a common carrier pipeline.

Applying an ultimate destination rule also will put Oregon

in the position of the majority of states that have had to

address the question under UDITPA. For these reasons,

the court is of the opinion that taxpayer prevails as to the

treatment of natural gas sales as well as with respect to the

nature of electricity.

In the opinion of the court, an ultimate destination

rule should be followed as to these sales of natural gas and

the position of the department must be rejected.

V. CONCLUSION

The taxpayer is entitled to the relief requested and

the deficiencies asserted by the department should be can-

celled with appropriate refunds to be paid in accordance

with law. Now, therefore,

IT IS THE DECISION OF THIS COURT that

Plaintiff’s appeal is granted.

6

See especially the concession of the Louisiana Department of Revenue in

Department of Revenue v. Parker Banana Co., 391 So 2d 762 (Fla Dist Ct App

1980) as to situations involving delivery to a common carrier, discussed in State

Taxation ¶ 9.18[1][a].