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The Coal Creek Co. v. Anderson County

Court of Appeals of Tennessee, Knoxville

October 5, 2017

THE COAL CREEK COMPANY
v.
ANDERSON COUNTY, TENNESSEE, ET AL.

          Session August 10, 2017

         Appeal from the Chancery Court for Knox County No. 190298-1 John F. Weaver, Chancellor

         This appeal concerns whether a tax on certain property containing oil and gas deposits constitutes an unlawful additional severance tax. The Coal Creek Company ("Coal Creek") appealed the tax assessments of various county property assessors ("Assessors"). After administrative proceedings and appeals, the Tennessee Assessment Appeals Commission reinstated the original assessments. Coal Creek filed suit in the Chancery Court for Knox County ("the Trial Court") seeking judicial review of the Appeals Commission's decision. Following a bench trial, the Trial Court entered an order dismissing Coal Creek's complaint. Coal Creek appeals to this Court. We hold, inter alia, that the taxes assessed upon Coal Creek's property relative to oil and gas remaining in the ground are property taxes, not a severance tax. We affirm the judgment of the Trial Court.

         Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Chancery Court Affirmed; Case Remanded.

          Lewis S. Howard, Jr. and Erin J. Wallen, Knoxville, Tennessee, for the appellant, The Coal Creek Company.

          Robert T. Lee, Mt. Juliet, Tennessee, for the appellee, Anderson County, Tennessee.

          Joseph G. Coker, Jacksboro, Tennessee, for the appellee, Campbell County, Tennessee.

          Andrew N. Hall, Wartburg, Tennessee, for the appellee, Morgan County, Tennessee.

          John Sharpe, Assistant General Counsel for the appellee, Tennessee Division of Property Assessments.

          Herbert H. Slatery, III, Attorney General and Reporter, Andrée Sophia Blumstein, Solicitor General, and, Mary Ellen Knack, Senior Counsel, for the appellees, State Board of Equalization and Assessment Appeals Commission.

          D. MICHAEL SWINEY, C.J., delivered the opinion of the court, in which JOHN W. MCCLARTY and THOMAS R. FRIERSON, II, JJ., joined.

          OPINION

          D. MICHAEL SWINEY, CHIEF JUDGE.

         Background

         Coal Creek owns the subject real property in Anderson, Campbell, and Morgan Counties. This property contains oil and natural gas deposits, which Coal Creek also owns in fee simple. The majority of Coal Creek's oil and gas operations are centered in Anderson County, Tennessee. Coal Creek receives royalty payments from lessees who remove the oil and gas. This case has its origin in a 2009 change in how the Coal Creek property was classified for tax purposes. Before 2009, Coal Creek's property had been classified as farm property and assessed at a 25% rate. Beginning in 2009, the Assessors assessed the property's mineral value at the industrial or commercial rate of 40%. From 2009 through 2014, Coal Creek paid these additional taxes to Anderson County in the amount of $122, 742.59; Morgan County in the amount of $27, 408; and, Campbell County in the amount of $1, 662. The Tennessee Division of Property Assessments assisted the Assessors in their work valuing the mineral interests. An income approach was utilized in the valuations.

         Coal Creek appealed the assessments to the State Board of Equalization. In October 2013, Coal Creek filed a motion for summary judgment. In January 2014, the Administrative Judge entered an initial decision and order granting Coal Creek's motion for summary judgment. In finding for Coal Creek, the Administrative Judge stated in part:

The Administrative Judge finds that the Assessors' methodology for estimating the contributory value of the oil and gas reserves does not comport with Tenn. Code Ann. § 67-5-602(a) insofar as the dictates of the Assessment Manual have been ignored. For example, the portions of the depositions summarized or quoted above make clear that the Assessors have no knowledge of, and make no meaningful attempt to obtain, information concerning the quantity of the reserves and the remaining economic life of the reserves. Moreover, no attempt is made to obtain information from the operator concerning its plans, income from royalties etc.
***
The Assessors have absolutely no information to support the assumption that the prior year's production is a reliable indicator of future production. Indeed, if a producer chooses to cease production for a year in hopes that the price of oil and gas will increase, the Assessors would assign no value to the oil and gas reserves for the current year because of no production the prior year. This valuation method quite clearly results in nothing more than an additional severance tax on oil and gas production that is purported to be an ad valorem tax on property containing oil and gas reserves. Consequently, the Assessors' methodology for valuing the mineral component of subject parcels violates the prohibition in Tenn. Code Ann. § 60-1-301 against taxing oil and gas removed from the ground except for a severance tax as set forth in that statutory provision.[1]

(Footnote added). In February 2014, the Tennessee Division of Property Assessments, acting on behalf of the counties, appealed the Administrative Judge's decision to the Tennessee Assessment Appeals Commission. In April 2015, a hearing was conducted before the Appeals Comission.

         Keith Gibson, an area supervisor for the Tennessee Division of Property Assessments, testified regarding the methodology used in valuing mineral interests:

I've been with the Division for 32, 33 years, started doing the mineral valuation probably in 2006 or 7. I had done it previously years ago as a young staff member that basically just plugged in a few numbers but just kind of took over this aspect of it in 2007 or 8. Since that time, I have been promoted up to supervisor, the current position that I'm in. I have not been directly involved with these appraisals, but I oversee each and every one of them. Therefore, I have the most knowledge.
But what we're trying to do is, we contend that it's not a severance tax, that all we're doing is just valuing an income stream. If you take two like properties, exactly like Mr. Howard suggested awhile ago, where you have a property that does not have a known mineral reserve and then you have another one that does, all we're doing is just looking at the royalty that they received from that one year and then projecting a lifetime in saying, you know, what is that income stream worth over a period of time. If you receive $5, 000.00 one year and you're expecting to receive that for an additional five or six years, what is that worth today? So that's all we're trying to do as far as valuing an income stream. It's not a severance tax. It's just saying that if you have two exact properties and both were up for sale, you know, what would you prefer to have, one that you're going to receive a royalty check for the next duration period of time or would you rather have the other one that you don't have a known reserve?
We're very conservative whenever we make all these estimates. On coal, we receive the Office of Surface Mining Permit which has not only reserve studies, but they have projections on what they're to receive each year. We look at that. We only put an economic life up to their legal use. In other words, if that permit even said that they had a 20-year life on it, they don't have a legal use to permit it for 20 years. They only give a five-year permit; so we're very conservative on coal by using only that legal use of the property.
On oil and gas, there is no reserve studies. It's kind of a run-by-wildcat operation. It's a lot simpler for them to go out and do a test hold just to tap and see if there's any oil and gas. Even if there were reserve studies, it's very unreliable. I mean, you know, you may do different kinds of tests to try to find out what kind of oil and gas you have down there, but it doesn't mean it's feasible to get out. So we have a very conservative approach with that.
In 2014, the Division had a meeting with several members of the oil and gas members. There were attorneys, purchasers, producers. We had a meeting with them and they had the same thought process on why we use a five-year life and we don't reduce it each and every year, we just keep the five.
On cross-examination, Gibson testified as follows:
Q. So when you are taking the estimate of cash value annually of oil and gas reserves in the ground, that's just pure speculation, is it not?
A. Repeat the question.
Q. You don't have any idea what the reserves are that you're talking about, do you?
A. The remaining reserves?
Q. Yes, sir.
A. No, sir. We do not have a reserve study to follow.
Q. And the manuals don't allow you to assess based on speculation, do they?
A. The Mineral Manual that we have in this section details different observations that you have to make; so I feel like I've applied everything that I can. Yes, sir.
Q. Well, what have you applied? What have you done to determine the mineral reserves?
A. There's nothing that I can do without a mineral reserve study; so I guess
I did everything that I could do to make an assumption, which you make assumptions all the time in an appraisal.

         In June 2015, the Appeals Commission issued its final decision and order wherein it reinstated the original assessments. In its final decision and order, the Appeals Commission stated in part:

The tax here was duly levied by the counties as an ad valorem tax based on the determined value of the property, and demonstrated error in the value determination does not convert the levy to another form of tax. The boards of equalization may reject the value as unduly speculative, or just plain wrong, but the boards do not thereby avoid their duty to determine value using the most persuasive evidence available. In this case, as in the coal cases decided in years past, the only evidence came from the assessing authority. The owner of the mineral interest offered no measure of actual depletion for these properties, in fact no evidence at all pertinent to the properties' value.
The assessors offered the testimony of Keith Gibson, a staff appraiser employed by the Tennessee Division of Property Assessments, who explained there were no reserve studies available to the Division or taxing authorities, just annual data on production for oil and gas. He stated the implicit assumption of a five year remaining life for these interests is conservative based on their historic production which typically exceeds five years. Projecting the coming year production will equal the prior year is a neutral assumption, not unlike any income projection for commercial properties, and the assessor invites more accurate information from the property owners who are better positioned to estimate future production. Lacking more accurate information would not excuse the assessor from the responsibility of assessing the contributory value of proven mineral reserves.
Disproving the assessors' assumptions, or raising the likelihood that a more accurate value is possible, did not render the tax levy void, and did not meet the property owner's burden to establish a more credible value. Accordingly, the Commission finds and concludes the original assessments for these properties should be reinstated subject to the owners' rights of further appeal.

         In September 2015, Coal Creek filed a complaint in the Trial Court seeking judicial review of the Appeals Commission's decision. This matter was tried in January 2017. William S. Lyon, III ("Lyon"), executive vice president for Coal Creek, testified. Lyon testified, in pertinent part, as follows:

Q. When did -- well, how much property does The Coal Creek Company own and where is it located?
A. We own 72, 000 acres across four counties, being Campbell, Morgan,
Anderson, and Blount.
Q. And where are the majority of the gas and oil operations located?
A. Anderson County.
Q. And when was the first time that you, on behalf of The Coal Creek Company, became aware of the taxation of these mineral interests that we've been talking about here today?
A. 2009.
Q. And how did that -- how did you become aware of that taxation?
A. Well, we received tax notices that -- in the past, we always received tax notices on the value of the land. And then in 2009, there was a tax notice on the mineral interests.
Q. Was it a separate tax notice?
A. Yes.
Q. Did the valuation of the land change in regard to -- well, did the valuation of the land change when you started receiving these separate mineral notices?
A. No. It probably increased just a tad because of the reappraisal period, but no appreciable change.
Q. And has the same process been followed from 2009 through 2016?
A. Yes.
Q. Have you had any conversations with any of the assessors for Morgan, Campbell, or Anderson counties regarding any sort of allocation of how these taxes are allocated ...

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