The Oregon Supreme Court has held that the sale of electricity constituted the sale of tangible personal property for Oregon corporation income tax apportionment purposes and should be sourced to the ultimate destination.¹ In making this determination, the Supreme Court reversed and remanded the Oregon Tax Court’s holding that the sale of electricity constituted the sale of an intangible that should be sourced using costs of performance (COP). However, the Supreme Court affirmed the Tax Court’s holding that the sale of natural gas (which was considered to be tangible personal property) was appropriately sourced based on the ultimate destination. Because the taxpayer delivered the natural gas to a “hub” in Oregon from which another company transported the gas to the purchaser’s out-of-state location, the natural gas sales were not sourced to Oregon.

Background

The taxpayer was a Canadian company that engaged in the business of selling natural gas and electricity at wholesale to purchasers throughout the western part of North America. The natural gas and electricity were initially delivered to hubs in Oregon but most of the electricity and all of the natural gas were ultimately destined to customers located outside the state. A majority of the COP associated with the electricity sales were incurred in Canada. For tax years ending March 31, 2002 through March 31, 2004, the taxpayer argued that the sales did not occur in Oregon for apportionment purposes, but the Oregon Department of Revenue argued that the sales should be sourced to Oregon.

In the Oregon Tax Court, the taxpayer and the Department agreed that natural gas is tangible personal property. However, they disagreed whether the taxpayer shipped or delivered natural gas to purchasers within Oregon. The Tax Court found that the taxpayer shipped gas to purchasers in other states through a hub in Oregon where two pipelines intersected. As a result, the Tax Court concluded that the taxpayer had not shipped or delivered gas to purchasers within Oregon. The taxpayer and the Department disagreed whether electricity is tangible personal property. After determining that electricity is not tangible personal property, the Tax Court ruled that the electricity sales should not be sourced to Oregon because the greater part of the income-producing activity occurred in Canada. Thus, the Tax Court ruled that neither the taxpayer’s sales of electricity nor its sales of natural gas occurred in Oregon. The Department challenged both rulings on appeal.

Sourcing of Sales

In 1965, Oregon adopted the Uniform Division of Income for Tax Purposes Act (UDITPA) to apportion income between states.² For purposes of the sales factor, the percentage of a multistate company’s sales within Oregon is used to determine the portion of the company’s business income that Oregon may tax.³ The rules for sourcing sales differ depending on the type of sale.⁴ Sales of tangible personal property are in Oregon if the property is “delivered or shipped” to a purchaser within Oregon without regard to the free on board (f.o.b.) location or other conditions of the sale.⁵ Sales, other than sales of tangible personal property, are sourced to Oregon if: (i) the income-producing activity is performed in Oregon; or (ii) the income-producing activity is performed both within and outside Oregon and the greater proportion of the income-producing activity is performed in Oregon than in any other state, based on COP.⁶

Natural Gas Sales Sourced to Ultimate Destination

The Oregon Supreme Court agreed with the Tax Court that natural gas constituted tangible personal property that should be sourced to the ultimate destination. Although the taxpayer delivered the natural gas to a hub in Oregon, the natural gas sales were not sourced to Oregon because the ultimate destination of the natural gas was to purchasers located outside the state. The Tax Court had determined that the gas was being transmitted through pipelines that functioned as common carriers. Because the ultimate destination of the sales at issue was California, the Tax Court concluded that the natural gas sales were not sales to a purchaser within Oregon.

On appeal, the Department argued against applying the ultimate-destination approach. The Department contended that the Oregon hub was critical for two reasons: (i) the taxpayer’s natural gas contracts specified the Oregon hub as the “contractual point of delivery;” and (ii) the contracts also specified that title passed to the purchaser at the Oregon hub. Based on these facts, the Department argued that the natural gas was delivered or shipped to the purchaser at the Oregon hub rather than in California.

In considering the Department’s argument, the Supreme Court initially examined the text, context and history of the tangible personal property sourcing statute. The Court explained that the statute, which was modeled on UDITPA, consists of two parts. The first part provides that sales of tangible personal property are in Oregon if the property is delivered or shipped to a purchaser within the state.⁷ The second part provides that the determination of where the property is shipped or delivered should be made without regard to the f.o.b. point or other conditions of the sale.⁸ The Court determined that the first part of the statute asks where the property is shipped or delivered to the purchaser.

The second part of the statute reinforces this interpretation by clarifying that the question of where the tangible property was shipped to the purchaser should not turn on legal technicalities such as the f.o.b. point. According to the Court, most authorities have acknowledged that the tangible personal property apportionment provision adopts an ultimate destination theory for sourcing sales.

The Court recognized that asking where property was shipped or delivered does not always provide a clear answer. For example, there are situations where a seller ships goods to a loading dock in one state where the purchaser picks them up and then transports them to an ultimate destination in another state. In this situation, it must be decided whether the goods were shipped to the purchaser in the first or second state. However, the Court did not feel compelled to take a position on this issue, relying on the Tax Court’s prior analysis on this issue. Because the Tax Court analogized the pipelines to be common carriers, the natural gas merely went from one common carrier to another at the Oregon hub on its way to the purchaser in California.

The Department unsuccessfully argued that the sales should be sourced to Oregon because the “contractual point of delivery” was in the state. After examining the relevant contracts, the Court determined that the “contractual point of delivery” served the same function as an f.o.b. point.⁹ Thus, the Department’s argument was based on the “other conditions of the sale” that the tangible property apportionment statute provides should be disregarded in determining where the property is delivered or shipped to the purchaser.

The Court rejected the Department’s arguments that its administrative rules supported sourcing the natural gas sales to Oregon. One of the rules provides that “[p]roperty is delivered or shipped to a purchaser within [Oregon] if the shipment terminates in [Oregon], even though the property is subsequently transferred by the purchaser to another state.”¹⁰ There was no support for the Department’s claim that the natural gas shipment actually “terminated” in Oregon. The Supreme Court also discounted a rule that was not effective until several years after the transactions at issue occurred. This rule provides that “[a] sale of tangible personal property . . . which is delivered or shipped to a purchaser with a contracted point of delivery in Oregon is a sale in this state.”¹¹ As explained by the Supreme Court, “contracted point of delivery” can have more than one meaning. Because the Department equated the term in this case with the f.o.b. point or other conditions of the sale, the rule is inconsistent with the apportionment statute as applied to gas sales.

Electricity Is Tangible Personal Property

The Supreme Court reversed the Tax Court and held that electricity is tangible personal property, consistent with the classification of natural gas. The Tax Court had previously determined that electricity was not tangible personal property and should be sourced using a COP approach. As a result, the Tax Court sourced all of the electricity sales to Canada and did not consider whether the electricity was shipped or delivered to purchasers in Oregon. The Tax Court based its determination on expert testimony discussing the physical properties of electricity.

In considering whether electricity is tangible personal property, the Oregon Supreme Court noted that the U.S. Supreme Court recently has explained that whether an object is “tangible” does not necessarily depend on physics or the object’s physical properties.¹² Instead, the determination depends on the context in which the legislature uses the word “tangible.” Accordingly, the Oregon Supreme Court considered the text, context and history of the Oregon apportionment statute before deciding whether the physical properties of electricity influenced the meaning of “tangible personal property.” Because UDITPA does not define the term, the Court considered the definitions provided by legal dictionaries. Based on these definitions, tangible personal property is perceptible to the senses and its physical features make it useful, but intangible property lacks “intrinsic or marketable value.” After examining the statute’s context, the Court concluded that: (i) tangible personal property is property that can be located physically within a state; and (ii) intangible property represents or symbolizes obligations and relationships to which the law gives effect. The legislative history did not provide any guidance on the issue.

With the text and context of the Oregon apportionment statute in mind, the Court considered whether electricity is tangible personal property for purposes of this statute. The Court discounted the expert testimony on the physical properties of electricity because the experts’ “approach to defining tangible personal property focuses on qualities that matter to physicists but not necessarily to lawyers and legislators.” Based on the text and context of UDITPA and the Oregon statute, the Court concluded that electricity is tangible personal property because it is perceptible to the senses, can be physically located in a state, can be shipped from one state to another and the physical properties of the electricity are what makes it valuable to the purchaser.

The taxpayer unsuccessfully argued that the Court should change its conclusion based on the UDITPA goal of uniformity among states. Two administrative decisions in other states that interpreted similar statutes ruled that electricity is not tangible personal property. The Oregon Supreme Court first considered the applicability of a California State Board of Equalization decision holding that electricity is not tangible personal property because the sale of electricity is the sale of a service.¹³ This ruling was based primarily on an Ohio Supreme Court decision holding that a distribution system for electricity was a service for product liability purposes.¹⁴ The Oregon Supreme Court determined that the California ruling was inapposite to the instant case. The Court then analyzed and rejected application of a Massachusetts Appellate Tax Board decision holding that electricity was not tangible property because it lacks physical form and concepts such as title, possession and delivery are difficult to determine for apportionment purposes.¹⁵

Despite the Court’s rejection of the two administrative rulings, the taxpayer argued that the Court should follow the rulings to achieve uniformity among the states that have adopted UDITPA. The Court noted that uniformity does not exist in this area of the law, because other state courts have held that electricity is tangible personal property.¹⁶ Based on a previous Oregon decision,¹⁷ the weight that should be given to the uniform application of UDITPA is a function of two variables: (i) the degree of certainty regarding the meaning of the statute that the Court is interpreting; and (ii) the degree of consensus that other states considering the same issue have reached. The Court was not swayed by these variables, continuing to hold that electricity is tangible personal property.

Finally, the Court disagreed with the taxpayer that it should defer to the version of the Multistate Tax Commission’s audit manual that was in effect for the relevant tax years. The audit manual provides that electricity is considered to be intangible property but does not explain the basis for this position. To the extent that the audit manual differed from the Court’s interpretation of the Oregon statute, the Court’s interpretation controlled.

Commentary

This case is significant because the Oregon Supreme Court reversed the Tax Court and held that electricity is tangible personal property for Oregon apportionment purposes. Because Oregon has adopted UDITPA, this decision may impact sellers of electricity in states beyond Oregon that have stayed silent on how to characterize electricity for corporation income tax purposes. Furthermore, this opinion clarifies the application of the ultimate-destination approach for sales of natural gas.

The Supreme Court remanded the case back to the Tax Court for further consideration, specifically to determine where to source the taxpayer’s electricity sales under the conception that electricity is tangible personal property. The remaining question is whether the taxpayer delivered or shipped the electricity to purchasers in Oregon or in other states. The Tax Court did not decide whether the transmission systems that carried the electricity functioned in the same manner as the natural gas pipelines. If the Tax Court finds on remand that the electricity transmission systems are the functional equivalent of common carriers, the Supreme Court’s conclusion regarding the natural gas sales presumably will control how much of the taxpayer’s electricity sales will be sourced to Oregon. However, if the Tax Court finds that the electricity hubs in Oregon functioned more like a loading dock, it will need to decide the position that Oregon will follow under UDITPA. It will be interesting to see how the Tax Court decides to source the taxpayer’s electricity sales.¹⁸

Note that the Department made significant changes to its rules after the tax years at issue in this case. In 2007, the Department amended the sales factor apportionment rule to include electricity within the definition of “tangible personal property”¹⁹ and promulgated a new rule to provide that the sourcing of electricity and natural gas sales is based on the contractual point of delivery rather than ultimate destination.²⁰ A sale occurs in Oregon if the electricity or natural gas is delivered or shipped to a purchaser with a contractual point of delivery in the state. These sales are sourced to Oregon regardless of whether the purchaser uses the property in Oregon, transfers the property to another state or resells the property in Oregon. As discussed above, the Court considered the rule’s “contracted point of delivery” language in its discussion of the sourcing of the natural gas sales. The Court explained that this language can have more than one meaning.²¹ The Department equated the “contacted point of delivery” with the f.o.b. point or other conditions of the sale. Because the apportionment statute provides that other conditions of the sale should not be considered when determining where tangible personal property is shipped or delivered to the purchaser, the Court determined that the rule, as applied to the natural gas sales, was “squarely inconsistent with the statute.”