S/V Drilling Partners, Snyder Armclar Gas Company, Tax Matters Partner, Petitioner v. Commissioner of Internal Revenue, Respondent, 114 T.C. 83

OPINION Colvin, Judge: On August 3, 1998, respondent issued two notices of final partnership administrative adjustment to S/V Drilling Partners (S/V), a partnership, in which respondent determined adjustments to S/V’s partnership returns for the tax years ending December 31, 1993 and 1994. On August 18, 1998, Snyder Armclar Gas Co. (Snyder), S/V’s tax matters partner, petitioned the Court to redetermine respondent’s adjustments to partnership items. In 1993 and 1994, S/V sold 32,410 barrels of oil equivalent (boe’

s) of natural gas produced from nonconventional sources, consisting of 15,483 BOE’s of gas produced from a tight formation that was not Devonian shale and 16,927 boe’s of gas produced from both a tight formation and Devonian shale. The issue for decision is the amount of S/V’s

section 29 credit. We hold that S/V is allowed a

section 29 credit equal to (1) 15,483 times $3, and (2) 16,927 times $3 indexed as provided in the first sentence of

section 29(b)(2). Unless otherwise indicated,

section references are to the Internal Revenue Code in effect for the years in issue, and Rule references are to the Tax Court Rules of Practice and Procedure. Background The parties submitted this case fully stipulated under Rule 122. S/V’s principal place of business was Kittanning, Pennsylvania, when the petition was filed. A. S/V’s Natural Gas Production From a Tight Formation and Devonian Shale In 1992, S/V, a partnership composed of Snyder and Victory Energy Corp. (Victory), drilled eight natural gas wells in Armstrong and Indiana Counties, Pennsylvania.

In December of that year, Victory filed with the Pennsylvania Department of Environmental Resources (der) two classification requests for each well, seeking determinations that these wells produced natural gas from Devonian shale and from a tight formation. The requests were made under

section 503 of the Natural Gas Policy Act of 1978 (NGPA), Pub. L. 95-621, 92 Stat. 3350, 15 U.S.C. sec. 3413 (1988) (repealed January 1, 1993, by the Natural Gas Wellhead Decontrol Act of 1989, Pub. L. 101-60, sec. 3(b)(5), 103 Stat. 157, 159). der approved Victory’s requests and determined that the wells were producing natural gas from rock formations that qualified as both Devonian shale and a tight formation. The Federal Energy Regulatory Commission (ferc) approved DER’s determinations. In 1993 and 1994, S/V sold 32,410 BOE’s of natural gas produced from the wells to public utilities.

During these years, 15,483 BOE’s of natural gas sold by S/V were produced from a tight formation that was not Devonian shale, and 16,92.7 BOE’s were produced from a tight formation that was also Devonian shale. BOE’s of natural gas produced by S/V from nonconventional sources (rounded to the nearest BOE) Year Total Produced from a tight formation but not Devonian shale Produced from a tight formation and Devonian shale 1993 15,137 7,343 7,794 1994 17,273 8,140 9,133 Total 32,410 15,483 16,927 B. S ¡V’s Tax Returns On its 1993 and 1994 partnership returns, S/V claimed a credit under

section 29 for 15,483 boe’s of natural gas it produced from a tight formation that was not Devonian shale and a double credit (one equal to $3 per BOE, and one equal to $3 (indexed) per BOE) for the 16,927 boe’s produced from a tight formation that was also Devonian shale. On its 1994 tax return, S/V based its computation of the Devonian shale credit on the 1995 inflation adjustment factor. Discussion Petitioner contends that S/V is entitled to a credit under

section 29 for the 15,483 boe’s of natural gas it produced from a tight formation that was not Devonian shale and a double credit for the 16,927 BOE’s it produced from a tight formation that was also Devonian shale. Thus, petitioner, in effect, contends that S/V produced 49,337 BOE’s (i.e., 15,483 plus (2 x 16,927)) of gas qualifying for the credit under

section 29. Respondent contends that S/V is entitled to a credit for only 16,927 BOE’s of gas. Respondent contends that S/V is entitled only to the larger of:

(1) A $3 per barrel credit for the 32,410 BOE’s of natural gas S/V produced, or

(2) A credit for the 16,927 BOE’s of natural gas S/V produced from property qualifying both as a tight formation and Devonian shale, at a rate of $3, indexed as provided in the first sentence of

section 29(b)(2). Since the latter amount is larger than the former, respondent’s position, in effect, is that S/V is entitled to a credit based on only 16,927 BOE’s. We agree and disagree in part with both parties. A. Credit for the 15,483 BOE’s of Natural Gas S/V Produced From a Tight Formation That Was Not Devonian Shale S/V produced 15,483 BOE’s of natural gas from a tight formation which was not Devonian shale.

Section 29(b)(2) (second sentence) provides that the $3 credit is not indexed for natural gas produced from a tight formation. Thus, S/V is entitled to a credit of $3 per BOE on the 15,483 BOE’s of natural gas it produced from a tight formation that was not Devonian shale. B. Credit for the 16,927 BOE’s of Natural Gas S/V Produced From Both a Tight Formation and Devonian Shale

Section 29 S/V produced 16,927 BOE’s of fuel from a tight formation that was also Devonian shale.

Section 29(

a) limits the credit for producing fuel from a nonconventional source to a fixed dollar amount per BOE.

Section 29(d)(5) defines a BOE of fuel as fuel with Btu content of 5.8 million. The Senate committee report accompanying enactment of

section 29 also clearly limits the credit to $3 per barrel of oil equivalent (before any indexing for inflation). That report states in pertinent part that the credit: would be equal to $3 for the production of an amount of energy equivalent to that contained in a barrel of crude oil, and all energy equivalent measurements would be made on the basis of Btu content. Therefore, a $3 credit would be allowed for the production of 5.8 million Btu’s of energy. ‡ * % * ^ The credit would be $3 for the production of 5.8 million Btu’s * * * . [S.

Rept. 96-394, at 87, 89 (1979), 1980-3 C.B. 131, 205, 207.] Similarly, the conference report states in pertinent part that the “credit is $3 for the production of each unit of 5.8 million Btus of energy, the equivalent of one barrel of oil”. H. Conf. Rept. 96-817, at 140 (1980), 1980-3 C.B. 245, 300.

The Senate bill also provided a formula to determine the entitlement to the credit for taxpayers with a fractional interest in the property: Production from a property shall be attributed to the taxpayer for the taxable year in an amount which bears the same ratio to the total sales during such year of qualified fuels from such property as the amount of the taxpayer’s gross income from such property for such year from such sales bears to the aggregate gross income from such property for such year from such sales. [Crude Oil Windfall Profit Tax Act of 1979, H.R. 3919, 96th Cong., 1st Sess., sec. 251 (1979) (proposing new I.R.C. sec. 44D(3)(3)(A)).] Thus, the committee reports, as well as

section 29, show that Congress intended the credit to be based on the barrel of oil equivalent of fuels produced. 2. Petitioner’s Argument Petitioner contends that, under a literal reading of

section 29, S/V is entitled to a double credit for the 16,927 BOE’s of natural gas it produced from a tight formation and from Devonian shale. Petitioner acknowledges that the legislative history indicates that

section 29 provides a fixed credit amount (initially $3) per 5.8 million Btu’s of energy produced but contends that

section 29, as enacted, does not. Petitioner contends that neither

section 29 nor any other authority prohibits a double credit. We disagree. The credit under

section 29(

a) is $3 times the BOE of “qualified fuels”. (Emphasis added.)

Section 29(c)(1) provides that three fuels, i.e., oil, gas, and synthetic fuels, may qualify for the credit. Gas qualifies for the credit if it is produced from geopressurized brine, Devonian shale, coal seams, tight formation, or biomass. See sec. 29(c)(1)(B).

Section 29 does not create a separate tight formation credit and Devonian shale credit. The definition of BOE in

section 29(d)(5) provides a uniform means of calculating the quantity of each qualified fuel produced and sold. S/V produced and sold a total of 32,410 BOE’s of qualifying natural gas in the tax years at issue. Of this total, S/V produced and sold 16,927 BOE’s of gas from both a tight formation and Devonian shale. Since gas produced from those sources qualifies under

section 29(c)(1), S/V is entitled to claim a credit based on that 16,927 BOE’s of natural gas. A taxpayer may claim a

section 29 credit only for non-conventional fuel sold to an unrelated person during the taxable year. See sec. 29(a)(2)(A). This requirement suggests double credits are not allowed because a producer would not sell the same fuel twice. Similarly,

section 29(d)(5) defines BOE as an amount of fuel that contains 5.8 million Btu’s. This definition implies that double credits are not allowed for a BOE of fuel because the effect would be to give a credit for each 2.9 million Btu’s. Petitioner contends that the holding of True Oil Co. v. Commissioner, 170 F.3d 1294 (10th Cir. 1999), affg. Nielson-True Partnership v. Commissioner, 109 T.C. 112 (1997), is contrary to our conclusion. We disagree. True Oil Co. did not involve whether the taxpayer was entitled to a double credit.

Section 29(c)(2)(

A) provides that ferc, under NGPA, determines gas production classifications. We held in True Oil Co. v. Commissioner, supra, that FERC (not the taxpayer) must determine gas production classifications. Petitioner contends that our result is inconsistent with the NGPA and True Oil Co. v. Commissioner, supra. We disagree. We do not dispute that FERC determines gas production classification. Petitioner cites Priv. Ltr. Rul. 86-42-052 (July 21, 1986) for the proposition that the Commissioner has known for many years that gas production can qualify for more than one NGPA classification.

The fact that natural gas may qualify under more than one NGPA classification does not entitle S/V to a double credit under

section 29. Petitioner contends that Congress intended to provide multiple incentives for natural gas production. Despite this, we conclude that Congress did not provide double credits under

section 29 for the same natural gas. Petitioner contends that we must liberally construe

section 29, citing Miller v. Standard Nut Margarine Co., 284 U.S. 498, 501 (1932). We disagree. The U.S. Supreme Court stated in Standard Nut Margarine Co. that

definitions of things subject to be taxed may not be extended beyond their clear import. See id.

Section 29 does not define things subject to tax. The denial of double credits under

section 29 is consistent with the longstanding judicial preference for interpreting tax statutes, absent a clear declaration of congressional intent, not to allow double credits. See United States v. Skelly Oil Co., 394 U.S. 678 (1969); Charles Ilfeld Co. v. Hernandez, 292 U.S. 62 (1934); United Telecomms., Inc. v. Commissioner, 589 F.2d 1383 (10th Cir. 1978), affg. 67 T.C. 760 (1977) and 65 T.C. 278 (1975). 3. Respondent’s Argument Respondent contends that S/V is entitled to a credit under

section 29 equal to the larger of (a) $3 times 32,410 or (b) $3 (indexed) times 16,927. Respondent points out that

section 101(b)(5) of the NGPA of 1978 provided that if any natural gas qualified under more than one provision of the NGPA, the provision which allowed the highest price applied. S/V would be entitled to a larger credit if the credit were based on 16,927 times $3 (indexed) than if it were based on 32,410 times $3 (unindexed). Thus, respondent contends that allowing a credit based only on S/V’s gas production from Devonian shale is consistent with the NGPA. Respondent offers no explanation for the fact that under that theory S/V would, in effect, be entitled to a credit for only 16,927 BOE’s of gas.

We disagree with respondent and conclude that S/V is entitled to a credit for all of the qualified fuel that petitioner produced and sold; i.e., 32,410 BOE’s of gas. 4. Whether the $3 Credit for the 16,927 BOE’s of Natural Gas S/V Produced From a Tight Formation and Devonian Shale Is Indexed Under

Section 29(b)

(2) Section 29(b)(2) indexes the $3 credit for gas produced from Devonian shale, but it does not index the credit for gas produced from a tight formation. Since S/V produced 16,927 BOE’s of gas from both a tight formation and Devonian shale, question may arise whether the $3 should be indexed for that fuel. The parties did not brief this issue. The first of respondent’s two alternative positions is that S/V qualifies for a credit based on the 16,927 BOE’s of gas S/V produced from a source that was both Devonian shale and a tight formation at a rate of $3 (indexed).

It is inherent in that position that respondent accepts that the $3 credit is indexed for gas produced from both a tight formation and Devonian shale. Indeed, respondent has made no argument that the credit should not be indexed for the natural gas S/V produced from Devonian shale even though it was also from a tight formation. Under these circumstances, we consider respondent to have conceded this issue. See Askew v. United States, 680 F.2d 1206, 1208 n.2 (8th Cir. 1982); Levin v. Commissioner, 87 T.C. 698, 722-723 (1986), affd. 832 F.2d 403 (7th Cir. 1987); Zimmerman v. Commissioner, 67 T.C. 94, 104 n.7 (1976).

C. Conclusion We hold that petitioner is entitled to a credit of (1) $3 per BOE on 15,483 BOE’s of natural gas produced from a tight formation, and (2) $3 (indexed) per BOE on 16,927 BOE’s of natural gas produced from both Devonian shale and a tight formation, for a total of 32,410 BOE’s. To reflect concessions and the foregoing, Decision will be entered under Rule 155. Reviewed by the Court. Cohen, Chabot, Parr, Wells, Ruwe, Whalen, Beghe, Chiechi, Laro, Gale, Thornton, and Marvel, JJ., agree with this majority opinion. A barrel of oil contains about 5.8 million British thermal units (Btu’s). SEC. 29.

CREDIT FOR PRODUCING FUEL FROM A NONCONVENTIONAL SOURCE. (

a) Allowance of Credit. — There shall be allowed as a credit against the tax imposed by this

chapter for the taxable year an amount equal to— (1) $3, multiplied by (2) the barrel-of-oil equivalent of qualified fuels— (

A) sold by the taxpayer to an unrelated person during the taxable year, and (

B) the production of which is attributable to the taxpayer. (

b) Limitations and Adjustments.—

(2) Credit and phaseout adjustment based on inflation. — The $3 amount in subsection (

a) and the $23.50 and $6 amounts in paragraph (1) shall each be adjusted by multiplying such amount by the inflation adjustment factor for the calendar year in which the sale occurs. In the case of gas from a tight formation, the $3 amount in subsection (

a) shall not be adjusted. (

c) Definition of Qualified Fuels. — For purposes of this section—

(1) In GENERAL. — The term “qualified fuels” means— (

A) oil produced from shale and tar sands, (

B) gas produced from— (

i) geopressured brine, Devonian shale, coal seams, or a tight formation, or (ii) biomass, and (

C) liquid, gaseous, or solid synthetic fuels produced from coal (including lignite), including such fuels when used as feedstocks. :j: * sfc sji (

d) Other

Definitions and Special Rules — * * * s * * •&

(5) Bakrel-of-oil equivalent. — The term “barrel-of-oil equivalent” with respect to any fuel means that amount of such fuel which has a Btu content of 5.8 million * * *. In computing its credit for the 16,927 BOE’s of gas produced from both Devonian shale and a tight formation, petitioner used the 1995, rather than the 1994, inflation adjustment factor. See sec. 29(d)(2); I.R.S. Notice 96-29, 1996-1 C.B. 377; I.R.S. Notice 95-26, 1995-1 C.B. 305. Accordingly, petitioner overstated its 1994 credit for such gas by $639.