Alliance Well Serv., Inc. v. Pratt Cnty.

61 Kan.App.2d 454

505 P.3d 757

ALLIANCE WELL SERVICE, INC., Amigos Well Service, Inc., and Redline Well Service, LLC, Appellants,

v.PRATT COUNTY, Kansas, Appellee.

No. 123,017

Court of Appeals of Kansas.

Opinion filed January 21, 2022.

John D. Beverlin II, of Stull, Beverlin, Nicolay & Haas, LLC, of Pratt, for appellants.

Trevor C. Wohlford, of Morris, Laing, Evans, Brock & Kennedy, Chartered, of Topeka, for appellee.

Shelley Woodard, of Legal Services Bureau, for amicus curiae Kansas Department of Revenue.

Before Green, P.J., Cline, J., and James L. Burgess, S.J.

Cline, J.:

Three oil and gas well servicers (Well Servicers) challenge Pratt County's classification of their mobile well service rigs as oil and gas property in tax years 2015 and 2016. They claim the rigs should be tax exempt under the "commercial and industrial machinery and equipment" (CIME) exception provided for in K.S.A. 79-223. They also argue the property valuation guidelines in the Kansas Oil and Gas Appraisal Guide (Guide) violate Kansas statutes and create an arbitrary and discriminatory tax classification that violates their right to equal protection under the law.

We find Pratt County properly taxed the rigs. Wells service rigs have been classified as oil and gas property since Kansas' property tax classification scheme was established by constitutional amendment and implemented in 1989. L. 1985, ch. 364, § 1 (effective January 1, 1989). Before the enactment of Article 11, section 1, such rigs were taxed as mineral leasehold property since at least 1965. The rigs are not CIME exception property, and the Guide does not violate Kansas statutes or the Constitution. Well Servicers have come to the wrong branch of government to seek redress. We affirm the district court's well-reasoned opinion.

FACTS

Well Servicers contract with oil and gas operators to provide services in connection with oil and gas well operations throughout Kansas. They are licensed and regulated by the Kansas Corporation Commission (KCC). Their principal place of business is Pratt County, Kansas. Collectively, Well Servicers possess 14 mobile well service rigs, also known as workover rigs. These rigs are used to perform services in Kansas oil and gas fields. The rigs are driven from location to location as needed to perform two types of services: (1) services through the wellbore mainly to influence the underground reservoir or formation and (2) services on the wellbore and related equipment. Well Servicers acquired 12 of the 14 rigs through bona fide transactions after June 30, 2006.

The first type of services—services through the wellbore mainly to influence the underground reservoir or formation—may be performed either during completion or recompletion of a well. Completion is preparing a well for commercial production with a wellhead and downhole tubing. Recompletion is reentering a well and redoing or repairing the original completion to restore or enhance the well's productivity.

During well completion, Well Servicers run tubing inside the cased wellbore and, if needed, they may run rods and insert pumping apparatuses. Well Servicers also pull and set tubing and equipment for production from new formations and plug or seal off depleted formations.

The second type of services—services on the wellbore and related equipment—consist of machine repairs, cleaning, and well stimulation. When performing such work, Well Servicers typically shut down production from the wells they are servicing and sometimes shut down production from the lease entirely.

Well Servicers also perform diagnostic oilfield well tests, well plugging services, and services in connection with observation wells, injection wells, and other wells that do not produce minerals. In the past, Well Servicers provided services in connection with drinking water wells, but such services did not occur during the tax years at issue.

Well Servicers' mobile service rigs are similar in use and character to rigs that were once dedicated to a single well location. Mobile service rigs became the industry standard in the 1950s. But some oil and gas companies still operate their own well service rigs and perform their own well service work rather than outsource the work to contractors (like Well Servicers).

Beyond Well Servicers' services and equipment, other contractors and equipment, such as seismic equipment, drilling rigs, backhoes, diagnostic equipment, downhole tools, and fishing tools, may be used to perform work during the various phases of an oil and gas project.

Property Tax Classification in Kansas Generally

Article 11, section 1 of the Kansas Constitution creates two general classes of property for tax assessment purposes. Class 1 consists of real property and Class 2 consists of tangible personal property. Kan. Const. art. 11, § 1. Class 2 property—tangible personal property—is divided into six subclasses with corresponding assessment rates:

Subclass	Description	Assessment Rate (percentage of value)
(1)	Mobile homes used for residential purposes.	11.5%
(2)	Mineral leasehold interests except oil leasehold interests the average daily production from which is five barrels or less, and natural gas leasehold interests the average daily production from which is 100 mcf or less, which shall be assessed at 25%.	30%
(3)	Public utility tangible personal property including inventories thereof, except railroad personal property including inventories thereof, which shall be assessed at the average rate all other commercial and industrial property is assessed.	33%
(4)	All categories of motor vehicles not defined and specifically valued and taxed pursuant to law enacted prior to January 1, 1985.	30%
(5)	Commercial and industrial machinery and equipment which, if its economic life is seven years or more, shall be valued at its retail cost when new less seven-year straight-line depreciation, or which, if its economic life is less than seven years, shall be valued at its retail cost when new less straight-line depreciation over its economic life, except that, the value so obtained for such property, notwithstanding its economic life and as long as such property is being used, shall not be less than 20% of the retail cost when new of such property.	25%
(6)	All other tangible personal property not otherwise specifically classified.	30%

Kan. Const. art. 11, § 1.

Property Tax Classification of Oil and Gas Property

K.S.A. 79-329 authorized the classification of Kansas oil and gas property as tangible personal property. The statute provides:

"For the purpose of valuation and taxation, all oil and gas leases and all oil and gas wells, producing or capable of producing oil or gas in paying quantities, together with all casing, tubing or other material therein, and all other equipment and material used in operating the oil or gas wells are hereby declared to be personal property and shall be assessed and taxed as such." K.S.A. 79-329.

Kansas law "requires oil and gas properties to be appraised uniformly and equally at fair market value. Toward that end, the law mandates county appraisers adhere to the Kansas Oil and Gas Appraisal Guide developed by the Kansas Department of Revenue's Property Valuation Division unless just cause is shown for deviation." In re Tax Appeal of River Rock Energy Company , 313 Kan. 936, 937-38, 492 P.3d 1157 (2021).

The Kansas Department of Revenue's Property Valuation Division (PVD), with advice and input from industry representatives and county appraisers, develops the Kansas Oil and Gas Appraisal Guide (the Guide) each year to help county appraisers value oil and gas properties for purposes of ad valorem property taxation. K.S.A. 79-5105a. The Guide does not list all equipment that may be used in connection with oil and gas well operations. Rather, it includes only a partial list of prevalent items used.

The Guide categorizes well service rigs according to engine size and hook load. The rig classification categories range from the 100 Series rig for shallow wells to the 500 series rig for deep wells. All series of rigs do essentially the same work; it is the depth of the well, and sometimes the well location, that determines which rig series is appropriate for a particular well servicing assignment.

For the tax years at issue in this appeal, Well Servicers listed and reported (rendered) the service rigs as Series 200 and Series 300 rigs. The Guide specifically identifies Series 200 and Series 300 rigs as " ‘[i]temized [e]quipment.’ " Itemized equipment is property located on the lease, in storage yards, or other sites which is not part of the producing " ‘prescribed’ " equipment.

Well service rigs have been classified as subclass 2 of section 2 oil and gas property since Kansas' property tax classification scheme was established by constitutional amendment and implemented in 1989. L. 1985, ch. 364, § 1 (effective January 1, 1989). Before the enactment of Article 11, section 1, Kansas property tax authorities have taxed well service rigs as mineral leasehold property since at least 1965.

Certain mobile equipment, or portions of equipment, used in Kansas oil and gas operations is not classified and taxed as subclass 2(2) oil and gas property. For example, Series 100 rigs do not include a truck/carrier value because the rig equipment typically can be separated from the chassis cab. The rig equipment on a Series 100 rig is taxed as subclass 2(2) oil and gas property, and the chassis cab is taxed as subclass 2(4) motor vehicle property. On the other hand, the values assigned to Series 200, 300, 400, and 500 rigs include a carrier value because the rig equipment and chassis cab are built as a single operating machine issued exclusively for serving, cleaning out, or drilling oil wells. For another example, diagnostic wireline equipment, consisting of data logging tools lowered on a truck-mounted wire, is classified as subclass 2(5) CIME property.

As discussed, oil and gas equipment is treated as tangible personal property for tax assessment...