Chevron Pipeline Company and West Texas Gulf Pipeline Company v. Carole Keeton Strayhorn, Comptroller of Public Accounts of the State of Texas, and Greg Abbott, Attorney General of the State of Texas

Citation: Not availableDocket: 03-05-00449-CV

Court: Court of Appeals of Texas; October 26, 2006; Texas; State Appellate Court

Original Court Document: View Document

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The Texas Court of Appeals denied Chevron Pipeline Company and West Texas Gulf Pipeline Company's motion for rehearing regarding a tax liability determination made by the Comptroller for excavation and backfilling services, as well as for the installation of cathodic protection devices. Chevron argued that these services were non-taxable, claiming they fell under exceptions in the Comptroller's rules and Texas tax code. The court affirmed the district court's judgment, stating that the evidence did not support Chevron's claims. 

The Comptroller had assessed taxes against Chevron and West Texas Pipeline during specific audit periods, leading Chevron to seek a redetermination and refund after the Comptroller denied their requests. During the trial, Chevron's witnesses detailed the processes involved in pipeline repairs, emphasizing that excavation was essential for recoating underground pipelines and that excavation services were not performed independently from repair work. Additionally, testimony on cathodic protection clarified that it involved installing anodes away from the pipeline, which is integral to corrosion prevention. Overall, the court upheld the tax assessments, concluding the services provided were taxable under the relevant statutes.

Caskey testified that the pipelines involved had existing cathodic protection devices, and Chevron determined that additional devices were necessary. New holes or trenches were created for these installations while the existing devices remained in place. Caskey noted that the existing anodes would deplete over time, leading Chevron to monitor their condition every two months using rectifiers. When anodes reached the end of their life, new ground beds would be installed.

The court ultimately ruled in favor of the Comptroller, with Chevron seeking findings of fact and conclusions of law, which were issued on June 16, 2005. The court found that Chevron and West Texas were entitled to a refund for sales taxes incorrectly assessed on their purchases of cathodic protection installations, excavation, and backfilling services from third-party contractors. The amounts agreed upon were $184,678.48 for cathodic protection and $89,837.23 for excavation and backfilling. Chevron and West Texas did not contest the validity of Comptroller Rule 34 Tex. Admin. Code. 3.357, acknowledging their tax liability.

Further findings indicated that the cathodic protection installations constituted repairs or modifications to non-residential real property, which restored existing property to its original condition without adding new square footage. The court also determined that excavation and backfilling were essential for performing pipeline repairs and recoating, making these services taxable. Consequently, the trial court concluded that Chevron and West Texas were not entitled to a sales tax refund, leading to the current appeal.

Judicial review of tax refund suits initiated by taxpayers is conducted de novo, meaning the court re-examines the case as if no prior agency decision had occurred. This principle is established in Tex. Tax Code Ann. 112.054, 154 and further outlined in the Administrative Procedure Act (APA), which states that in a de novo trial, the reviewing court addresses all issues as in standard civil cases. In this instance, the trial court ruled in favor of the Comptroller after a de novo trial, supporting its decision with findings of fact and conclusions of law that carry the same weight as a jury verdict.

Chevron is appealing the trial court's legal conclusions regarding its liability for taxes on two specific issues: the taxability of the installation of cathodic protection devices and the excavation and backfilling services related to repair work. Chevron argues that the installation should be classified as non-taxable new construction rather than taxable repair or remodeling, and that the excavation services are non-taxable "unrelated services" under Comptroller Rule 3.357.

The Comptroller counters that the installations are considered taxable repairs and remodeling, and that the excavation services cannot be deemed unrelated. Chevron must demonstrate that no reasonable fact-finder could have determined its tax liability for these services. The tax code defines "real property repair and remodeling," which includes various forms of modifications to real property, and the Comptroller has exclusive jurisdiction over these determinations, as outlined in Tex. Tax Code Ann. 151.0047 and 151.0101. The Comptroller has also established Rule 3.357 to guide these classifications.

Chevron does not contest the legitimacy of Rule 3.357, which defines terms related to construction activities. New construction involves improvements to real property, including finishing additional floors before occupancy or adding usable square footage to an existing structure, such as new wings or mezzanines. Reallocation of existing space is classified as remodeling, which encompasses alterations that do not increase usable square footage, like changing room sizes or repurposing spaces. Remodeling also includes tasks post-initial finish out, such as repainting a unit before rental. Partial demolition is taxable remodeling, while complete demolition is neither remodeling nor modification and is not taxable.

Repair refers to restoring property to its original functioning state, with minor repairs exempt from taxation if they qualify as scheduled maintenance. Restoration aims to return deteriorated property to its original condition, with minor restorative actions classified as maintenance, not restoration. Chevron argues that the installation of cathodic protection devices constitutes new construction due to the addition of usable square footage. However, this interpretation is incorrect; the installation does not expand the existing pipeline's capacity and merely serves to prevent corrosion. Thus, it does not fulfill the criteria for new construction outlined in Rule 3.357.

Caskey indicated that the pipelines in question already had cathodic protection devices, with new anode ground beds installed by Chevron only when existing ones were deemed depleted or failing. The existing devices would remain for any residual protection. These remedial installations do not constitute "new construction" as defined by Rule 3.357, as they do not increase the usable square footage of the existing structure. This is likened to adding stadium lights to a field, which enhances use but does not expand the physical space. The court referenced GATX Terminals Corporation v. Rylander, asserting that Rule 3.357 implies more than simply adding new equipment. The evidence supports the trial court's conclusion that Chevron was liable for taxes related to these installations, as the existing devices remained in place, and the remedial actions merely upgraded or replaced them.

Chevron’s arguments citing other Comptroller decisions were dismissed, as those did not pertain to cathodic protection devices, and the Comptroller has consistently ruled that such installations do not qualify as non-taxable new construction. Therefore, Chevron's first issue was overruled. Regarding the second issue, Chevron contested the trial court's finding that excavation and backfilling services were not "unrelated services" and subject to taxation. Despite being non-taxable when provided independently, these services were determined to be taxable when purchased alongside taxable pipeline recoating services, which Chevron acknowledged as subject to tax.

Excavation and backfilling services are generally non-taxable when performed independently, as outlined in Tex. Tax Code Ann. 151.0101(a). The current dispute revolves around the tax treatment of these services when bundled with pipeline repair services. Rule 3.357 specifies that all entities involved in repairing nonresidential real property must collect taxes on the total sales price minus any separately stated charges for unrelated services. For a service to qualify as "unrelated" under Rule 3.357(a)(15), it must meet a three-prong test: it must not relate to the repair or restoration of nonresidential real property or any other taxable service, it should be commonly provided on a stand-alone basis, and its performance must be distinct and identifiable.

The parties concur that excavation and backfilling services are non-taxable; however, they dispute whether these services are commonly offered independently and if their performance is distinct. Chevron’s witness, Mark Hildebrand, testified that the excavation was conducted solely for the purpose of necessary repairs, indicating that there were no instances where Chevron contracted exclusively for excavation and backfilling services. Hildebrand confirmed that the contracts' primary purpose was repair and recoating, rather than stand-alone excavation and backfilling.

The trial court found sufficient evidence to conclude that the excavation and backfilling in question did not qualify as unrelated services under the rule. Chevron did not engage these services on a stand-alone basis, and Hildebrand's testimony reinforced that the excavation was part of a continuous process involving repair and recoating, not an independent task. Therefore, Chevron failed to meet the second and third prongs of the unrelated service test as per Rule 3.357(a)(15).

Hildebrand's testimony revealed that Chevron could not recoat its underground pipelines without conducting excavation and backfilling, and all related invoices included costs for both services alongside pipeline repair or recoating. Consequently, Chevron did not meet the third prong of Rule 3.357(a)(15). The evidence supports that excavation and backfilling were integral to the recoating process, rendering them indistinct and not "unrelated services" under the rule. Therefore, the trial court's findings that these services were necessary for repair and subject to tax were legally sufficient. Chevron's argument that excavation and backfilling could be categorized as non-taxable when itemized was rejected, aligning with the Comptroller's precedent that separate billing does not imply separate taxation. The trial court's judgment was affirmed based on the sufficiency of the evidence presented.