Supreme Court reverses license tax assessment on Virginia mineral lands

When Wise County decided to impose a license tax on land with natural gas reserves, it was obligated to assess the property’s fair market value — which must include the gas reserves — the Supreme Court of Virginia ruled unanimously.

EQT Production Co. and Diversified Production, which subsequently purchased the Southwest Virginia property, applied for tax relief after the county levied taxes on gas wells but not the gas reserves on the property, pursuant to Va. Code § 58.1-3286.

The state’s high court ruled that Wise County needed to assess the land’s value pursuant to all three subdivisions in the code before imposing a license tax under Va. Code § 58.1-3712(A).

Wise County levied taxes on the gas wells for tax years 2018, 2019 and 2020. EQT and Diversified Production argued that the county failed by only valuing the improvements on the land, such as well infrastructure, but not the gas reserves, because the tax was levied under Va. Code § 58.1-3712(A).

Both the trial court and the Court of Appeals affirmed the tax assessments. The taxpayers appealed, though, and the state’s highest court reversed the lower courts’ rulings.

“As the County opted to impose a license tax under Code § 58.1-3712(A), it was obligated to assess the fair market value of the mineral lands pursuant to all three subdivisions in Code § 58.3286,” Chief Justice Cleo E. Powell wrote. “As the record establishes that the County failed to assess a critical component of the fair market value analysis without being statutorily excused, its assessment of the Taxpayer’s property was incomplete and, therefore, plainly wrong.”

The 12-page opinion is EQT Production Co. v. County of Wise, Virginia (VLW 026-6-026).

Neither Stephen M. Hodges of PennStuart in Abingdon, who represented the taxpayers, nor Roanoke attorney Harwell M. Darby Jr. of Glenn
Feldmann Darby & Goodlatte, who represented the county, responded to requests for comment.

Tax assessments

The property at issue consists of 578 gas wells, 187.7 miles of gas pipelines and 14 gas compressors at eight stations.

To calculate the tax, the county assessed the fair market value of the gas wells using the cost approach method of appraisal. The county valued the lands at $134,329,600 for the 2018 and 2019 tax years and $104,573,100 for the 2020 tax year.

When the taxpayers applied for relief, they argued that the county erred by relying on only one valuation approach — the cost approach — and failed to consider and properly reject the income or market approach.

At trial, the taxpayers’ expert testified that the preferred method for valuing assets in the oil and gas industry is the income approach, which he used to value the lands at $32,898,000 for 2018, $22,234,000 for 2019 and $27,212,000 for 2020.

The trial court affirmed the tax assessments.

Although the issue was not raised in the trial court, the parties agreed in their briefing to the Court of Appeals that the county levied a Va. Code § 58.1-3712 tax but disagreed on whether imposing a tax pursuant to Va. Code § 58.1-3712 excused the county from assessing the gas reverses under
Va. Code § 58.1-3286.

The state Court of Appeals affirmed the trial court, and the taxpayers appealed.

How to tax mineral lands

The Virginia General Assembly established a tax assessment framework for mineral lands through Va. Code § 58.1-3286, which requires counties to “specially and separately assess at the fair market value all mineral lands and the improvements thereon,” the court explained.

When assessing mineral lands under state code, a county must assess three parts of the property: the area and the fair market value of such portion of each tract as is improved and under development; the fair market value of the improvements upon each tract; and the area and fair market value of such portion of each tract not under development.

The legislature did provide an exception to assessments under the first subdivision, however, if a county chooses to impose by ordinance a severance tax.

In contrast, Va. Code § 58.1-3712(A) allows a locality to “levy a license tax on every person engaging in the business of severing gases from the earth.”

“Thus, if a locality chooses to impose a license tax under Code § 58.1-3712(A), it must forego the severance tax under paragraph 4 of Code § 58.1-3286 and the corresponding exception to assessments under subdivision 1,” the court wrote. “In so doing, the locality would also be required to assess the fair market value of mineral lands using all of the applicable subdivisions, including subdivision 1.”

The court emphasized that the specific nature of the taxes imposed by the statutes was “demonstrably different.” A severance tax is a tax imposed on the value of oil, gas, timber or other natural resources extracted from the earth, while with a license tax, “‘it is the privilege or franchise itself which is being taxed, and not the items by which the tax is measured.’ … It is the privilege of being in the business of severing gases from the earth that is being taxed, as opposed to the property tax imposed under Code § 58.1-3286.”

Three taxing options

The fact that the severance tax under paragraph four of Va. Code § 58.1-3286 and the license tax under Va. Code § 58.1-3712 are mutually exclusive of each is dispositive, the court said.

Therefore, the state legislature permitted three different avenues for localities to tax mineral lands: They can directly assess the fair market value of the entire property pursuant to subdivisions one through three of Va. Code § 58.1-3286; levy a severance tax pursuant to paragraph four; or levy a license tax pursuant to Va. Code § 58.1-3712(A) and directly assess the fair market value of the entire property pursuant to subdivisions one through three of Va. Code § 58.1-3286.

As the county opted to impose a license tax under Va. Code § 58.1-3712(A), it was required to assess the fair market value of the mineral lands pursuant to all three subdivisions in Va. Code § 58.1-3286, the court held, and since the county did not do so, the tax assessment of the taxpayers’ property was incorrect.

The court reversed and remanded.

EQT Production Co. v. County of Wise, Virginia

ISSUE           When a county opts to impose a license tax under Va. Code § 58.1-3712(A), is it obligated to assess the fair market value of mineral lands pursuant to all three subdivisions in Va. Code § 58.1-3286?

Answer      Yes (Supreme Court of Virginia)

Attorneys  Stephen M. Hodges, PennStuart, Abingdon (plaintiff); Harwell M. Darby Jr., Glenn Feldmann Darby & Goodlatte, Roanoke (defendant)