LARRY W. WALTHER, IN HIS OFFICIAL CAPACITY AS DIRECTOR, ARKANSAS DEPARTMENT OF FINANCE AND ADMINISTRATION, APPELLANT
WEATHERFORD ARTIFICIAL LIFT SYSTEMS, INC., APPELLEE
This opinion is uncorrected and subject to revision before publication in the printed official reporter.
APPEAL FROM THE PULASKI COUNTY CIRCUIT COURT, SIXTH DIVISION. NO. 60CV11-3290. HONORABLE TIMOTHY DAVIS FOX, JUDGE.
Susan E. Nichols, Revenue Legal Counsel, for appellant.
Dover Dixon Horne PLLC, by: Michael G. Smith and Michael O. Parker, for appellee.
JOSEPHINE LINKER HART, Associate Justice. HANNAH, C.J., and DANIELSON and WYNNE, JJ., dissent. ROBIN F. WYNNE, Justice, dissenting.
JOSEPHINE LINKER HART,
Appellant, Larry W. Walther, in his official capacity as the Director of the Arkansas Department of Finance and Administration (ADFA), appeals from the order of the circuit court finding that " proppants" are " equipment" under Arkansas Code Annotated section 26-52-402 (Repl. 2014) and thus exempt from taxation. We affirm the circuit court's decision.
According to the circuit court's order, appellee Weatherford Artificial Lift Systems, Inc. (Weatherford) provided oil-field services that included hydraulic fracturing to the oil-and-gas production industry in Arkansas. The proppants, which according to the circuit court's order are granular substances used in extracting natural gas from unconventional natural-gas reservoirs such as the Fayetteville Shale in Arkansas, prevent rock fractures from closing when used in connection with the hydraulic fracturing of new natural-gas wells. ADFA conducted an excise-tax audit of Weatherford's purchases and sales for the period of October 1, 2006, through July 31, 2009. ADFA's assessment included $1,347,096.66 in gross-receipts tax and interest. Weatherford paid the entire amount, including additional interest accrued, and then brought this lawsuit to recover the amount paid. A trial was held to determine whether the proppants were exempt from the gross-receipts tax.
The circuit court entered judgment in favor of Weatherford. The court concluded that the proppants used by Weatherford are exempt because they constitute equipment as defined by the statutes and ADFA's own rules. Further, the circuit court found that ADFA's Gross Receipts Tax Rule GR-57(E)(5), which characterized proppants as nonexempt, was invalid and unenforceable as applied in this case because it was contrary to applicable statutes and cases, lacked a rational basis, violated the separation-of-powers provision of the Arkansas Constitution, was arbitrary and capricious, and exceeded the regulatory authority of ADFA. The circuit court concluded that Weatherford was entitled to judgment in the amount of $1,356,440.60, with interest.
ADFA appeals. For its first point on appeal, ADFA maintains that proppants do not constitute equipment. In sum, ADFA argues that proppants are not equipment because they are not complex tools or devices, with continuing utility, that are used directly in the process of extracting oil and gas, and further, proppants do not cause a recognizable and measurable mechanical or chemical action to take place as a necessary and integral part of manufacturing, without which oil-and-gas production would cease. ADFA's second point on appeal is that the circuit court erred in finding that Arkansas Gross Receipts Tax Rule GR-57(E)(5), which characterized proppants as nonexempt, was invalid and unenforceable as applied to this case.
Under our statutes, exempt from taxation are " [g]ross receipts or gross proceeds derived from the sale of tangible personal property consisting of machinery and equipment used directly in producing, manufacturing, fabricating, assembling, processing, finishing, or packaging of articles of commerce at manufacturing or processing plants or facilities in the State of Arkansas[.]" Ark. Code Ann. § 26-52-402(a)(1)(A). " Manufacturing" specifically includes the extraction of oil and gas. Ark. Code Ann. § 26-52-402(b)(4). The statute exempts " only the machinery and equipment as shall be used directly in the actual manufacturing or processing operation at any time from the initial stage when actual manufacturing or processing begins through the completion of the finished article of commerce and the packaging of the finished end product." Ark. Code Ann. § 26-52-402(c)(1)(A). Further, the word " directly" is " used to limit the exemption to only the machinery and equipment used in actual production during processing, fabricating, or assembling raw materials or semifinished materials into the form in which such personal property is to be sold in the commercial market." Ark. Code Ann. § 26-52-402(c)(1)(B). The statute further defines the phrase " used directly," as " [m]achinery and equipment used in actual production," including " machinery and equipment that meet all other applicable requirements and which cause a recognizable and measurable mechanical, chemical, electrical, or electronic action to take place as a necessary and integral part of manufacturing, the absence of which would cause the manufacturing operation to cease." Ark. Code Ann. § 26-52-402(c)(2)(A)(i). This court has noted that the word " equipment" has been referred to as an exceedingly elastic term, the meaning of which depends on context, and has stated, " In sum, we believe it is clear that the General Assembly, by the use of the terms machinery and equipment, intended implements, tools or devices of some degree of complexity and continuing utility." Ragland v. Dumas, 292 Ark. 515, 520, 732 S.W.2d 118, 120 (1987); see also Weiss v. Chem-Fab Corp., 336 Ark. 21, 26, 984 S.W.2d 395, 397-98 (1999) (same).
In its findings of fact, the circuit court concluded that the proppants at issue included silica-sand proppants, cured and uncured resin coated proppants, and ceramic proppants, and that all proppants were used in establishing new natural-gas wells in the Fayetteville Shale during the audit period. The circuit court further noted that these Fayetteville Shale wells were developed using modern horizontal-well and hydraulic-fracturing technologies that rely on the proppants in order for the wells to be productive.
The court stated that the proppants used by Weatherford were selected by it to conform to certain industry specifications and to meet the specific requirements of the type of reservoir involved. The circuit court further noted that hydraulic fracturing created fractures in the formation that surround the horizontal well bore, and that proppants are selected based on their ability to form proppant packs to hold the fractures open when the hydraulic-fracturing fluids are withdrawn and establish permanent channels through which natural gas flows from the unconventional natural-gas reservoir at the production site through the well bore to the ...