Iowa Supreme Court says ‘no’ to natural gas tax challenge

An ethanol plant that filed a lawsuit arguing Iowa's excise taxing system was unconstitutional did not prevail, writes Francina Dlouhy of Faegre Baker Daniels. Producers facing this issue would be best served by pushing for legislative reform.
By Francina Dlouhy | July 15, 2015

On April 10, 2015, the Iowa Supreme Court found that although the state’s excise tax on the delivery of natural gas “does not produce uniform results for taxpayers,” it is not unconstitutional because the legislature had “a rational basis for writing it the way it did.” In 1998, Iowa restructured its tax on natural gas providers. Before then, Iowa had taxed natural gas utility companies on the value of the property they owned in the area they serviced, i.e., an ad valorem property tax. The replacement taxing scheme imposes an excise tax on the delivery, consumption or use of natural gas.

Under that excise tax, the state is divided into 52 geographic areas, each with its own tax rate imposed on the number of therms delivered into that geographic district. Interstate pipelines are exempt from the tax, but the tax is imposed on state regulated utilities that remove natural gas from interstate pipelines and deliver it to customers. Utilities pass the tax on through the varying rates they charge customers.

The replacement tax is also imposed on consumers that directly connect and draw natural gas from interstate pipelines, treating a “direct connect” consumer as delivering the natural gas to itself. Ethanol plants (as well as any other plants that tap directly into interstate pipelines) pay the tax based on the amount of gas they consume using the rate prescribed for their location.

Little Sioux Corn Processors, a consumer of a substantial volume of natural gas, filed a lawsuit arguing the excise taxing system was unconstitutional because:

1. The varying tax rates for different geographic areas leads to disparate results for similar plants. Little Sioux compared itself to a biorefining plant located in Emmetsburg that is directly connected to the interstate pipeline. However, because the other plant is within the Emmetsburg district, which has a replacement tax rate of zero, it does not pay any tax. (The Court observed that the tax rate could be zero in many municipal districts.)

2. Plants that receive natural gas from state regulated utilities pay less tax per therm because the utilities often allocate the tax burden among customers, so that high-volume customers pay tax at the lower rate than imposed on a customer that directly connects with the interstate pipeline. Little Sioux argues that penalizes interstate commerce.

Even though the Court acknowledged that Little Sioux was paying a higher rate of tax on deliveries of natural gas than paid by other direct consumers in other districts in the state or purchasers from utilities, the Court refused to find that this amounted to unconstitutional discrimination under the United States Constitution or the Iowa Constitution, or that it violated the Commerce Clause of the United States Constitution. In a lengthy and strongly worded opinion, the Court found that because the intent of the replacement tax scheme was to protect individual customers from rate swings in tax bills and to provide stable revenue streams for local governments, the scheme was lawful.

The Court also rejected, in short order, the second argument that the utilities’ allocation of the tax burden discriminated against interstate commerce, saying that under the tax all therms delivered into a geographic area are taxed at the same rate.

This case reflects how difficult it is to bring a challenge to a taxing scheme on either state or federal equal protection grounds. For ethanol producers facing this issue, the best bet is pushing for legislative reform of a system that is clearly unfair yet surprisingly not unlawful. While the decision is bad news for Little Sioux, it certainly lays out several glaring disparities in the replacement tax scheme that could provide ammunition for arguing for legislative reform.

Author: Francina Dlouhy
Partner, Faegre Baker Daniels