Chevron USA, Inc.



The Taxpayer is an integrated petroleum company whose main operation in New Mexico is the sale of natural gas.  The Department conducted audits of the Taxpayer for tax years 2004, 2005 and 2006.  During the audit period the Taxpayer operated approximately 800 oil and gas wells in New Mexico and owned working interests in approximately 1700 additional oil and gas wells in New Mexico. The Taxpayer acquires rights to oil and gas property both by purchase and by lease.  The oil and gas leases provide for payment of royalties to the lessors of the oil and gas properties.  For purposes of calculating the Taxpayer’s property factor under the Uniform Division of Income for Tax Purposes Act, “UDITPA”, codified at §§ 7-4-1 to 7-4-21 NMSA 1978, the Taxpayer treated the royalties it pays lessors of oil and gas properties as rents.  Section 7-4-12 NMSA provides that property rented by a taxpayer is valued at eight times the net annual rental rate.  Regulation NMAC 3.5.12. C (1) broadly defines “annual rent” as “any amount payable for the use of real or tangible personal property…whether designated as a fixed sum of money or a percentage of sales, profits or otherwise”.  The Department’s auditors determined that the calculation of the value of the Taxpayer’s rented property should be adjusted to exclude all royalty payments by the Taxpayer to lessors of natural resource interests.  The Department’s auditors relied on Multistate tax Commission Regulation IV.11. (b), which excludes from the definition of “annual rent” royalties based on extraction of natural resources.  After adjusting the taxpayer’s property factor to disallow royalty payments from the valuation of the Taxpayer’s property, additional corporation income tax and interest was assessed for the years under audit.  The Taxpayer filed a timely written protest to the assessment and asserted that their calculations on the original returns were correct.  The sole issue was whether royalties paid to lessors of natural resources are rents for purposes of calculating the Taxpayer’s property factor.  The Hearing Officer found that there was case law from other jurisdictions to support both the Taxpayer’s argument that royalties can be considered rents and the Department’s argument that royalties are not rents.   The Hearing Officer also found that New Mexico had not adopted the Multistate Tax Commission Regulation which excludes royalties for the extraction of natural resources from the definition of annual rent.  The Hearing Officer found that royalties fall within the broadly worded definition of annual rent in regulation NMAC  The Hearing Officer also found that the Taxpayer’s method for calculating the value of its oil and gas leaseholds was reasonable because it produces a value which is equivalent to the value of the production from those properties.  For those reasons, the Taxpayer’s protest was granted.