COURTNEY JENKINS BRENDAN R. BEATTY Special Assistant Attorneys General MONTANA DEPARTMENT OF REVENUE Legal Services Office 125 North Roberts Street PO Box 7701 Helena, MT 59604-7701 Phone: (406)444-5849; (406) 444-1602 Attorneys for the Department MONTANA FIRST JUDICIAL DISTRICT COURT, LEWIS CLARK COUNTY CLOUD PEAK ENERGY RESOURCES, LLC, Plaintiff, vs. STATE OF MONTANA DEPARTMENT OF REVENUE, Defendant. Cause No.: BDV-2012-239 Jeffrey M. Sherlock Presiding Judge MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR RESPONSE TO CLOUD CROSS-MOTION FOR SUMMARY JUDGMENT ON COUNT I Defendant, Montana Department of Revenue (Department), appears now and files this Reply in Support of its Motion for Summary Judgment on Counts I and Ill and its Response to Cloud Peak Energy Resources, LLC's (CPE) Cross Motion for Summary Judgment on Count I. DISCUSSION A. Declaratory Judgment The parties agree that this matter is properly before this Court as a Declaratory Judgment action pursuant to 15-1-406, MCA. B. Statutory Framework for NAL Coal Sales It is undisputed that 15-35-107, MCA, permits the Department to impute a value to coal only under certain circumstances. It provides: When value of coal may be imputed -- procedure. (1) The department may or shall at the request of the taxpayer impute a value to the coal which 'approximates market value f.o.b. mine in a case where: a person sells coal under a contract which is not an arm's--length agreement[.] Section 15-35-107, MCA (2005). The parties agree that pursuant to this section, the Department must meet a two- part standard in order to impute a value to the coal. It must determine that the contract price does not represent an arm's length agreement and that the transaction is less than market value. Section 15-35-107, Decker Coal Company v. Dep't of Revenue, 2000 MT 125, 299 Mont 477, 2 P.3d 245 (2000). CPE's Brief and supporting documents are replete with the admission that the parties also agree that many of the NAL contracts at issue meet both parts of the above test. See, Atf. St. John; CPE Brief at 16. C. A Prevailing Market and Economic Conditions at the Time of Sale As demonstrated by the parties' briefs, the only relevant Montana case involving imputed coal revenues for purposes of coal severance, gross proceeds and Resource MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR 2 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT I Indemnity Trust tax, is Decker Coal v. Department of Revenue. CPE, in advancing its incorrect argument that the Department failed to consider the proper time frames of comparable arm's length coal sales, misrepresents to this Court what the Montana Supreme Court held in that case. Notwithstanding misrepresentations concerning it, the parties agree that Decker Coal is controlling in the dispute at bar. Application of Decker Coal requires an understanding that the contracts at issue were |ong--term coal contracts entered into in 1974 and running into the 19903, with pre-determined price escalators established in 1974 that "were not designed to closely follow changes in the market price for coal, however defined." Decker Coal, 1111 5, 6, 33, 37. The taxpayer sold certain coal from its Decker mine to an affiliated entity through NAL contracts at per ton, who then sold that same coal to an unrelated third party for $24-$28 per ton. The Department imputed a value to the coal sold under the NAL contracts for the $24-$28 per ton, arguing that because theactual coal was sold for the higher figures, that represented "market value" pursuant to 15-35-107, MCA. In holding that the $24-$28 per ton did not represent "market value'' the Court concluded that long--term contract prices, when implemented according to predetermined price escalators do not represent a market value "at the time of sale." Decker Coal, 11 37. It further held that "market value" pursuant to 15-35-107, MCA, requires the Department to find a "representative market" for the NAL sales that "reflects market value 'at the time of sale. Decker Coal, 11 41 (emphasis added). The instant case is similar to Decker Coal because the contracts at issue are undisputedly non arm's length contracts. This matter differs from Decker Coal in that MDOR REPLY TO FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 3 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT I none of the NAL contracts or any of the arm's length contracts used by the Department as comparable sales in its imputation of market value are long-term contracts with pre- determined escalators. lnstead, it is undisputed that the Department arrived at an imputed price for the NAL coal sales by comparing CPE's invoice logs for coal sold each month under arm's length contracts with the NAL sales. The Department further narrowed its comparable sales by comparing only those sales of similar volume and quality to those of the NAL sales. In a nutshell, the Department imputed a market value for NAL sales "at the time of sale'' by comparing average values of arm's length sales of similar volumes of similar quality coal sold from the same mine each month of the audit period. Thus, similar volumes and quality of the "same coal, same hole" sold in the same month were the comparable sales used to determine the imputed market value. MDOR Exhibit 7 - Baerlocher Deposition, p. 49, I. 18. Contrary to CPE's representations to this Court, the Decker Coal Court held only that market value, as required by 15-35-107, MCA, "refers to the price that a willing buyer would pay to a willing seller under the market and economic conditions at the time of the sale." Decker Coal, Ti 32 (emphasis added). it concluded in that case that the appellant demonstrated market value with a report documenting "coa| sales from 1986-1988." Decker Coal, 1] 32. The audit period at issue in Decker was 1986-1988. In so concluding, the Court stated that "[b]oth logic and law dictate that the assessment be based upon market value at the time of the sale." Decker Coal, 1] 38. In Decker Coal, therefore, the relevant period of time for examining the time of sale represented sales occurring in the 1986-1988 period. Decker Coal, 1] 37 (stating . . the price at MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR 4 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT I which coal is sold under the long-term contracts is determined at or near the time of sale.") CPE misrepresents the Decker Coal Court's holdings in its statements that "a compliant methodology must take into account 'both short term (spot market) contracts and long term contracts negotiated in the same time frame as' the NAL contracts at and "imputation must be based on . . . both short term (spot market) contracts and long term contracts negotiated in the same time frame as Decker's 1986-1988 contracts." CPE Brief at 9-10 (citing Decker Coal, 1] 31). Even a cursory examination of Decker Coafs paragraph 31 clearly demonstrates that it was simply the Court's recitation of those sales that the appellant's expert witness considered to form his opinion of value. The Court's only holding in 1] 31 was that the record demonstrated that the prices paid to the appellant "met or exceeded market value . . . the price that a willing buyer would pay to a willing seller under market and economic conditions at the time of the sale.'' Decker Coal, 1] 31. The fact that the appellant's expert witness considered spot market contracts and long term contracts negotiated in the same time frame as the years of the audit period did not result in a holding that both are required to lmpute a value in any other case and therefore does not translate into the holding represented by CPE. The Decker Coal Court recognized that the time of sale, rather than negotiation date, is pertinent because the price of coal under long term contracts is not determined until the actual sale. Decker Coal, 1] 37. Obviously, the Court was discussing long term coal contracts, but the fact that the price of coal is not determined until the actual sale under shorter term contracts is exactly the same. See, CPE Exhibit I. This point is REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 5 RESPONSE TO CLOUD CROSS-MOTION FOR SUMMARY JUDGMENT ON COUNT I "clearly reflected in the applicable statutes. The taxes at issue are severance taxes, and are not attached until the coal is "extracted and prepared for shipment." Sections 15- 32-102(5) and MCA (2005). Contrary to CPE's contention, which incorrectly argues that the negotiation date of the contract is the "time of sale," the statute and Decker Coal clearly demonstrate that the price of coal at the "time of sale" is the sales price of the coal when it is "extracted and prepared for shipment." Interestingly, CPE's Exhibit I clearly indicates that the arm's length contract prices change reflecting the current market, while the NAL contracts at issue remain the same. CPE Exhibit I. Pursuant to 15-35--107, MCA, and Decker Coal, the Department properly utilized the arm's length sales prices of similar volumes and quality of coal sold by CPE each month as comparable sales of coal for imputing the value of CPE's NAL sales. Decker Coal, when read in context of and MCA, undoubtedly demonstrates that "time of sale'' is the time the coal is sold, not the date of contract negotiation when the contracts at issue are not long--term coal supply contracts. CPE's misrepresentations of the applicable law must be rejected, and the Department's methodology must be affirmed. D. The Department's Methodology is Proper CPE incorrectly asserts to this Court that the Department's methodology for imputing the NAL coal sales value is improper. As discussed above, the Department properly utilized arm's length coal prices for similar volumes and quality coal sold by CPE from the actual "time of sale" as comparable sales of coal for imputing the value of CPE's NAL coal sales. "Market value" pursuant to 15-35-107, MCA, requires the Department to find a "representative market" for the NAL sales that "reflects market MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 6 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT I value 'at the time of sale.'" Decker Coal, 'll 41 (emphasis added). CPE recognizes the applicable statutory and regulatory rule that the Department may consider the "taxpayer's own sales of ores of like kind and grade," and that "a 'representative' market is one that reflects market value 'at the time of the CPE Brief at 10 (quoting Decker Coal, 41). Despite this, it incorrectly misrepresents the Decker Coal decision--that the Department is required to incorporate a mechanism for addressing the time of contract negotiation and that it must utilize spot sales and other market data. It is undisputed that certain coal sales' utilized by the Department in imputing values to CPE's NAL coal sales arose from contracts negotiated in a different month or year than the NAL contracts "negotiation dates." It is also undisputed that none of the contracts at arm's length contracts and the NAL contracts--are remotely similar to the long--term contract with price escalators examined in Decker Coal. Thus, it is undisputed that the Department compared similar volumes and quality of invoiced sales of coal from relatively short term arm's length coal sales by CPE to invoiced sales of coal from relatively short term NAL coal sales by CPE. Clearly, the . month the coal was actually sold is obviously the best indicator of coal's value "at the time of sale." CPE attempts to misdirect this Court in fabricating claims of "irrationality" with the example on page 11 of its brief, where the Department calculated market value of the coal sold over a nearly two-year period under NAL contract 918 at values ranging from $8 per ton to $16 per ton. CPE Brief, p. 11; Aff. St. John, 1] 5b. CPE then provides this Court with the unsupported, conclusory claim that it "had no opportunity, during the MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 7 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT I period in question, to sell this coal for the" prices . . that DOR has imputed." CPE Brief at 11. What CPE fails to show this Court is that its NAL contract 918, fixed for a period of 5 years, set forth a nearly static price of per ton for its entire period. CPE Exhibit E, Bates CPE-DOR 001886--001887. The DOR's calculations reflect the fluctuations of a market representing prices "at the time of sale," while CPE's static price does not. CPE Exhibit D. It is simply this difference that created the imputed additional revenue of $929,719,000. CPE Exhibit at p. 7; Baerlocher DepositionAff. St. John, 1] 5c. CPE carefully argues that the Department made coal comparisons based on the date of "shipment," rather than the date of negotiation. CPE Brief at 13. By carefully not recognizing that the sale of the coal occurred on the shipment date, CPE attempts to distract the Court away from when the actual "date of sale" occurred. As discussed above, Montana's coal severance taxes are predicated upon the severance and preparation for shipment (production) of coal, not the contract negotiation date. See, and -103(1), MCA (2005). Obviously, Montana's coal severance tax statutes define time of shipment is the "time of the sale." CPE takes issue with the Department's use of the volumes of coal sold as part of its criteria in arriving at comparable sales for imputing the value of the NAL sales. Even a cursory review of CPE's argument demonstrates that it is a red herring. As set forth above, the Department must utilize comparable sales as close to the "date of sale'' as is reasonably possible. It is undisputed that the record demonstrates that invoice logs, which set out volumes, quality and price "at the time of sale" are as specific as reasonably possible. See, CPE Exhibit D. CPE argues without support MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 8 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT I that certain arm's length contracts are "outliers" with nothing demonstrating that those contracts are anything other than comparable arm's length contract at prices higher than CPE would like for purposes of Montana's coal severance tax. Nothing in Montana statute, rule, or Decker Coal permits the Department to "smooth" the effect of including comparable coal sales that are simply at a higher price than the taxpayer prefers. Although CPE certainly reaped the benefit of obtaining these higher prices for business purposes, it is clear that CPE, at this later date, does not approve of the result when it comes to taxation. CPE additionally does not approve of the result the Department arrived at when utilizing a simple average of the various prices of coal "at the time of sale'' when calculating the imputed market price. However, it provides nothing to this Court demonstrating that this methodology is illegal or improper. The Department respectfully request this Court ignore CPE's attempt to confuse the issues before it. E. The Department's Contentions are Undisputable The Department's contentions in its briefs are undisputable, and CPE's disingenuous attempts to distort the truth must be disregarded. CPE now alleges that it did not acknowledge that imputation is appropriate for all NAL sales. CPE Brief at 16. It fails to apprise this Court that only the NAL sales that were below market value are at issue. CPE's November 17, 2010, objection to the Department's audit assessment, disputes "the method utilized to value these sales. We ask that the State and CPE develop a method for valuation of these sales to value these tons at a market price, consistent with Montana Statute." MDOR Exhibit 5, CPE--DOR 000091, numbered 11 3. (emphasis added). CPE's earlier admission over what constituted the relevant issue in MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR 9 RESPONSE TO CLOUD CROSS-MOTION FOR SUMMARY JUDGMENT ON COUNT this case--imputation for NAL sales falling below market value--could not be more clear. CPE's lack of candor to this Court is most pronounced in its allegation that "[b]ecause the department erroneously had included certain arms--length contracts in its NAL calculations, CPE also included those contracts in its NAL calculations for the sake of consistency." CPE Brief at 16 (citing CPE Response Request for Admission No. 2). The record undisputedly demonstrates, however, that the "market study" CPE provided to the Department when attempting to prove that the NAL contracts were at market value, included as comparables the numerous contracts it listed as NAL contracts that were in fact arm's length contracts. Baerlocher Deposition, p. 19, ll. 4-10. The purpose of this "market study" was to "demonstrate that our non--arm's length sales pricing is not out of line with our arm's-length pricing." Aff. St. John, pp. 1-4. The significance of this cannot be understated--clear|y, including arm's length contract prices market value prices) in an analysis of NAL contract prices proves that the "market study" is wholly unreliable. Even CPE concedes that to include such contracts is erroneous. MDOR Exhibit 4 - St. John Deposition, p. 14, II. 20-25. CPE attempts to hide this misrepresentation and justify it with the unsupported allegation that the Department had included these contracts in its NAL calculations. CPE Brief at 16. The record clearly demonstrates that the Department provided CPE only its first Assessment Letter prior to CPE providing the flawed "market study" at issue containing the admittedly erroneous representations at the informal conference regarding that assessment. MDOR Exhibits 1, 11; Aff. St. John, p. 8, ll. 3-25. The Assessment Letter clearly does not specifically reference any contracts. CPE's attempts to misrepresent MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 10 RESPONSE TO CLOUD CROSS-MOTION FOR SUMMARY JUDGMENT ON COUNT I the facts must be disregarded and should cause this Court to give pause to consideration of any representations made by CPE. F. Penalty and Interest Are Applicable CPE's only argument that penalty and interest do not apply arises from its contention that the assessment at issue is illegal and improper. Should this Court agree with the Department's position, it is undisputed that assessment of penalty and interest is proper. CONCLUSION Analysis of the applicable statutes and Decker Coal, along with the undisputed facts, unequivocally establish that the Department's June 2012 Assessment complies with Montana law. The Department respectfully requests this Court grant the Department's Motions for Summary Judgment on Counts and Ill and deny CPE's Cross-Motions for Summary Judgment. In so doing, the Department requests this Court Declare that, for imputing revenues to NAL contracts pursuant to ?15--35-107, MCA: 1. The Department may consider the "taxpayers own sales of ores of like kind and grade." 2. In so doing, a '"representative' market is one that reflects market value 'at the time of the sale'.'' 3. "The time of the sale" occurs when the coal is actually sold and invoiced on a basis. 4. The Department properly utilized comparable volumes of coal sold and that simple averaging of comparable sales complies with Montana law. 5. Penalty and interest are properly assessed. MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR RESPONSE TO CLOUD CROSS-MOTION FOR SUMMARY JUDGMENT ON COUNT I A review of the record clearly demonstrates that the material facts are not in dispute. This matter is properly before this Court on Cross-Motions for Summary Judgment and upon filing of this Brief the matter is considered fully briefed and submitted pursuant to this Court's Order dated September 11, 2013. For all of the foregoing reasons, the Department respectfully requests this Court issue a declaratory judgment affirming the Department's assessment. 1 ti: Dated this 77: day of September, 2013. MONTANA DEPARTMENT OF REVENUE JENKINS - BRENDAN R. BEATTY Special Assistant Attorneys General MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR 12 RESPONSE TO CLOUD CROSS-MOTION FOR SUMMARY JUDGMENT ON COUNT I CERTIFICATE OF SERVICE lhereby certify that on the ay of September, 2013, I served true and accurate copies of the foregoing MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND AND MDOR RESPONSE TO CLOUD CROSS--MOTION FOR SUMMARY JUDGMENT ON COUNT I by the method(s) indicated below, addressed as follows: Robert L. Sterup Mail, Postage Prepaid Kyle Anne Gray Federal Express, Billed to Sender Michael Manning Hand Delivery HOLLAND HART LLP E-Mail 401 315* St, Ste 1500 Fax to PO Box 639 Billings MT 59103-0639 I A A I ,1 . MDOR REPLY TO MOTION FOR SUMMARY JUDGMENT ON COUNTS I AND Ill, AND MDOR 13 RESPONSE TO CLOUD FOR SUMMARY JUDGMENT ON COUNT