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By Erica Horn and Stephen Sherman
“In this case, we find ourselves in the unusual position of needing to sort out questions relating to the way in which the Commonwealth of Kentucky taxes gasoline.” This is the opening sentence of the opinion of the U.S. Court of Appeals for the Seventh Circuit in Bulk Petroleum Corp. v. Kentucky Dept. of Revenue (In re Bulk Petroleum Corp.), Case No. 13-1870, 2015 U.S. App. LEXIS 13378 (7th Cir. 2015). The Court, which was deciding an appeal on an adversary proceeding arising from a bankruptcy case in the Eastern District of Wisconsin, held Kentucky law required a refund of Kentucky gasoline or special fuel tax (“Fuel Tax”) paid on fuels delivered outside the state.
As an initial matter, tax practitioners may wonder why the 11th Amendment failed to prohibit the Court from deciding the case. The answer is simple – the case arose in the context of a bankruptcy. The Court stated, “‘States agreed in the plan of the [Constitutional] Convention not to assert any sovereign immunity defense they might have had in proceedings brought pursuant to the ‘Laws on the subject of Bankruptcies’.’”
Bulk Petroleum Corporation (“Bulk”) was a gasoline distributor and owned gas stations in Kentucky, Indiana and Tennessee. The company sought a refund of approximately $1.3M in Kentucky Fuel Tax. Bulk was actively pursuing its refund claim when the company filed for bankruptcy in February 2009. A few months later, Bulk filed an adversary proceeding against the Kentucky Department of Revenue (“KDOR”) to obtain payment of its refund. In the meantime, the KDOR had filed a proof of claim against Bulk for approximately $525,000, leaving a net due to Bulk of roughly $775,000.
Bulk held a Kentucky gasoline distributor license until October 2006, at which time the license was revoked. Bulk regained its license in August 2007. The period from October 2006 through August 2007 is referred to by the Court as the “Revocation Period.” Pursuant to Kentucky law, holders of a license may self-assess and remit fuel taxes owed. Without a license, however, suppliers are required to collect and remit the Fuel Tax on purchases by distributors.
Bulk’s fuel purchases were picked up by tankers owned by Bulk, and the gasoline was then processed through its Louisville, Kentucky facility. From the Kentucky facility, the gasoline was distributed to stations in Kentucky, Indiana and Tennessee. The Fuel Tax, however, was only owed on the gasoline distributed within Kentucky.
When Bulk had a valid license, the company was able to calculate the tax on the amount of gasoline that stayed in the state. But, during the Revocation Period, Bulk’s suppliers, BP and Marathon, had to collect tax on all the gasoline purchased by Bulk and processed in Kentucky. That is, the tax collected by the suppliers did not take into account that Bulk was going to ship some of the gasoline to Indiana and Tennessee. Bulk’s refund claim was for the overpayment of Fuel Tax made during the Revocation Period when BP and Marathon were collecting the tax on 100% of the shipments to Louisville.
The KDOR claimed Bulk never paid any tax while unlicensed, but rather Marathon and BP paid the tax, and Bulk should seek its refund from those suppliers rather than the state. The Court disagreed, holding that, pursuant to Kentucky law, the legal incidence of the Fuel Tax is on the receiving party, regardless of who collects the tax, and Bulk was the receiving party. The Court found support for its holding in Dept. of Revenue v. Jack Cole Co., 474 S.W.2d 70 (Ky. App. 1971) wherein the Kentucky Court of Appeals held that although the Fuel Tax was collected by a supplier, the dealer was the taxpayer.