Legislature(2005 - 2006)

2006-02-21 House Journal

Full Journal pdf

2006-02-21                     House Journal                      Page 2593
HB 488                                                                                            
HOUSE BILL NO. 488 by the House Rules Committee by request of                                       
the Governor, entitled:                                                                             

2006-02-21                     House Journal                      Page 2594
     "An Act repealing the oil production tax and gas production tax                                
     and providing for a production tax on the net value of oil and gas;                            
     relating to the relationship of the production tax to other taxes;                             
     relating to the dates tax payments and surcharges are due under                                
     AS 43.55; relating to interest on overpayments under AS 43.55;                                 
     relating to the treatment of oil and gas production tax in a                                   
     producer's settlement with the royalty owner; relating to flared                               
     gas, and to oil and gas used in the operation of a lease or property,                          
     under AS 43.55; relating to the prevailing value of oil or gas under                           
     AS 43.55; providing for tax credits against the tax due under                                  
     AS 43.55 for certain expenditures, losses, and surcharges; relating                            
     to statements or other information required to be filed with or                                
     furnished to the Department of Revenue, and relating to the                                    
     penalty for failure to file certain reports, under AS 43.55; relating                          
     to the powers of the Department of Revenue, and to the disclosure                              
     of certain information required to be furnished to the Department                              
     of Revenue, under AS 43.55; relating to criminal penalties for                                 
     violating conditions governing access to and use of confidential                               
     information relating to the oil and gas production tax; relating to                            
     the deposit of money collected by the Department of Revenue                                    
     under AS 43.55; relating to the calculation of the gross value at                              
     the point of production of oil or gas; relating to the determination                           
     of the net value of taxable oil and gas for purposes of a production                           
     tax on the net value of oil and gas; relating to the definitions of                            
     'gas,' 'oil,' and certain other terms for purposes of AS 43.55;                                
     making conforming amendments; and providing for an effective                                   
was read the first time and referred to the Resources and Finance                                   
The following fiscal note(s) apply:                                                                 
1.  Zero, Dept. of Natural Resources                                                                
2.  Fiscal, Dept. of Revenue                                                                        
The Governor's transmittal letter dated February 21, 2006, follows:                                 

2006-02-21                     House Journal                      Page 2595
"Dear Speaker Harris:                                                                               
Under the authority of art. III, sec. 18, of the Alaska Constitution, I am                          
transmitting a bill relating to the oil and gas production tax.                                     
This bill would eliminate the economic limit factor (ELF) from the                                  
determination of production tax, and would replace it with a more                                   
progressive and investment-friendly tax system.                                                     
Under current law, the tax imposed on oil or gas production generally                               
is determined by multiplying the gross value at the point of production                             
times the appropriate tax rate times the economic limit factor for that                             
The economic limit factor was intended to provide a proxy for costs.                                
It is determined by a complex formula that uses as input the total                                  
production from, and productivity of, the wells in a field.  The theory                             
behind the economic limit is that a producer would not be taxed for                                 
production below the economic limit while still recovering costs.                                   
However, this has not worked well in recent practice.  On the one                                   
hand, under current conditions, producers are allowed proxy costs                                   
several times their actual costs.  On the other hand, a producer                                    
reinvesting its profits from Alaska production in exploration,                                      
production, or development in the state may receive little or no tax                                
benefit compared to a producer who exports its profits and makes                                    
those same investments in another state or country.                                                 
As explained in more detail below, this bill introduces two important                               
investment-friendly tax concepts in place of the economic limit factor.                             
 · The tax proposed in the bill is based essentially on the cash flow                               
     from a lease, or the profit net of all qualified costs.  Thus, a                               
     deduction is allowed for all upstream costs, including expenses                                
     and capital investment.  In other words, the tax base is not gross                             
     value at the point of production but the net value.  In addition,                              
     every producer is allowed an annual allowance of up to $73                                     
     million, so if a producer's cash flow is $73 million or less in a                              
     year, there would be no tax.                                                                   

2006-02-21                     House Journal                      Page 2596
 · A 20 percent tax credit is allowed for all the upstream capital                                  
     investment, even if a deduction was taken for that investment as                               
      described above.  Another credit is allowed for operating losses.                            
Because of this proposed switch from a gross to net basis, a higher tax                             
rate is appropriate and this bill would raise the rate (before applying                             
ELF) from the current 15 percent (or 12.25 percent for new                                          
production) to 20 percent.  In addition, the minimum tax is repealed.                               
Thus, as mentioned above, a company would incur a production tax                                    
liability only if it has positive cash flow from its Alaska production                              
properties greater than $73 million a year.                                                         
Upstream Cost Deduction                                                                           
The calculation of the net value of a producer's oil and gas starts with                            
gross value, which is essentially unchanged from current law, with                                  
some streamlining.  Direct lease costs, including both capital                                      
investment and operating costs are deducted from that gross value.  If                              
in any month the total cash flow is reduced to zero by those costs,                                 
remaining costs are carried forward to future months (or, if unused by                              
the end of a calendar year, are translated into a credit applicable in                              
future years).  In addition, each producer is granted an allowance of up                            
to $200,000 a day or $73 million a year.  That is, if after calculating its                         
net profit a producer still showed positive cash flows of $73 million or                            
less, this allowance may be used to reduce that cash flow to zero                                   
(though again, not any lower).  If the producer showed a positive cash                              
flow of more than $73 million, the allowance would be used to reduce                                
the taxable cash flow by $73 million.  Finally, as a transition measure,                            
for the first 72 months in which the Alaska North Slope oil spot price                              
is above $40 a barrel, a producer is allowed to include in its upstream                             
deduction a pro rata amount of capital costs incurred in the five years                             
before the new production tax takes effect.                                                         
In the interests of streamlining and simplicity, the Department of                                  
Revenue is directed to take into account the kind of costs that an                                  
operator typically bills a working interest owner (and a working                                    
interest owner typically audits) and the Department of Natural                                      
Resources' net profit share lease regulations.                                                      

2006-02-21                     House Journal                      Page 2597
A number of indirect costs that may not be included in the calculation                              
of direct lease costs are specified in the bill.  Finally, the bill specifies                       
that any deduction for lease expenses must be reduced by any                                        
reimbursements that a taxpayer receives from other taxpayers, say, for                              
example, for use of facilities, or from the government where such                                   
payments are in the nature of field costs.                                                          
New Investment Credits                                                                            
Two major new credits are provided for in the bill.                                                 
     (1)  A credit would be allowed against the production tax for 20                               
     percent of any qualified investment, even though that same outlay                              
     may also be deductible in calculating taxable net value of the oil                             
     and gas.  This credit and the exploration credits under AS                                     
     43.55.025 may not both be taken for the same expenditures.                                     
     Qualified capital expenditures include outlays for new (or new-to-                             
     Alaska) assets that are treated as capital under the federal tax                               
     code, as well as geological and geophysical exploration costs and                              
      drilling costs that would be expensed under the federal tax code.                            
     (2)  A credit also would be allowed for 20 percent of any annual                               
     loss.  Because the tax due can only be reduced to zero (and not                                
     below zero), mechanically this is the same as allowing unclaimed                               
     expense to be carried forward year to year, but for tax                                        
     administration purposes it is preferable for carryforwards to be in                            
     the form of credits.                                                                           
These credits would be non-refundable; that is, they could not be used                              
to reduce a taxpayer's liability below zero.  However, any credit not                               
used in a given period could either be carried forward or sold to                                   
another taxpayer who might better be able to use it.  Taxpayers who                                 
purchase credits may not use the credits to reduce their production                                 
taxes by more than 20 percent in any year.                                                          
In addition to the two major new credits, producers would be allowed                                
to credit their oil conservation surcharge payments under AS 43.55                                  
against the production tax.                                                                         

2006-02-21                     House Journal                      Page 2598
Other Provisions                                                                                  
In providing for taxation of the net value of oil and gas, the bill also                            
would preserve most of the current provisions on calculating gross                                  
value at the point of production, since this calculation is an                                      
intermediate step in calculating taxable net value.  This approach has                              
the benefit of conserving the body of regulations, interpretations, and                             
case law that has developed over several decades.  In the interest of                               
fostering simplicity and efficiency, however, the bill would make a                                 
significant addition to the current provisions, authorizing the                                     
Department of Revenue to allow taxpayers, if appropriate, to rely on                                
royalty settlement agreements with the Department of Natural                                        
Resources (DNR), or other royalty values or methodologies accepted                                  
by the DNR, or the United States Department of the Interior (in the                                 
case of some federal leases or units) or to use a simplifying formula                               
approved by the Department of Revenue.                                                              
The bill would make several changes in current law to facilitate                                    
administration of the new production tax approach.  The subjects                                    
addressed include tax returns and tax payment due dates, definitions of                             
oil and gas and other terms, and treatment of private royalty oil and                               
gas for production tax purposes.  The bill clarifies how the Department                             
of Revenue may disclose certain otherwise confidential information to                               
taxpayers when the information affects their tax liabilities.  Persons                              
who violate the conditions of such disclosure would be subject to the                               
same criminal penalties that currently apply to state employees who                                 
violate taxpayer confidentiality.  The bill also simplifies the tax                                 
treatment of flared gas and extends to oil the current tax exemption for                            
gas that is used on the lease.                                                                      
The bill would make needed updates and clarifications to certain                                    
provisions of the production tax statute: confirming the Department of                              
Revenue's long-standing application of the prevailing value concept to                              
internal transfers of oil or gas, incorporating a necessary reference to                            
the constitutional budget reserve fund regarding the department's                                   
disposition of revenue, and repealing a specific failure-to-file penalty                            
that is superfluous in the light of the general penalty provisions of the                           
revenue laws.                                                                                       

2006-02-21                     House Journal                      Page 2599
The proposed new production tax on net value, and related provisions                                
of the bill, would apply prospectively, as of July 1, 2006.  The bill has                           
an immediate effective date for other purposes.                                                     
This bill will greatly improve Alaska's oil and gas tax system,                                     
encouraging investment in the state, making tax administration more                                 
predictable, better reflecting the variable economics of oil and gas                                
development, and providing Alaskans with a fairer share of the value                                
of the oil and gas taken out of the ground in our state.  I urge your                               
prompt and favorable action on this legislation.                                                    
                                 Sincerely yours,                                                   
                                 Frank H. Murkowski