Legislature(2005 - 2006)SENATE FINANCE 532

04/05/2005 09:00 AM FINANCE

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     SENATE BILL NO. 151                                                                                                        
     "An  Act excepting  from  the  Alaska Net  Income  Tax Act  the                                                            
     federal  deduction  regarding  income attributable  to  certain                                                            
     domestic production  activities; and providing for an effective                                                            
This  was the first  hearing  for this  bill in  the Senate  Finance                                                            
Co-Chair  Green explained  that this  legislation  would decouple  a                                                            
federal tax deduction from the Alaskan Net Income Tax Act.                                                                      
DAN  DICKENSON,  Director,  Tax  Division,  Department  of  Revenue,                                                            
explained  that,   beginning  in  2005,  the  Qualified   Production                                                            
Activities  Income  (QPAI)  section  of the  federal  American  Jobs                                                            
Creation  Act of  2004, would  phase in  tax relief  to certain  tax                                                            
payers  by excluding  a specified  percentage  of  their net  income                                                            
earned from extraction,  production, and manufacturing activities in                                                            
the United  States. Several handouts,  including "The American  Jobs                                                            
Creation  Act of  2004", the  "Tax  Analysis Special  Report"  dated                                                            
February  21, 2005, and  the "Primer: IRC  199 Qualified  Production                                                            
Activity Income  (QPAI)" dated April 4, 2005, [copies  on file] were                                                            
provided to Members to provide additional information.                                                                          
Mr. Dickenson stated that  QPAI is "an attempt" by the United States                                                            
(U.S.) Congress  "to advantage these kind of activities"  that occur                                                            
in the nation  "relative to those activities occurring  abroad". The                                                            
affected  industries in this  State would  include the construction                                                             
industry,  the fishing  and  fish processing  industry,  the  mining                                                            
industry, and  the refinery/production  and marketing activities  of                                                            
the oil  and gas  industry.  The QPAI  would allow  a three  percent                                                            
deduction of their  QPAI for the specified activities  in 2005-2006,                                                            
a six percent  deduction in 2007-2008, and a nine  percent deduction                                                            
Mr. Dickenson stressed  that the QPAI deduction would not be limited                                                            
to new  activity.  Companies  would operate  "exactly"  as they  had                                                            
before; however,  under this new tax  law, their "taxable  income is                                                            
going  to decrease",  as a percentage  of the  specified  activities                                                            
income  "would  be deducted,  or  excluded"  from  the calculation.                                                             
Alaska typically "adopts  the federal tax code by reference" and, as                                                            
a result, the  Alaska tax is based  on the business's "worldwide  or                                                            
U.S."  taxable income.  As  of the  year 2005,  QPAI  would lower  a                                                            
business's  taxable income  by three percent.  This would in  effect                                                            
reduce the amount of money Alaska would collect in taxes.                                                                       
Mr. Dickenson  informed that  the State has  the option to  decouple                                                            
from federal  law. This has  occurred in other  areas of State  law:                                                            
for example, Alaska's  depreciation deductions differ  from those of                                                            
the federal  government.  He  pointed out  that the  impact of  QPAI                                                            
would be more  severe on Alaska than  on any other state  due to the                                                            
fact  that  "natural resources  …  form  the  base" of  the  State's                                                            
taxable income.  The State  has limited service  industry income  in                                                            
its tax base.                                                                                                                   
Mr. Dickenson  also observed that it is impossible  for the State to                                                            
mirror  the concept  of  the federal  QPAI,  which is  to  encourage                                                            
business  activities  in the  United  States  rather than  in  other                                                            
countries,  as the  State  is prohibited  from  passing  a law  that                                                            
would, in effect,  lower a business's  tax on an activity  occurring                                                            
in Alaska rather than in another state.                                                                                         
Mr. Dickenson  theorized that had the entire nine-percent  deduction                                                            
been  in effect  in Fiscal  Year  (FY) 2004,  the  State would  have                                                            
received  approximately  $24.7  to $27.4  million less  revenue.  He                                                            
reminded  that the  deduction would  gradually  increase from  three                                                            
percent  in the year  2005 to nine  percent beginning  in 2009.  The                                                            
projected  revenue loss,  by year, is  depicted on  page two  of the                                                            
aforementioned  "Primer:   IRC 199  Qualified  Production   Activity                                                            
Income (QPAI)"  in the section titled "Projected State  Revenue Loss                                                            
from QPAI Deduction".  As reflected  on that chart, the State  would                                                            
lose  approximately  $100  million in  tax  revenues over  the  next                                                            
decade "as a consequence" of this federal tax.                                                                                  
Mr. Dickenson  reiterated  that this  federal tax  and its  economic                                                            
policy goals  could "not be replicated"  by the State. In  addition,                                                            
the income  of foreign oil and gas  corporations is viewed  in terms                                                            
of corporations' worldwide  income rather than their U.S. income. To                                                            
that point, the State is  required to create a deduction table based                                                            
on those companies' worldwide  income. "We believe that we would" be                                                            
required  to  allow QPAI-like  deductions  for  activities  done  in                                                            
places  outside of  the United  States  such as  Nigeria. The  State                                                            
would be prohibited  "from drawing  that line between interior  U.S.                                                            
and exterior  U.S."  activities in  the same manner  as allowed  the                                                            
federal government.                                                                                                             
Mr.  Dickenson   detailed  that  when  the  State   audits  a  large                                                            
multinational  oil company, it relies  on the federal government  to                                                            
conduct 95-percent  of the work. While the State does  not replicate                                                            
any audit work  that the federal government conducts,  it does audit                                                            
any income  that  might be  attributed to  Alaska or  how a  company                                                            
managed  rules exclusive  to Alaska.  Were the State  to accept  the                                                            
QPAI deduction,  it must be recognized  that the federal  government                                                            
would not be auditing a  company's construction activities occurring                                                            
outside  of the  U.S.; therefore,  the  State would  be required  to                                                            
either conduct  that audit or ignore  it. To that point,  the fiscal                                                            
notes accompanying this  legislation do not reflect that, absent the                                                            
adoption  of  this  legislation,   more  State  resources  would  be                                                            
required as the  State would be required to conduct  audits "without                                                            
the support  of the  federal Internal  Revenue  System. This  effort                                                            
would not be required were the legislation adopted.                                                                             
[NOTE Co-Chair Wilken assumed chair of the meeting.]                                                                            
10:04:50 AM                                                                                                                   
Mr.  Dickenson  noted  that  when  this  issue  was  discussed  with                                                            
Governor  Frank Murkowski,  "his quick reaction"  was that  this was                                                            
"another unfunded federal  mandate. Basically the feds have passed a                                                            
law, it has desirable policy  goals for the federal government". The                                                            
State could  recognize QPAI  as being beneficial  to taxpayers  even                                                            
though the State  would lose revenue. However, unlike  most unfunded                                                            
federal mandates,  the State,  in this case,  has the option  to not                                                            
Mr. Dickenson  clarified that  were the State  to decouple  the QPAI                                                            
for State  taxes, that  action would  "not make  any changes  to the                                                            
benefits the taxpayers  receive when they file their  federal income                                                            
taxes".  The  State's action  would  have  no  affect on  the  rules                                                            
governing a taxpayer  and the federal government.  Were the State to                                                            
decouple the  QPAI section of the  federal revenue code,  the affect                                                            
on a taxpayer would be  that the information filed on the taxpayer's                                                            
federal  tax return  would  be used  as the  basis  for their  State                                                            
filing. This  legislation would simply  specify that one  section of                                                            
the federal tax code would not apply in this State.                                                                             
Mr. Dickenson  qualified  that this legislation  would require  some                                                            
transitional  rules  to be  developed in  order to  avert  confusion                                                            
regarding such things as estimated payments.                                                                                    
Mr. Dickenson remarked  that the backup material in Members' packets                                                            
is  extensive  in comparison  to  "the  brevity  of the  bill".  The                                                            
aforementioned  "The American  Jobs  Creation Act  of 2004"  handout                                                            
explains the  history of the Act and  briefly explains QPAI  and the                                                            
other sections  of the Act. Were this legislation  adopted, with the                                                            
exception of the decoupling  of the QPAI section, the other sections                                                            
of the Act would  become part of State law. Another  handout, titled                                                            
the "Tax Analysts Special  Report" is a 24-page report that provides                                                            
information to  companies about how to deal with the  Act. The third                                                            
piece  of  material   is  a  brochure  notifying  the  Department's                                                             
Certified  Public Accountants  (CPAs), who  are required to  undergo                                                            
continuing  professional  education,  about an  upcoming  conference                                                            
that would  educate CPAs  on how "to maximize  U.S. tax benefits  on                                                            
domestic  production activities".  Department  participation  in the                                                            
conference  might be  beneficial,  as it  would allow  the State  to                                                            
review tax  codes and issues  that could be  relevant to the  Alaska                                                            
Tax Code.                                                                                                                       
Mr. Dickenson stated that  Chuck Harlamert with the Department's Tax                                                            
Code Division could address Members' technical questions.                                                                       
10:09:26 AM                                                                                                                   
Senator Stedman  voiced apprehension about whether  this legislation                                                            
is "as  simple of  an issue as  stated". His  understanding  is that                                                            
other  than decoupling  domestic  production  activities,  no  other                                                            
activity would  be excepted from the federal Act.  To that point, he                                                            
asked for further  clarification regarding  whether specific  groups                                                            
of industries,  such as the oil and gas industry for  instance, have                                                            
been identified for exclusion.                                                                                                  
Mr.  Dickenson  responded  that the  State  has not  identified  any                                                            
particular industry:  the oil and gas industry would  be treated the                                                            
same  as the  fishing  and  construction  industries.  However,  the                                                            
federal  tax exemption's  application  to the oil  and gas  industry                                                            
would  have significant  impact  as  that  industry "is  paying  the                                                            
majority of the dollars" under the State's tax system.                                                                          
Senator Stedman  asked for further  information about how  the State                                                            
would  be  affected  by  the federal  nine-percent   taxable  income                                                            
Mr.  Dickenson  explained  that  a  company  would  calculate  their                                                            
taxable  income based  on revenues  less taxable  expenses. The  Act                                                            
would allow  an additional  deduction of up  to nine percent  of the                                                            
income  derived  from  qualified  production  activity.  This  would                                                            
essentially  allow  some  expenses   to  be "deducted   twice".  One                                                            
limiting factor is that  expenses could not exceed 50-percent of the                                                            
business's W-2 wages.                                                                                                           
10:12:02 AM                                                                                                                   
Senator  Stedman  asked  whether this  legislation  would  permit  a                                                            
business to incorporate  an appreciation schedule, referred to as an                                                            
Accelerated   Cost  Recovery  System   (ACRS),  which  would   allow                                                            
appreciation  to occur, for instance,  over a 15-year period  rather                                                            
than a 30-year  period. Such compression would increase  deductions.                                                            
Mr. Dickenson  responded  no, current appreciation  schedules  would                                                            
continue unaffected. The  only other change specifically included in                                                            
this legislation  would be an accelerated  appreciation schedule  in                                                            
regards to an Alaska gas plant "for federal purposes".                                                                          
Senator  Stedman  asked,  were  this legislation   to fail  and  the                                                            
federal Act to become effective  in its entirety, whether a business                                                            
would  be  able  to incorporate  an  ACRS  instead  of  the  regular                                                            
depreciation schedule.                                                                                                          
Mr.  Dickenson  stated  that  neither  the  action  of  adopting  or                                                            
rejecting  this legislation  would  provide  a business  "access  to                                                            
10:13:38 AM                                                                                                                   
Senator Olson  understood  that the theory  behind this federal  Act                                                            
was to  create jobs. He  asked whether that  theory would hold  true                                                            
for Alaska, regardless of the outcome of this legislation.                                                                      
Mr. Dickenson agreed that  the purpose of the Act was to create jobs                                                            
in the U.S.  There is "no sense" that  this would result  in jobs in                                                            
Alaska. The  Act would essentially  provide a "tax advantage  if you                                                            
create  jobs"  in the  United  States.  No tax  advantage  would  be                                                            
provided  were  an entity  to  create  jobs outside  of  the  United                                                            
States. Alaska  is prohibited "from  drawing that same line".  There                                                            
is no doubt that  this legislation would provide the  economic tools                                                            
to encourage new jobs in  the nation; however, "the point is that it                                                            
doesn't help Alaska at all".                                                                                                    
Senator Olson  calculated that, absent  this legislation,  the State                                                            
would experience a $10,000,000  a year revenue loss for the next ten                                                            
years. He inquired  to the cost associated  with the implementation                                                             
of this legislation.                                                                                                            
Mr. Dickenson  expressed that this  legislation would not  incur any                                                            
expenses.  To the  contrary,  costs would  be incurred  absent  this                                                            
legislation,  as the State  would be required  to conduct  deduction                                                            
auditing on  "QPAI-like activities  that occur outside of  the U.S".                                                            
Senator  Bunde questioned  the Department  of Revenue indeterminate                                                             
Fiscal Note  #1, dated March  22, 2005, [copy  on file], as  it does                                                            
not reflect the cost to  the State were the legislation not enacted,                                                            
as specified in  the Note's analysis on page two under  the "Revenue                                                            
Discussion" heading.                                                                                                            
Mr. Dickenson replied that  the Department based its calculations on                                                            
FY  2004, "which  was  a  very high"  taxable  income  year.  Future                                                            
taxable  income level  projections,  which consider  such things  as                                                            
falling oil prices,  are lower than FY 2004. Projections  indicate a                                                            
range of losses  from five million  dollars in the initial  years to                                                            
$16 million dollars  in FY 2013. Losses could amount  to $25 million                                                            
were a year similar to FY 2004 to occur.                                                                                        
Co-Chair  Green commented  that  the fiscal  note is  "a little  bit                                                            
misleading in that the  information on page two must be brought into                                                            
10:17:12 AM                                                                                                                   
Senator Stedman  understood that this legislation  would, in effect,                                                            
opt the  State  of Alaska  out of  this federal  "economic  stimulus                                                            
concept". To that  point, he asked whether that action  would affect                                                            
the  accounting  practices  of such  entities  as  "Sub-chapter  "S"                                                            
Mr. Dickenson  reiterated  that the State  would be uncoupling  from                                                            
only  one  section  of  a  large  multi-section   piece  of  federal                                                            
CHUCK HARLAMERT,  Juneau Section Chief, Tax Division,  Department of                                                            
Revenue, expressed  that while the  QPAI section is "a major  piece"                                                            
of The  American Jobs  Creation Act  of 2004, it  does not have  any                                                            
specific  affect on "S"  Corporations under  Alaska law.  "Basically                                                            
the affect  of this  bill would  be to  reverse in  your Alaska  tax                                                            
return",  one line item  in the  Other Deductions  category of  your                                                            
federal  tax return.  "Only corporations  who pay  tax now would  be                                                            
affected; S Corps would not".                                                                                                   
Senator Stedman  noted that the State  has two options: to  uncouple                                                            
from the  QPAI or  to incorporate  the federal  Act in its  entirety                                                            
into  State  tax   code.  The  question  is,  "from  the   corporate                                                            
standpoint  and  from  the State  standpoint"  which  of  these  two                                                            
options would  encourage development  of refineries and other  large                                                            
capital projects in the State.                                                                                                  
Mr. Harlamert  voiced being unaware  of any element in this  federal                                                            
Act that would incentivize  construction of a refinery in Alaska; as                                                            
regardless  of the location,  be it in Alaska,  Texas, or any  other                                                            
state, the  company would  benefit from the  federal tax  exemption.                                                            
This benefit  would also be allowed  under Alaska tax code  were the                                                            
State to adopt the Act in its entirety.                                                                                         
Senator Stedman  asked which state would be in a better  position to                                                            
attract development  of a refinery:  a state that has chosen  not to                                                            
opt out or one that opted out.                                                                                                  
Mr. Harlamert responded  that that would depend on a mix of economic                                                            
factors including the specific  state's taxation. Texas's income tax                                                            
laws, for example, differ  from Alaska's. However, were the tax laws                                                            
identical and Texas to  accept the Act in its entirety and Alaska to                                                            
uncouple the  QPAI, the tax rate for  the refiner would be  lower in                                                            
Texas.  However, it  should be  noted that  even  were the  refinery                                                            
built in Alaska,  the refiner would  receive the same tax  deduction                                                            
in Texas; the refiner would  not receive the tax deduction in Alaska                                                            
regardless of whether the  refinery was built in Texas or Alaska. In                                                            
conclusion, regardless  of where the refinery was built, the refiner                                                            
would receive the same result under the State tax law.                                                                          
Senator  Stedman   stressed  that  the  encouragement   of  economic                                                            
development  in the State is important.  The concern is,  therefore,                                                            
that  the State  not  position  itself  at a  disadvantage  in  that                                                            
Senator  Bunde  asked  whether  any  taxpayer  would  be  testifying                                                            
regarding this legislation.                                                                                                     
Co-Chair  Green  replied  that  none  have,  of yet,  signed  up  to                                                            
Senator Bunde stated that  that could be an indication of "a lack of                                                            
concern" as he doubted their being unaware of the issue.                                                                        
Senator  Stedman requested  that the  bill be held  in Committee  to                                                            
allow for further discussion.                                                                                                   
Co-Chair Green agreed.                                                                                                          
Senator  Olson  referenced  the "Status  of  QPAI in  Other  States"                                                            
section  on  page  three  of  the  Department's   "Primer:  IRC  199                                                            
Qualified  Production  Activity  Income  (QPAI)" report,  and  asked                                                            
whether  the  desire is  to  move the  State  from the  "Conform  to                                                            
Federal QPAI Deduction"  column to the "Decoupled  from Federal QPAI                                                            
Deduction" column.                                                                                                              
Mr. Dickenson responded that would be correct.                                                                                  
Senator Olson  commented that none  of the states in the  "Decoupled                                                            
from Federal  QPAI Deduction" column  resemble the State  of Alaska.                                                            
Alaska is an oil producing  state and has no personal income tax. He                                                            
inquired to the  reason that Alaska should consider  decoupling when                                                            
other  oil producing  states  such as  Oklahoma and  Louisiana  were                                                            
listed in the "Conform to Federal QPAI Deduction" column.                                                                       
Mr.  Harlamert expressed  that  the  information reflected  on  page                                                            
three was voluntary, was  not all-inclusive, and was not up-to-date.                                                            
One  issue on  which  the State  "stands  alone  in the  nation  for                                                            
applying worldwide  combined reporting" is that major  industries in                                                            
the  State,  specifically  oil and  gas  companies,  represent  "80-                                                            
percent of the  State's tax base". There is no other  state in which                                                            
the implications  of the bill would  be "as dramatic as they  are in                                                            
Mr. Harlamert  continued that there "is a good argument  for staying                                                            
in conformity  with federal law …  [it] keeps things simple".  Minor                                                            
timing  differences  should  be avoided,  as  they  would  "generate                                                            
headaches for  taxpayers and the State for years to  come". However,                                                            
this legislation  addresses  "a permanent  difference"  … the  State                                                            
"would  never be  able to  recoup the  revenue" once  its gone.  The                                                            
affect of this  Act would be more  dramatic for Alaska than  for any                                                            
other  state. Most  states typically  adopt federal  standards  in a                                                            
manner similar  to how Alaska does as that is the  easiest approach:                                                            
it "takes an effort to come forth and change it".                                                                               
Mr.  Dickenson  observed  that West  Virginia,  Montana,  and  North                                                            
Dakota, which  are also considered resource states,  have decoupling                                                            
legislation pending.                                                                                                            
10:26:53 AM                                                                                                                   
Co-Chair  Green recognized  Arkansas,  which has  already  decoupled                                                            
from the Federal QPAI Deduction, as a resource state.                                                                           
Mr. Dickenson voiced that  the Department would be available to work                                                            
with the Committee to address further concerns.                                                                                 
Co-Chair Green ordered the bill HELD in Committee.                                                                              
AT EASE 10:27:37 AM / 10:30:35 AM                                                                                           

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