Legislature(2011 - 2012)BARNES 124

03/23/2012 01:00 PM House RESOURCES


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01:22:33 PM Start
01:22:50 PM Continuation of Overview(s): Oil & Gas Taxes & Credits
02:51:58 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
-- Delayed to 1:15 pm Today --
+ Bills Previously Heard/Scheduled TELECONFERENCED
+ Continuation of Overview: Oil & Gas Taxes & TELECONFERENCED
Credits by Dept. of Revenue
<Overview Held Over from 3/21/12>
-- Testimony <Invitation Only> --
                    ALASKA STATE LEGISLATURE                                                                                  
               HOUSE RESOURCES STANDING COMMITTEE                                                                             
                         March 23, 2012                                                                                         
                           1:22 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Representative Paul Seaton, Co-Chair                                                                                            
Representative Peggy Wilson, Vice Chair                                                                                         
Representative Alan Dick                                                                                                        
Representative Neal Foster                                                                                                      
Representative Bob Herron                                                                                                       
Representative Cathy Engstrom Munoz                                                                                             
Representative Berta Gardner                                                                                                    
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Representative Eric Feige, Co-Chair                                                                                             
Representative Scott Kawasaki                                                                                                   
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
CONTINUATION OF OVERVIEW(S):  OIL & GAS TAXES & CREDITS                                                                         
                                                                                                                                
     - HEARD                                                                                                                    
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
No previous action to record                                                                                                    
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
BRUCE TANGEMAN, Deputy Commissioner                                                                                             
Office of the Commissioner                                                                                                      
Department of Revenue                                                                                                           
Juneau, Alaska                                                                                                                  
POSITION STATEMENT:  Provided a PowerPoint presentation entitled                                                              
"Overview of Alaska's Oil & Gas Tax Structure."                                                                                 
                                                                                                                                
LENNIE DEES, Audit Master                                                                                                       
Production Audit Group                                                                                                          
Tax Division                                                                                                                    
Department of Revenue (DOR)                                                                                                     
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:  Answered questions related to the overview                                                               
of Alaska's oil and gas tax and credit structure.                                                                               
                                                                                                                                
CHERYL NIENHUIS, Acting Chief Economist, Commercial Analyst                                                                     
Anchorage Office                                                                                                                
Tax Division                                                                                                                    
Department of Revenue (DOR)                                                                                                     
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:   Answered questions related  to the overview                                                             
of Alaska's oil and gas tax and credit structure.                                                                               
                                                                                                                                
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
1:22:33 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON called  the House  Resources Standing  Committee                                                             
meeting  to order  at 1:22  p.m.   Representatives Seaton,  Dick,                                                               
Foster,  P. Wilson,  and  Gardner  were present  at  the call  to                                                               
order.  Representatives  Munoz and Herron arrived  as the meeting                                                               
was in progress.                                                                                                                
                                                                                                                                
^CONTINUATION OF OVERVIEW(S):  Oil & Gas Taxes & Credits                                                                        
    CONTINUATION OF OVERVIEW(S):  Oil & Gas Taxes & Credits                                                                 
                                                                                                                                
1:22:50 PM                                                                                                                    
                                                                                                                                
CO-CHAIR SEATON announced  that the only order  of business would                                                               
be a continuation  of the Overview on Alaska's Oil  and Gas Taxes                                                               
and Credits.                                                                                                                    
                                                                                                                                
1:24:53 PM                                                                                                                    
                                                                                                                                
BRUCE TANGEMAN, Deputy Commissioner,  Office of the Commissioner,                                                               
Department  of  Revenue,  continued his  PowerPoint  presentation                                                               
from  March 21,  beginning with  slide 37  entitled, "Limitations                                                               
under AS 43.55.011(e)," which deals  with Cook Inlet gas and oil.                                                               
He stated that Cook Inlet  gas is discussed in AS 43.55.011(j)(1)                                                               
and (2), and said that for  any lease or property with commercial                                                               
production prior to April 1, 2006,  the tax is based on the rates                                                               
in effect  at that time.   For any lease or  property which began                                                               
commercial production after March 31,  2006, the tax is $.177/MCF                                                               
[million cubic feet],  and this rate is in  effect until December                                                               
31, 2021.                                                                                                                       
                                                                                                                                
1:27:17 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  P. WILSON  asked how  much increased  revenue the                                                               
state has received  as a result of the change  in tax after March                                                               
31, 2006.                                                                                                                       
                                                                                                                                
LENNIE DEES, Audit Master, Production  Audit Group, Tax Division,                                                               
Department of  Revenue (DOR), replied the  $0.177/MCF was applied                                                               
to any new commercial production  properties coming on line after                                                               
April 1,  2006, and said this  rate was determined by  taking the                                                               
average rate of all properties in  Cook Inlet for the prior year.                                                               
He offered his  belief that no new properties  have actually come                                                               
on to  production since then,  so there really is  no difference.                                                               
He said this tax limitation in  Cook Inlet has resulted in almost                                                               
no  income  for the  state  because  of  tax sales  and  taxpayer                                                               
credits  against the  tax  liability.   While  there  is a  small                                                               
amount of  revenue from the tax  on private royalties and  from a                                                               
few producers  that have enough  production to pay some  tax, the                                                               
revenue from Cook Inlet is minute.                                                                                              
                                                                                                                                
1:29:56 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE P.  WILSON inquired as  to whether there  would be                                                               
any future tax profit to the state from Cook Inlet.                                                                             
                                                                                                                                
MR. TANGEMAN  responded these tax  rates do not expire  until the                                                               
end  of 2021,  but said  the tax  system has  generated a  lot of                                                               
interest  over  the  past  couple  of  years  and  production  is                                                               
expected to be coming from those areas.                                                                                         
                                                                                                                                
REPRESENTATIVE P.  WILSON asked whether  the state will  make any                                                               
money in Cook Inlet before 2021, given the tax credits.                                                                         
                                                                                                                                
MR.  TANGEMAN answered  he did  not know  and suggested  that the                                                               
Department  of   Natural  Resources   (DNR)  could   address  the                                                               
projected new production between now and 2021.                                                                                  
                                                                                                                                
1:31:25 PM                                                                                                                    
                                                                                                                                
CO-CHAIR SEATON reflected  that this provision was  added in 2006                                                               
because  representatives  from  Anchorage had  wanted  to  ensure                                                               
there was  not a consumer  tax increase.   He said  the necessary                                                               
costs and tax credits to develop  a gas field would "probably eat                                                               
up any tax,"  but pointed out that the state  could still receive                                                               
royalties.  He  stated that the total tax generated  had been $2-                                                               
$3 million when  the petroleum production profits  tax (PPT) came                                                               
into effect, which was before  establishment of the credits under                                                               
Alaska's Clear and Equitable Share (ACES).                                                                                      
                                                                                                                                
1:33:55 PM                                                                                                                    
                                                                                                                                
CO-CHAIR SEATON, in response to  Representative P. Wilson, agreed                                                               
that balancing  provisions have been  made for the  various areas                                                               
of the state.                                                                                                                   
                                                                                                                                
REPRESENTATIVE  P. WILSON  clarified  that she  wants to  balance                                                               
provisions  for the  northern  and western  parts  of the  state,                                                               
given there have been hydropower projects in Southeast Alaska.                                                                  
                                                                                                                                
CO-CHAIR SEATON noted  the committee does not want to  ask DOR to                                                               
advocate  or   suggest  a  certain   policy,  but   that  today's                                                               
discussion  was for  committee members  to better  understand the                                                               
current tax system.                                                                                                             
                                                                                                                                
MR.  TANGEMAN agreed  that today's  goal was  to discuss  current                                                               
statutes.                                                                                                                       
                                                                                                                                
1:36:51 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN continued his discussion  of the laws governing Cook                                                               
Inlet,  noting that  [AS 43.55.011(k)(1)  and  (2)] address  Cook                                                               
Inlet oil  [slide 38].   He  stated the  tax rate  is zero  for a                                                               
lease or property  that had commercial production  prior to April                                                               
1, 2006.  For a  lease or property entering commercial production                                                               
after March  31, 2006, the  rate is  zero based on  ELF [economic                                                               
limit factor] tax rates during  the period April 1, 2005, through                                                               
March 31,  2006.   He related  that these  rates would  remain in                                                               
effect until December 31, 2021.                                                                                                 
                                                                                                                                
REPRESENTATIVE FOSTER asked how many leases were prior to 2006.                                                                 
                                                                                                                                
MR. DEES replied  that only a few leases have  come on line since                                                               
April 1, 2006,  therefore about 80-90 percent of  the leases were                                                               
producing before April 1, 2006.                                                                                                 
                                                                                                                                
1:38:25 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN,  moving to slide 39,  pointed out that gas  used in                                                               
state under AS  43.55.011(o) has the same ceiling  as gas subject                                                               
to [AS  43.55.011(j)(2)], which  is the Cook  Inlet gas  at $.177                                                               
per MCF.                                                                                                                        
                                                                                                                                
MR.  TANGEMAN, responding  to  Representative  P. Wilson,  stated                                                               
that 68 degrees latitude defined  the North Slope versus south of                                                               
the North Slope.  In further  response, he said gas used in state                                                               
covers the  entire state, with  no differentiation  between north                                                               
and south of 68 degrees.                                                                                                        
                                                                                                                                
MR. TANGEMAN,  responding to Co-Chair Seaton,  confirmed that the                                                               
definition for  gas used in  state is any gas  used commercially,                                                               
residentially,  for  power  generation, or  for  conversion  into                                                               
something  such  as  gas-to-liquids,   but  not  conversion  into                                                               
liquefied natural gas (LNG) for shipment out of state.                                                                          
                                                                                                                                
1:40:05 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON understood  that  in 2006  Cook  Inlet was  ring                                                               
fenced for  its expenses, but  since then changes have  been made                                                               
so that  the current  tax lets credits  be applied  against North                                                               
Slope or other production.                                                                                                      
                                                                                                                                
MR. DEES replied  the referenced change was passed  two years ago                                                               
and was made  to AS 43.55.011(m); it allows for  tax credits from                                                               
Cook Inlet  to be used  on the North  Slope and elsewhere  in the                                                               
state.   He pointed out that  not many taxpayers operate  in both                                                               
Cook Inlet  and other areas,  including the North Slope,  but the                                                               
change  allows  these  taxpayers  the opportunity  to  apply  the                                                               
credits  elsewhere in  the  state without  having  to apply  them                                                               
against the  full tax  liability in  Cook Inlet.   He  added that                                                               
this  law   did  not  change   the  treatment  of   excess  lease                                                               
expenditures, so lease  expenditures are still ring  fenced a bit                                                               
in Cook Inlet.  These  excess lease expenditures can be converted                                                               
to  a  net  operating  loss  carry  forward  credit,  but  it  is                                                               
necessary to  use them as  if there is  no ceiling in  Cook Inlet                                                               
before any excess can be converted to that credit.                                                                              
                                                                                                                                
1:44:52 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN,  resuming his presentation, pointed  out that slide                                                               
40  depicts AS  43.55.011(j) and  (k), the  statute language  for                                                               
Cook Inlet gas and oil, and gas used in state.                                                                                  
                                                                                                                                
CO-CHAIR SEATON understood  that the tax credits  are computed as                                                               
a  net operating  loss at  the base  rate and  not at  the higher                                                               
corporate rate off the North Slope  so that they get converted at                                                               
ACES net operating loss base rate to be applied elsewhere.                                                                      
                                                                                                                                
MR. DEES confirmed  the aforementioned is correct,  to the extent                                                               
a company  has excess  lease expenditures,  which are  defined as                                                               
the  amount  of operating  and  capital  lease expenditures  that                                                               
exceed the amount  of revenue from a specific  property or lease.                                                               
He  explained  that  those  excess   lease  expenditures  can  be                                                               
converted  at the  base rate,  25  percent, and  that 25  percent                                                               
credit can be  used anywhere in the  state as an offset  to a tax                                                               
liability.  He concurred that it  is capped at the base rate, not                                                               
the nominal rate.                                                                                                               
                                                                                                                                
1:46:59 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON  noted that  under  the  current situation  [the                                                               
state provides] a  very preferential, low tax rate  in Cook Inlet                                                               
which  needed to  be  balanced  in its  capacity  for write  off.                                                               
Therefore, it was set at the net operating carry forward.                                                                       
                                                                                                                                
MR.  TANGEMAN concurred  that the  Cook  Inlet area  is the  most                                                               
confusing part of the state's tax  structure because of how it is                                                               
calculated for Cook  Inlet as well as how it  affects other parts                                                               
of the  state when  a company has  production or  expenditures in                                                               
other  parts of  the state.   He  directed attention  to the  two                                                               
handouts, "Table of Tax Credits...,"  and "Summary of Tax Credits                                                               
under AS  43.55," which he characterized  as concise explanations                                                               
for a working knowledge of the various tax credits.                                                                             
                                                                                                                                
1:48:24 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE P. WILSON, referring to  the three areas which did                                                               
not have  any tax  regulations, shared that  she received  a call                                                               
from  DOR  explaining  that  there   is  not  yet  any  need  for                                                               
regulations in those areas.                                                                                                     
                                                                                                                                
MR. TANGEMAN clarified  that DOR used the term "not  yet" when it                                                               
would have been more accurate to state "not required".                                                                          
                                                                                                                                
1:49:28 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN,  returning to his  presentation, stated  that slide                                                               
41 is the  explanation of the Cook Inlet credits  in three bullet                                                               
points, which are as follows:                                                                                                   
                                                                                                                                
   · In 2010 AS 43.55.011(m) was amended to allow that credits                                                                  
     no longer had to be recalculated and applied as if there                                                                   
     were no tax ceilings for Cook Inlet oil & gas and for gas                                                                  
     used in-state                                                                                                              
   · In other words, beginning in 2011 any tax credits remaining                                                                
     after application against the tax ceilings of AS                                                                           
     43.55.011(j), (k), & (o) could be applied against any tax                                                                  
     obligation in the state                                                                                                    
   · However, for the period 2007 - 2012, the tax credits must                                                                  
     first be applied as if no ceilings existed before any                                                                      
     'excess tax credits' can be determined                                                                                     
                                                                                                                                
MR.  TANGEMAN stated  that  slide 42  is a  reading  chart on  AS                                                               
43.55.011(m), which  is what  Mr. Dees referred  to in  how lease                                                               
expenditures are handled after January 1, 2011.                                                                                 
                                                                                                                                
1:50:11 PM                                                                                                                    
                                                                                                                                
MR.  TANGEMAN  next  reviewed  the payment  of  tax  [slide  43],                                                               
explaining  that a  producer subject  to tax  under AS  43.55.011                                                               
"must make  a monthly estimated  payment of  tax."  He  said "any                                                               
under  or  overpayment amount  of  an  installment payment  bears                                                               
interest at the rate provided  under the federal Internal Revenue                                                               
Code",  which  is compounded  daily.    In response  to  Co-Chair                                                               
Seaton, he  said this is corporate-wide/state-wide.   In response                                                               
to Representative P.  Wilson, he said it is in  the best interest                                                               
of the taxpayer  to make the monthly payment as  close to correct                                                               
as possible.   Payments  will vary  between a  little over  and a                                                               
little under, so they balance out  in the end.  The interest rate                                                               
is severe, so  it is in the  best interest of the  company to get                                                               
it correct  and it is in  the state's best interest  to make sure                                                               
it is  correct because in  the case  of an overpayment  the state                                                               
would owe interest to the taxpayer.   He said the true-up for the                                                               
previous year occurs on March 31.                                                                                               
                                                                                                                                
1:51:57 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON asked  when the  overpayment  interest would  be                                                               
reimbursed.                                                                                                                     
                                                                                                                                
MR. DEES  replied the March 31  true-up must occur because  it is                                                               
only at  the end  of the  year that the  real numbers  are known.                                                               
Alaska law  requires that  the estimated  monthly tax  payment be                                                               
calculated at  one-twelfth of  the annual  lease payment,  so the                                                               
numbers are  actualized on  March 31  to determine  whether there                                                               
was an over- or underpayment for the  year.  He said the rate was                                                               
about 3 percent for an underpayment  and about 1.5 percent for an                                                               
overpayment.   When  the true-up  is submitted  on March  31, the                                                               
taxpayer includes  either the  additional tax  and interest  or a                                                               
request for  a refund of an  overpayment.  The department  has 90                                                               
days to  pay a refund to  the taxpayer at no  interest, but after                                                               
that  90-day  period  the  interest  rate  turns  to  11  percent                                                               
compounded quarterly.                                                                                                           
                                                                                                                                
MR. TANGEMAN  summarized that the monthly  payments are estimates                                                               
based on one-twelfth  of the annual lease  expenditures; March 31                                                               
is the  first true-up; DOR  has 90 days to  do a desk  audit; and                                                               
DOR can  take up  to six  years to do  the full-blown  audit that                                                               
verifies these numbers.                                                                                                         
                                                                                                                                
1:55:34 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN said  slides 44-46 spell out  the statutory language                                                               
about the payment of tax to the state.                                                                                          
                                                                                                                                
MR. TANGEMAN,  responding to Representative  P. Wilson,  said the                                                               
companies have until March 31  to present their final tax filings                                                               
and  the state  has 90  days from  then to  confirm the  filings,                                                               
which  is   the  interest-free  time  period.     Therefore,  the                                                               
companies  basically have  until March  31 of  interest-free time                                                               
period to finalize their tax returns.                                                                                           
                                                                                                                                
1:56:47 PM                                                                                                                    
                                                                                                                                
MR.  TANGEMAN moved  to slide  47 to  continue his  presentation,                                                               
explaining that under  AS 43.55.150 the gross value  at the point                                                               
of production  (GVPP) "is determined  at the point where  the oil                                                               
or gas first  enters into the transportation system  and does not                                                               
include any  cost upstream  of the  point of  production (lifting                                                               
and processing costs)."  For  example, this would be Pump Station                                                               
1 for  Prudhoe Bay and for  Kuparuk this would be  entry into the                                                               
Kuparuk Pipeline.   He  said that "generally  the first  point of                                                               
entry  into a  common carrier  pipeline is  considered to  be the                                                               
point  of  production."    Responding   to  Co-Chair  Seaton,  he                                                               
confirmed that all of the  upstream costs are subtracted from the                                                               
value and that is the gross value at the point of production.                                                                   
                                                                                                                                
MR. TANGEMAN explained that  for "netback" purposes determination                                                               
of the GVPP begins with the  destination value at the sales point                                                               
of the oil  or gas [slide 48].  The  determination allows for the                                                               
actual  cost  of transportation  except  when:   the  shipper  is                                                               
affiliated  with the  transportation  carrier;  the contract  for                                                               
transportation is  not an arms-length transaction;  or the method                                                               
of  transportation  is  "not  reasonable"  in  view  of  existing                                                               
alternatives.                                                                                                                   
                                                                                                                                
MR.  DEES,  responding  to   Representative  Gardner,  said  "not                                                               
reasonable"  would  be  a  situation such  as  a  pipeline  being                                                               
available to ship  the oil but instead the oil  was loaded onto a                                                               
car  and  driven to  Valdez.    He  said  that to  his  knowledge                                                               
something unreasonable has not happened.                                                                                        
                                                                                                                                
2:00:09 PM                                                                                                                    
                                                                                                                                
MR.  DEES, responding  to Representative  Dick, defined  an arms-                                                               
length transaction as being two  unaffiliated people executing an                                                               
exchange where  the agreed-to  price of that  exchange is  what a                                                               
reasonable  buyer or  seller would  do that  transaction for,  as                                                               
opposed  to dealing  with an  affiliate  where one  or the  other                                                               
[could influence the price or the cost].                                                                                        
                                                                                                                                
MR. TANGEMAN  added that if  it does not  appear to be  a market-                                                               
price transaction, it would not be arms-length.                                                                                 
                                                                                                                                
CO-CHAIR  SEATON  explained  the  concept  using  a  real  estate                                                               
example:   a  willing buyer  and a  willing seller  would be  the                                                               
market  value, while  selling  to one's  daughter  at half  price                                                               
would not be an arms-length transaction.                                                                                        
                                                                                                                                
2:02:05 PM                                                                                                                    
                                                                                                                                
MR. DEES, responding to Representative  Seaton, said the point of                                                               
production is  defined in AS  43.55.900.   For oil, the  point of                                                               
production is  before the inlet  of the pipeline connecting  to a                                                               
particular field;  the oil must  go through an  automatic custody                                                               
transfer meter, called a lack meter,  and that meter is the point                                                               
of production.   Under rules mandated  by the Alaska Oil  and Gas                                                               
Conservation  Commission (AOGCC),  each  field must  have a  lack                                                               
meter to measure the oil before it leaves the field.                                                                            
                                                                                                                                
2:05:04 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN,  continuing his presentation,  noted that  slide 49                                                               
spells out the actual statutory language for AS 43.55.150.                                                                      
                                                                                                                                
MR. TANGEMAN  next reviewed the  determination of  production tax                                                               
value  of  oil   and  gas  [slide  50],   explaining  that  lease                                                               
expenditures under  AS 43.55.165 "must  be upstream of  the point                                                               
of production; must be ordinary  and necessary costs of exploring                                                               
for, developing,  or producing oil  or gas;" and "must  be direct                                                               
costs of  exploring for,  developing, or  producing oil  or gas."                                                               
He said they  are adjusted by reimbursements  or similar payments                                                               
under AS 43.55.170, and also  noted that under AS 43.55.160(b) "a                                                               
production tax  value calculated  under this  section may  not be                                                               
less than zero."                                                                                                                
                                                                                                                                
2:06:05 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON requested  Mr. Tangeman  to distinguish  between                                                               
gross value at the point of production and production tax value.                                                                
                                                                                                                                
MR. TANGEMAN directed attention to  the income statement on slide                                                               
10 and explained that the gross  value at the point of production                                                               
is  the value  after  transportation costs  are subtracted;  from                                                               
this value the  lease expenditures are deducted to  arrive at the                                                               
production tax value.                                                                                                           
                                                                                                                                
REPRESENTATIVE  DICK asked  how  closely the  state monitors  the                                                               
cost numbers [that are provided by the companies].                                                                              
                                                                                                                                
MR.  TANGEMAN responded  that  the monthly  tax  payments are  an                                                               
estimate but in March the  company trues up the entire [previous]                                                               
12-month  year.   The state  then spends  90 days  confirming the                                                               
numbers,  after  which  the state  conducts  a  full-blown  audit                                                               
reviewing the details.  Hanging over  this for the entire time is                                                               
the  interest payment  clause, so  there  is incentive  to be  as                                                               
accurate as possible through each stage.                                                                                        
                                                                                                                                
2:08:31 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN,  responding to Co-Chair Seaton,  confirmed that the                                                               
gross  value  at the  point  of  production  is  not shown  on  a                                                               
specific  line on  slide 10,  but pointed  out that  it would  be                                                               
right after  the line for  total transportation costs  and before                                                               
the line for lease expenditures.                                                                                                
                                                                                                                                
2:10:06 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN  resumed his  presentation, moving  to slide  51 and                                                               
explaining that  lease expenditures are direct  costs "allowed by                                                               
the  department  by  regulation".    Regulation  15  AAC  55.250,                                                               
standards  for lease  expenditures other  than overhead,  defines                                                               
the  types  of  activities  for  which  direct  charges  will  be                                                               
allowed.  Responding to Co-Chair  Seaton, he confirmed that these                                                               
would be all  the lease expenditures.  Regulation  15 AAC 55.260,                                                               
direct charges,  defines the allowed  expenses for  activities in                                                               
15 AAC 55.250.                                                                                                                  
                                                                                                                                
2:11:02 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON surmised  this standard  for lease  expenditures                                                               
does not  have anything  to do  with the  limitation that  was in                                                               
place for the first three years on the allowable expenditures.                                                                  
                                                                                                                                
MR. DEES answered  the aforementioned reference is  to a standard                                                               
deduction that  was placed  on the legacy  fields based  on their                                                               
actual lease  expenditures in 2006.   These regulations  were not                                                               
in place  in 2006  so they  were not  really addressing  what was                                                               
allowable  as part  of that  calculation.   However, DOR  audited                                                               
those years  and found expenditures  it did not  think allowable.                                                               
Because 2006  was a  nine-month year,  statute allowed  for those                                                               
particular legacy  fields a deductible lease  expenditure of 1.37                                                               
times the number that was reached  for 2006.  The number for 2008                                                               
was  1.03.   So, the  number  grew by  an inflation  amount of  3                                                               
percent each  year until  2009, which  was the  last year  of the                                                               
standard deduction.   In further response, he  said the standards                                                               
in 15 AAC 55.250 do apply  eventually to what those expenses were                                                               
because DOR  did not  allow any activities  that were  not within                                                               
the parameters  of those standards.   These regulations  were not                                                               
in place  at the time  that those audits were  done, so in  a way                                                               
these  standards would  have been  what  DOR would  have used  to                                                               
determine what those numbers were for those years.                                                                              
                                                                                                                                
MR. TANGEMAN  interjected that  Sections 250  and 260  are actual                                                               
and extensive  listings of  items that are  allowed and  they are                                                               
post that timeframe.                                                                                                            
                                                                                                                                
2:15:10 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON inquired  whether the  combined direct  costs on                                                               
the  North Slope  are all  the  lease expenditures.   He  further                                                               
asked  how much  those direct  costs are;  for example,  how much                                                               
were those costs  for last year.  He understood  that 4.5 percent                                                               
of direct costs  are allowed for overhead given  that overhead is                                                               
not an allowed deduction.                                                                                                       
                                                                                                                                
2:16:53 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN believed  that was part of  the capital expenditures                                                               
shown  in  DOR's  Revenue  Sources  Book.   He  deferred  to  Ms.                                                             
Nienhuis for answering the question further.                                                                                    
                                                                                                                                
CHERYL  NIENHUIS,  Acting  Chief Economist,  Commercial  Analyst,                                                               
Anchorage  Office, Tax  Division,  Department  of Revenue  (DOR),                                                               
replied DOR  would probably  take a  percentage of  the operating                                                               
expenditures  because   the  overhead  is  the   4.5  percent  of                                                               
operating and capital expenditures.   She said she would get this                                                               
information for the committee.                                                                                                  
                                                                                                                                
MR. TANGEMAN, responding  to Co-Chair Seaton, agreed  to have DOR                                                               
go back for three years of this information.                                                                                    
                                                                                                                                
2:18:13 PM                                                                                                                    
                                                                                                                                
MR.  TANGEMAN,  continuing  his  review  of  lease  expenditures,                                                               
explained that direct costs include  charges for both capital and                                                               
operating expenses [slide  52].  He said  AS 43.55.023(o) defines                                                               
"qualified  capital expenditures"  as  an expenditure  that is  a                                                               
lease  expenditure   under  AS  43.55.165   and  that  it   is  a                                                               
capitalized   expenditure  under   the  Internal   Revenue  Code.                                                               
Because  DOR  relies on  the  federal  codes  there is  no  other                                                               
objective  or  defining  criteria  to  be  a  "qualified  capital                                                               
expenditure".  Moving to slide  53, he noted that exclusions from                                                               
lease expenditures are provided for under AS 43.55.165(e).                                                                      
                                                                                                                                
MR.  TANGEMAN, responding  to Co-Chair  Seaton, confirmed  that a                                                               
capitalized expenditure  under the  Internal Revenue  Code [slide                                                               
52] is not  capitalized in the state's system and  that the state                                                               
allows full  write off.   He  said [AS  43.55.023(o)] establishes                                                               
what is allowable.                                                                                                              
                                                                                                                                
2:19:42 PM                                                                                                                    
                                                                                                                                
MR.  TANGEMAN  returned  to  slide  53  and  related  that  lease                                                               
expenditures   include  an   exclusion  for   "that  portion   of                                                               
expenditures   that   would   otherwise  be   qualified   capital                                                               
expenditures" and reduces the  deduction for capital expenditures                                                               
by  $.30 times  the total  taxable production  for each  lease or                                                               
property in British Thermal Unit (BTU) equivalent barrels.                                                                      
                                                                                                                                
MR. DEES, responding to Co-Chair  Seaton, confirmed that the $.30                                                               
is applicable  to all  areas of  the state.   He said  it reduces                                                               
what otherwise  would be qualified  capital expenditures  by $.30                                                               
times the total production in  BTU equivalent barrels; so even in                                                               
an area that produces gas, the  taxpayer will have to convert the                                                               
gas to a  BTU equivalent barrel and multiply it  by $.30 and that                                                               
figure  will be  deducted  from the  total capital  expenditures.                                                               
While the reason  for this exclusion depends on  the person being                                                               
talked to, some suggest it was  done to allow for a deduction for                                                               
deferred maintenance in  the field, recognizing that  some of the                                                               
expenditures a company has could be for maintenance items.                                                                      
                                                                                                                                
2:22:14 PM                                                                                                                    
                                                                                                                                
MR.  TANGEMAN  resumed  his  definition  of  lease  expenditures,                                                               
stating that  in Cook  Inlet each  lease or  property (LOP)  is a                                                               
segment  [slide  54]  and  on  the  North  Slope  all  leases  or                                                               
properties are  segments.  "Both  statute and  regulation require                                                               
that costs are ring fenced to  each segment.  A single production                                                               
tax value must  be calculated for each segment  within the state.                                                               
The provision  of [AS] 43.55.160(b)  that a production  tax value                                                               
may not  be less than zero  applies to each production  tax value                                                               
calculated for each segment," he explained.                                                                                     
                                                                                                                                
MR.  DEES, responding  to Co-Chair  Seaton,  explained that  each                                                               
lease  or property  and each  product  on a  particular lease  or                                                               
property is a  segment.  For example, a lease  or property within                                                               
Cook  Inlet  that  produces  both  oil and  gas  would  have  two                                                               
segments,  so the  cost would  have to  be allocated  to each  of                                                               
those products on the basis of  BTU equivalent barrels and then a                                                               
production  tax  value would  be  calculated  for each  of  those                                                               
segments.   For a  particular taxpayer  the overall  excess lease                                                               
expenditures are  determined on a  Cook Inlet-wide basis,  so the                                                               
ring  fence in  Cook Inlet  is on  a Cook  Inlet-wide basis.   To                                                               
determine  whether a  taxpayer with  10  different properties  in                                                               
Cook Inlet had excess lease  expenditures, all 10 of those leases                                                               
or properties would  be considered.  Responding  to Mr. Tangeman,                                                               
he confirmed that in this  example there would be 20 calculations                                                               
- one for gas  and one for oil for each of the  10 segments - and                                                               
then these calculations  would be taken as a whole  for the lease                                                               
expenditures.                                                                                                                   
                                                                                                                                
2:25:11 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON inquired  whether this  is a  holdover from  the                                                               
economic  limit factor  (ELF) where  the less  the volume  from a                                                               
segment or a  property the less the tax, so  a taxpayer holding a                                                               
lot of segments did not pay any taxes.                                                                                          
                                                                                                                                
MR. DEES offered his belief that this  is the case.  He said that                                                               
under ELF  there were  separate economic  limit factors  for each                                                               
product; thus there  was an ELF for  oil and an ELF for  gas.  To                                                               
keep Cook  Inlet from  having a  tax increase  under the  new net                                                               
tax, the integrity of those  segments was maintained to determine                                                               
the tax ceilings and to prevent the tax increase.                                                                               
                                                                                                                                
2:26:23 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON stated  that  the economic  limit  factor was  a                                                               
factor based on  the total production in a field  and the average                                                               
production  per  well   in  that  field;  so,   the  smaller  the                                                               
production in  a field the  less tax paid  and the more  wells in                                                               
the field the lower  the tax on that field.   Given the tax rates                                                               
in Cook  Inlet, he asked whether  there really is any  tax effect                                                               
of having  these segments  since the  inlet is  ring fenced.   He                                                               
also  asked  whether this  complicated  tax  system is  currently                                                               
serving a purpose.                                                                                                              
                                                                                                                                
MR. TANGEMAN  replied that things  were locked in when  the state                                                               
went to  this system.   Either existing production was  locked in                                                               
based on the  previous 12 months or new production  was locked in                                                               
based on the calculation with $.177.                                                                                            
                                                                                                                                
MR.  DEES verified  that for  Cook Inlet  all these  calculations                                                               
must be  done to  determine that basically  the taxpayer  owes no                                                               
tax.  All  the calculations must be done for  all the segments to                                                               
determine whether  there are excess lease  expenditures or excess                                                               
tax credits that could be used in  another area of the state.  He                                                               
concurred there is  a lot of complexity in Cook  Inlet that could                                                               
be simplified.                                                                                                                  
                                                                                                                                
CO-CHAIR SEATON  commented that this complexity  may be something                                                               
to  look  at  since  the  result is  zero  tax,  making  all  the                                                               
calculations useless.                                                                                                           
                                                                                                                                
2:30:49 PM                                                                                                                    
                                                                                                                                
MR.  TANGEMAN returned  to his  overview  of lease  expenditures,                                                               
noting that segments  would be identified under  15 AAC 55.206(c)                                                               
[slide 55].   Moving to slide 56 he pointed  out that in addition                                                               
to  the oil  and  gas  production tax  under  AS 43.55.011(e),  a                                                               
producer  must  also pay  the  following  surcharges:   $.01  per                                                               
taxable barrel  of oil from each  lease or property in  the state                                                               
[AS  43.55.201] and  $.04 per  taxable  barrel of  oil from  each                                                               
lease or  property in the  state [AS  43.55.300].  He  noted that                                                               
"the  legislature may  appropriate  these funds  to the  response                                                               
account  in   the  oil  and   gas  hazardous   substance  release                                                               
prevention and response fund established by AS 46.08.010."                                                                      
                                                                                                                                
2:32:24 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE GARDNER asked  what the current balance  is of the                                                               
aforementioned fund  and whether that  balance is adequate  for a                                                               
possible need.                                                                                                                  
                                                                                                                                
MR.  TANGEMAN offered  to get  back  to the  committee with  this                                                               
figure.                                                                                                                         
                                                                                                                                
MR. TANGEMAN,  responding to Representative  P. Wilson,  said the                                                               
two  surcharges  apply  to  taxable  barrels  after  the  royalty                                                               
barrels  are taken  out; thus,  the total  surcharge per  taxable                                                               
barrel is $.05.                                                                                                                 
                                                                                                                                
MS.  NIENHUIS,  responding  to   Co-Chair  Seaton,  related  that                                                               
according  to  DOR's  Revenue  Sources   Book  the  AS  43.55.201                                                             
surcharge of $.01 is called  the "response surcharge" and the [AS                                                               
43.55.300] surcharge of $.04 is  the "prevention surcharge".  She                                                               
said the $.01 per barrel  surcharge is suspended when the state's                                                               
response  account equals  or exceeds  $50 million  and since  the                                                               
account's  current balance  is  about $48  million  the state  is                                                               
still  collecting the  entire  $.05.   In  further response,  Ms.                                                               
Nienhuis reported  that the response  account is  administered by                                                               
the Department of Environmental Conservation (DEC).                                                                             
                                                                                                                                
2:35:26 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  SEATON concurred  with Representative  Herron that  the                                                               
committee will  probably want to  look at whether $50  million is                                                               
adequate for  oil spill prevention and  response, given inflation                                                               
over  the years.   In  further response,  Co-Chair Seaton  stated                                                               
that DEC will  be asked to address the committee  about the fund.                                                               
He  surmised  that  DOR's  responsibility is  only  to  make  the                                                               
calculations and to put the money into the fund.                                                                                
                                                                                                                                
MS. NIENHUIS confirmed that DOR's  responsibility is to track the                                                               
fund balance.   She  said DOR receives  notification of  the fund                                                               
balance  so  the  department  knows when  to  suspend  or  resume                                                               
charging that  penny per barrel.   She  added that the  penny per                                                               
barrel only  went into place again  in 2007.  While  DOR monitors                                                               
the  fund's balance  and has  occasional  conversations with  DEC                                                               
about  the fund,  she said  DOR  has little  influence over  that                                                               
money.                                                                                                                          
                                                                                                                                
2:37:49 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  MUNOZ  thanked  the  Department  of  Revenue  for                                                               
providing graphs  depicting the scenarios of  profit splits under                                                               
HB  110  and  SB  192  [8 slides  produced  in  response  to  the                                                               
committee's request  to reproduce slide  number's 22 and  23 from                                                               
DOR's 3/21/12  presentation to reflect absolute  profit split and                                                               
share of profit  under HB 110 and  CSSB 192].  She  asked why the                                                               
federal  tax  increases  in  the scenarios  when  the  state  tax                                                               
decreases.                                                                                                                      
                                                                                                                                
MR. TANGEMAN responded  that as the producer  share increases the                                                               
producer  is keeping  more of  the  revenue, so  the producer  is                                                               
responsible to pay [federal tax].                                                                                               
                                                                                                                                
REPRESENTATIVE MUNOZ  asked whether all  of the scenarios  in the                                                               
aforementioned graphs  take into account the  credits provided to                                                               
the producers by the state.                                                                                                     
                                                                                                                                
MS.  NIENHUIS answered  the graphs  take into  account the  lease                                                               
expenditures and  the oil  that is  being produced  and therefore                                                               
the  credits  that are  taken  against  tax liability.    Credits                                                               
generated by  companies that  are not  applying those  credits to                                                               
the tax liability are handled  through the budget cycle, so those                                                               
credits are not included in the graphs.                                                                                         
                                                                                                                                
MR. TANGEMAN  clarified that not  included in the graphs  are the                                                               
explorers that do not yet have a tax liability.                                                                                 
                                                                                                                                
2:39:52 PM                                                                                                                    
                                                                                                                                
MR. TANGEMAN,  responding to Co-Chair Seaton,  confirmed that the                                                               
graphs for HB 110  are calculated on old, not new,  oil.  He said                                                               
they are based  on the fall forecast, both  production and price,                                                               
so DOR is  not assuming any hypothetical new  production based on                                                               
any bill passing.                                                                                                               
                                                                                                                                
2:43:01 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE P.  WILSON, requested  Mr. Tangeman to  expound on                                                               
the difference  between absolute  profit split  and the  share of                                                               
profit.                                                                                                                         
                                                                                                                                
MR. TANGEMAN  explained that DOR  had originally used slide  7 as                                                               
looking  at   just  the  percentage  split,   but  then  received                                                               
questions about what the dollar split  would look like.  So slide                                                               
4 [of  the 8  slides] is  purely the dollar  impact as  the price                                                               
progresses upward.  Slides 6 and  7 depict a percentage split, so                                                               
it is just two different ways to look at it.                                                                                    
                                                                                                                                
CO-CHAIR SEATON observed  from the graphs that  the producers are                                                               
always  making more  money as  the price  rises.   While slide  7                                                               
shows that the producers' percentage  may go down, they are still                                                               
making more  money in absolute terms.   He pointed out  that when                                                               
Alaska's share increases, that amount  is deductible from federal                                                               
taxes;  when the  state's share  is reduced,  35 percent  of that                                                               
reduction goes  to the  federal government  because that  is then                                                               
profit to  the producer.  The  state only taxes profits,  so when                                                               
$100 million is shifted from the  state, $35 million of that goes                                                               
to the federal government.                                                                                                      
                                                                                                                                
2:46:04 PM                                                                                                                    
                                                                                                                                
MS. NIENHUIS,  responding to Co-Chair Seaton,  confirmed that the                                                               
graphs on these  8 slides include royalty,  corporate income tax,                                                               
and property tax - so they include all the state revenues.                                                                      
                                                                                                                                
CO-CHAIR  SEATON  requested  the  graphs be  redone  without  the                                                               
royalty  because  in other  states  the  royalty is  private  and                                                               
private  royalties are  not computed  into the  government share,                                                               
which makes  it hard to  do comparisons between Alaska  and other                                                               
states.                                                                                                                         
                                                                                                                                
MR. TANGEMAN said  this could be done, but advised  that it would                                                               
skew the producers' share because  a producer in another state is                                                               
paying a  royalty.  Whether that  royalty goes to the  state or a                                                               
private  landowner, it  is still  a  payment that  a producer  is                                                               
making.                                                                                                                         
                                                                                                                                
CO-CHAIR  SEATON  pointed out  that  what  is being  compared  is                                                               
government take,  so it  does not matter  whether the  royalty is                                                               
being paid to the  State of Alaska or someone else.   So when the                                                               
12.5 Alaska royalty is included in  the graphs it does not depict                                                               
the  same  tax  consequences  seen in  another  state  where  the                                                               
royalties  are not  included  because they  are  paid to  private                                                               
entities.   He  would like  to be  able to  compare Alaska's  tax                                                               
system with another state's tax system.                                                                                         
                                                                                                                                
MR. TANGEMAN believed DOR has  produced charts that break out the                                                               
state's  four  revenue  streams  and said  he  will  provide  the                                                               
committee with them.                                                                                                            
                                                                                                                                
2:49:41 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  GARDNER  added  that most  informative  would  be                                                               
charts comparing Alaska  to other regimes with  the royalty added                                                               
to  that -  but not  as government  take -  so committee  members                                                               
could see how  industry take in Alaska compares  to industry take                                                               
elsewhere, given  that royalty  in other states  can be  twice as                                                               
much as it is in Alaska.                                                                                                        
                                                                                                                                
REPRESENTATIVE  P.  WILSON  commented  it  is  unknown  what  the                                                               
private royalty take is because it is a private contract.                                                                       
                                                                                                                                
CO-CHAIR  SEATON  concurred,  but  said it  is  known  from  some                                                               
landowners  that those  landowners  are  receiving 25-30  percent                                                               
royalty.   He allowed  that this amount  varies; for  example, in                                                               
Kansas certain landowners are receiving 16 percent.                                                                             
                                                                                                                                
MR. TANGEMAN pointed  out that today's presentation  was based on                                                               
current statutes,  so DOR will  need some direction from  the co-                                                               
chairs on  what the  committee would  like for  additional graphs                                                               
when there is another bill.                                                                                                     
                                                                                                                                
CO-CHAIR SEATON said the committee is currently asking for                                                                      
charts that DOR has already prepared now.                                                                                       
                                                                                                                                
2:51:58 PM                                                                                                                    
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
There being no further business before the committee, the House                                                                 
Resources Standing Committee meeting was adjourned at 2:52 p.m.                                                                 

Document Name Date/Time Subjects
DOR.H.RES.Presentation.3.21.12.pdf HRES 3/23/2012 1:00:00 PM
HRES 3.21.12 Credits Table.pdf HRES 3/23/2012 1:00:00 PM
HRES 3.21.12Credits Summary.pdf HRES 3/23/2012 1:00:00 PM