Legislature(1993 - 1994)
05/13/1994 09:00 AM STA
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HOUSE STATE AFFAIRS STANDING COMMITTEE May 13, 1994 9:00 a.m. MEMBERS PRESENT Representative Al Vezey, Chairman Representative Pete Kott, Vice Chairman Representative Jerry Sanders Representative Fran Ulmer Representative Gary Davis Representative Bettye Davis Representative Harley Olberg MEMBERS ABSENT None OTHER LEGISLATORS PRESENT Representative Gail Phillips Representative Cliff Davidson Representative Brian Porter Representative Joe Green Representative John Davies Representative Jim Nordlund Representative Jeannette James Representative Bill Hudson Representative Joe Sitton Representative Con Bunde Representative Gene Therriault Representative Tom Brice COMMITTEE CALENDAR SB 377: "An Act relating to state agency fiscal procedures, including procedure related to the assessment and collection of certain taxes; and providing for a effective date." HEARD AND HELD WITNESS REGISTER BRUCE BOTELHO, Attorney General State of Alaska Department of Law P.O. Box 110300 Juneau, Alaska 99811-0300 Phone: 465-3600 POSITION STATEMENT: Testified in favor of SB 377 SPENCER HOSIE, Legal Counsel for the Department of Law 510 L Street Anchorage, Alaska 99501 Phone: None Given POSITION STATEMENT: Testified in favor of SB 377 RICHARD BREWER, Assistant Director, Technical Oil and Gas Audit Division Department of Revenue 15021 Longbow Anchorage, Alaska 99516 Phone: 276-1363 POSITION STATEMENT: Testified in favor of SB 377 PAUL SULLIVAN, General Tax Counsel Exxon Corporation, USA 240 Main Street Juneau, Alaska 99801 Phone: 463-2577 POSITION STATEMENT: Testified in opposition to SB 377 PREVIOUS ACTION BILL: SB 377 SHORT TITLE: STATE AGENCY FISCAL PROCEDURES SPONSOR(S): FINANCE JRN-DATE JRN-PG ACTION 04/13/94 3633 (S) READ THE FIRST TIME/REFERRAL(S) 04/13/94 3633 (S) FINANCE 04/13/94 3650 (S) FIN WAIVED UNIFORM RULE 23 04/14/94 (S) FIN AT 09:00 AM SENATE FIN 518 04/20/94 (S) RLS AT 06:45 PM FAHRENKAMP ROOM 203 04/21/94 3839 (S) FIN RPT CS 6DP 1DNP SAME TITLE 04/21/94 3839 (S) FN TO SB & CS PUBLISHED (ADM) 04/21/94 3839 (S) ZERO FN TO SB & CS PUBLISHED (REV) 04/21/94 (S) FIN AT 10:00 AM SENATE FIN 518 04/21/94 (S) RLS AT 2:15 PM FAHRENKAMP RM 203 04/22/94 3870 (S) RLS RPT 3CAL 1NR 4/22/94 04/22/94 3876 (S) READ THE SECOND TIME 04/22/94 3877 (S) FIN CS ADOPTED Y12 N8 04/22/94 3877 (S) AM NO 1 MOVED BY KERTTULA 04/22/94 3882 (S) QUESTION: AM NO 1 GERMANE? 04/22/94 3883 (S) AM NO 1 GERMANE Y17 N3 04/22/94 3883 (S) AM NO 1 ADOPTED Y14 N6 04/22/94 3883 (S) AM NO 2 MOVED BY DONLEY 04/22/94 3884 (S) AM NO 2 FAILED Y9 N11 04/22/94 3884 (S) ADVANCED TO THIRD READING UNAN CONSENT 04/22/94 3884 (S) READ THE THIRD TIME CSSB 377(FIN) AM 04/22/94 3884 (S) PASSED Y16 N4 04/22/94 3885 (S) EFFECTIVE DATE PASSED Y17 N3 04/22/94 3885 (S) Pearce NOTICE OF RECONSIDERATION 04/22/94 3885 (S) TAKE UP RECON ON SAME DAY WITHDRAWN 04/22/94 3937 (S) RECON TAKEN UP SAME DAY Y18 N2 04/22/94 3937 (S) PASSED ON RECONSIDERATION Y16 N4 04/22/94 3938 (S) EFFECTIVE DATE SAME AS PASSAGE 04/22/94 3941 (S) TRANSMITTED TO (H) 04/27/94 3746 (H) READ THE FIRST TIME/REFERRAL(S) 04/27/94 3747 (H) STA, O&G, JUDICIARY, FINANCE 05/07/94 (H) STA AT 08:00 PM CAPITOL 102 05/07/94 (H) MINUTE(STA) 05/08/94 (H) MINUTE(STA) 05/13/94 (H) STA AT 09:00 AM CAPITOL 519 05/14/94 (H) STA AT 09:00 AM CAPITOL 519 05/15/94 4412 (H) STA RPT HCS(STA) 1DP 4NR 2AM 05/15/94 4413 (H) DP: VEZEY 05/15/94 4413 (H) NR:SANDERS,OLBERG,G.DAVIS,ULMER 05/15/94 4413 (H) AM: B.DAVIS, KOTT 05/15/94 4413 (H) -PREV SENATE ZERO FN (REV) 4/21/94 05/15/94 4413 (H) REFERRED TO O&G 05/15/94 4413 (H) O&G REFERRAL WAIVED 05/15/94 4414 (H) JUD REFERRAL WAIVED 05/15/94 4414 (H) FIN REFERRAL WAIVED 05/15/94 4414 (H) RULES TO CALENDAR 5/15/94 05/15/94 4415 (H) READ THE SECOND TIME 05/15/94 4415 (H) STA HCS ADOPTED UNAN CONSENT 05/15/94 4415 (H) AMENDMENT NO 1 BY VEZEY 05/15/94 4415 (H) AMENDMENT NO 1 ADOPTED UNAN CONSENT 05/15/94 4416 (H) AMENDMENT NO 1-A BY VEZEY 05/15/94 4416 (H) AMENDMENT NO 1A ADOPTED UNAN CONSENT 05/15/94 4416 (H) AMENDMENT NO 2 BY B.DAVIS 05/15/94 4416 (H) AMENDMENT TO AMENDMENT NO 2 BY VEZEY 05/15/94 4417 (H) AM TO AM NO 2 ADOPTED UNAN CONSENT 05/15/94 4417 (H) AM NO 2 AS AMENDED ADOPTED Y24 N14 E2 05/15/94 4418 (H) AMENDMENT NOS 3-5 NOT OFFERED 05/15/94 4418 (H) ADVANCED TO THIRD READING UNAN CONSENT 05/15/94 4418 (H) READ THE 3RD TIME HCS CSSB 377(STA) AM H 05/15/94 4418 (H) FAILED PASSAGE Y15 N23 E2 05/15/94 4419 (H) ULMER NOTICE OF RECONSIDERATION 05/16/94 4437 (H) RECON TAKEN UP/IN THIRD READING 05/16/94 4438 (H) RECONSIDERATION FAILED Y18 N21 E1 05/16/94 4438 (H) MOTION TO RESCIND PREV ACTION IN FLNG TO 05/16/94 4438 (H) ...ADOPT HCS CSSB 377(STA) AM H(FLD H) 05/16/94 4439 (H) RESCIND PREVIOUS ACTION FLD Y15 N24 E1 05/19/94 (H) RETURNED TO SENATE 05/19/94 (S) PERMANENTLY FILED IN THE (S) ACTION NARRATIVE TAPE 94-60, SIDE A Number 000 SB 377 - STATE AGENCY FISCAL PROCEDURES CHAIRMAN AL VEZEY called the meeting to order at 9:00 a.m. and stated the committee would be taking up SB 377. He said, "I realize that everything came together here on very short notice, and we're trying to make some order out of the confusion, but the intent here is that we would take testimony today - perhaps tomorrow - we don't know how long from agency personnel, and some industry personnel. The intent right now is that we will take testimony from four people from state agencies and four people from the industry. Now this schedule is flexible, but it is the opinion of the Chairman that that is a reasonable amount of technical and competent testimony on this subject. There have been previous hearings and there certainly have been lots of public input in the form of POMs (public opinion messages) and letters, et cetera and telephone calls (indiscernible) of the meeting is primarily to get down to the subject matter, technical aspects of it, the legal aspects of it, and just the general public policy. I see we have Mr. Bruce Botelho with us, and I'm expecting Mr. Darrel Rexwinkel. Mr. Botelho, I don't want to tell the state really who their four witnesses would be. I think that you would probably - would you like to join us at the table here - I think that you would probably agree that four is a reasonable number to cover the subject and to avoid - and we don't need to get into repetitive testimony, but I certainly want to be flexible as to who those four are and certainly, I anticipate that you would be one of them." BRUCE BOTELHO, ATTORNEY GENERAL, ALASKA DEPARTMENT OF LAW: "Thank you, Mr. Chairman and if with the Chairman's indulgence, I know that Commissioner Rexwinkel was called at the last minute to speak with the Governor. I expect that accounts for his delay right now. We are certainly prepared to speak, and I believe that your allowing us as many as four persons to testify will adequately serve the state's interest here." Number 055 REPRESENTATIVE GAIL PHILLIPS: "Mr. Chairman, before we start, are we on listen-only teleconference across the state?" CHAIRMAN VEZEY: "We're not on any teleconference, that I'm aware of." REPRESENTATIVE CLIFF DAVIDSON: "Also, I'd like to question, if I may, after the legal and technical input or testimony, will the general public have any opportunity at all during these proceedings, today or tomorrow, to..." CHAIRMAN VEZEY: "It's not my intent to take general public testimony, at this time. We will be flexible on that - we can change it, but the intent really is to talk to the agencies and to the industry and to answer problems that are more a problematic, technical, legal nature." REPRESENTATIVE DAVIDSON: "So, what would change that you would envision public testimony coming?" CHAIRMAN VEZEY: "If there was great desire on the part of the legislature, on the part of the committee, to extend these hearings, we can extend them as long as the legislature would like. And with that, Mr. Botelho, would you care to - and I understand that you have testified before the State Affairs Committee before. We have additional people sitting at the table and I'd just like to try to assume that we're starting from ground zero again and not assume that people have heard testimony previously." MR. BOTELHO: "Thank you Mr. Chairman, and Chairman Porter, and Chairman Green. It is again a pleasure to have this opportunity to testify once again on Senate Bill 377 and I want to express, particularly, my appreciation for your willingness to devote such time to an issue of great statewide importance and import. I'd like, with your permission Chairman Vezey, to ask Spencer Hosie, our chief attorney, dealing with statutes of limitations, to join me at the table." CHAIRMAN VEZEY: "Certainly. Please state his name and affiliation for the record." SPENCER HOSIE: "Good morning, Mr. Chairman. My name is Spencer Hosie and I'm counsel for the Department of Law." Number 096 MR. BOTELHO: "Mr. Chairman, let me begin by noting that the May 10 draft that you have before you, is one that is dramatically different than the bill, Senate Bill 185, that was originally introduced by Senator Robin Taylor in April of last year." Number 103 CHAIRMAN VEZEY: "If I may interrupt, the document that the attorney general is referring to, is a cover letter of a sectional analysis, the memorandum is dated May 10 - three pages of sectional analysis followed by a (indiscernible) House Committee Substitute for SB 377, Version X, dated May 10, 1994." Number 111 MR. BOTELHO: "Thank you Mr. Chairman, for that clarification for the record. Let me speak briefly to this draft and the origins of this draft, because I think it's important to recognize that it is a substantially different document than had been debated initially in the Senate and (indiscernible) transmitted to this body a month ago. The version which was transmitted, Committee Substitute for SB 377 amended on the floor, is one that retains extensive legislative findings and validated, in essence, the interpretation of the Departments of Revenue and Law with respect to both the three-year statute of limitations on assessments and the six-year statute of limitations on collections. But it had one feature which made it different, and again I'm talking only about the oil and gas portions of the bill, I'm not addressing the prorata provisions of SB 377. It had one other feature that was different than Senate Bill 185 and that provision was - again, in recognition of the concern (indiscernible) from industry about the lack of finality in the assessment process - that beginning with this tax year, 1994, taxpayers could rely on the fact that if the Department of Revenue had not completed its assessment process within those five years; that is, done an initial assessment, filed any number of amended assessments within five years, after that five year period, the Department of Revenue was, at that point, barred from issuing any amended assessments whose affect was to raise the amount at issue. That was the bill that was presented to this body. Mr. Chairman, you have conducted, I believe, two hearings as the Chair of the House State Affairs Committee, on this bill and there have been extensive discussions coordinated by the Speaker of this body, with representatives of industry and the administration, and as a consequence, the bill, Draft X, before you today, reflects those discussions. In addition to the statute of limitations issues, you'll find divisions dealing with gas liquids, a methodology for determining oil valuation prospectively, you will find further references to royalty settlements as a basis for tax payments in the Cook Inlet, dealing with urea and ammonia. Those are the primary differences that are reflected in this bill. I now turn to Mr. Hosie to give a more extensive background on the bill and what it will do for the state and for the industry. Mr. Hosie." Number 174 MR. HOSIE: "Thank you. As the attorney general mentioned, I serve as counsel for the state in connection with the statute of limitations case, now pending in the Alaska Supreme Court. Before I turn to the specifics of this piece of legislation, Senate Bill 377, I'd like to take a minute or two to describe the issue pending in that Supreme Court appeal and the process and (indiscernible) that gave rise to this piece of legislation. Now the issue before the Supreme Court actually can be put in fairly straightforward fashion. Can a tax assessment that has been issued before the three- year statute of limitations has expired, be amended after that three-year statute of limitations has expired? The state says yes, the taxpayers say no. You can amend after the three year period only if the amendment reduces the amount of tax claimed; that is, changes are proper, but only if they cut in the taxpayer's favor. That is the issue before the Supreme Court. "Now how does this amendment problem arise? Well, the process of assessing and collecting taxes begins with the tax assessment, itself. And a tax assessment is a formal legal document very similar to a complaint that initiates a civil lawsuit. A lawsuit for breach of contract, or an automobile accident, or fraud. It is a formal document and it starts a dispute resolution process. It's an adjudicatory process that will resolve the differences between the Department of Revenue on the one hand, and the taxpayers on the other hand. That equivalency, the parallel between a tax assessment on the one hand, and a civil complaint on the other hand, was one of the principal reasons the Supreme Court ruled as it did in the recent Budget Reserve Fund. Now, after the tax assessment is issued, the parties continue with the process of discovery. And the auditors for the Division of Revenue get the company's documents, and they read them, and they talk to witnesses, and they think about what they've learned, and through that process they often develop additional facts and a more complete understanding of the tax issues and the tax sums owed. And occasionally, those additional facts and that greater understanding prompts the division to amend the assessment and herein, the problem. The industry says that those amendments are not proper after the three year period has run, even though the assessment was issued for, if they serve to increase the tax. Now, if these were just every day garden variety civil suits, there would not be an issue and it would be absolutely clear that amendments are proper. In this state, as in every other state, as in the federal system, it's proper to amend a complaint after the statute of limitations has run, so long as the amendment relates back to the same general issues already in dispute. It's a doctrine called the `relation back doctrine,' that is, the amendments relate back to the initial filing. And the logic of the rule is this: If the parties are already fighting about something, if the matters are already in dispute, you shouldn't be surprised by amendments, after all you should expect them - you're already in a fight. Let me give an example from our everyday experience that some of us may have experienced, to our chagrin. Assume you were in an automobile accident, and you took your car in to get repairs, and you picked it up at the shop and you drove it for awhile and you realized that the work had been done badly; that the car really wasn't fixed and you concluded that the garage owed you some money. And you went down and talked to them, and they really weren't much interested in hearing you out or giving you back your money. So eventually, angry and frustrated, you join the litigation explosion and you file a lawsuit. And after you filed the lawsuit, using a complaint, you got the garage's documents. And lo and behold, you discover that the parts they put in the car - parts that you were told were new - were in fact used. You're outraged by this, and so you amend your complaint to seek additional damages. You amend your complaint to conform to the new facts discovered. In Alaska, as in every other jurisdiction, that amendment is proper even if it comes after the statute of limitations. Why? Because it relates back. After all, you're already in a dispute with the garage about the integrity of the repair work and who owes whom how much money. No surprise in an amendment in an ongoing fight. And that's the issue in the Supreme Court; should the state in the tax context be denied the benefits of this relation back doctrine, which apply in every other garden variety suit in Alaska and elsewhere. "It's probably a good time now to turn to the specifics of Senate Bill 377 and explain how the various provisions of this piece of legislation address the problem that I outlined very briefly. And please let me invite questions at any point. Section 1..." Number 265 CHAIRMAN VEZEY: "Mr. Hosie, since you had asked for questions, most importantly, could you spell your name for us?" MR. HOSIE apologized for not doing so before, and spelled his name for the record. Number 275 CHAIRMAN VEZEY: "You have made several examples of statute of limitations, but under current Alaska statutes, what is the statute of limitations on fraud?" MR. HOSIE: "The statute of limitations on fraud would be three years from the date of discovery. And so, if you uncovered a fraud you would have three years from the date of your discovery to file a lawsuit. And if you didn't, you'd lose your right to sue." CHAIRMAN VEZEY: "So, how does this interrelate to the three years under Alaska Statute 43.05.230?" Number 287 MR. HOSIE: "Well, there are, I guess, two parallels. First, the principal statute of limitations in the tax area simply gives you three years to get your assessment out. There is no statute of limitations in the case of fraud or an intent to evade tax. And so, if a taxpayer's discovered to have committed fraud, or has exhibited an intent to evade tax, the statute of limitations doesn't apply. And so that's the parallel between the fraud statute of limitations and its application in the taxing context." CHAIRMAN VEZEY: "So if a taxpayer commits, then the three years that we're talking about is inapplicable - there's no limitations." MR. HOSIE: "That's exactly right." CHAIRMAN VEZEY: "We're not talking fraud, we're talking audits and differences of opinion." MR. HOSIE: "We're talking normal audits with the normal discovery process with the unearthing of additional facts and new information that do not involve fraud, because if it does, as you pointed out, Mr. Chairman, the statute does not apply at all." CHAIRMAN VEZEY: "Thank you." Number 292 REPRESENTATIVE DAVIDSON: "Mr. Hosie, so the nature of the new information, why (indiscernible) of the types of new information that would affect the amount of taxes owed or that would change the assessment and why wouldn't that information not have been available earlier when the state made the effort to assess the tax obligation?" MR. HOSIE: "I'd be happy to, Representative Davidson. Let me cite an example from the now pending Exxon case in the Supreme Court. One of the issues in the tax case is the proper amount of a tanker transportation deduction. The oil, as most of you probably know, is not refined in Alaska for the most part, but is moved to various downstream markets and destinations where it's there refined. To calculate the value of that oil in Alaska for both royalty and tax purposes, you need to conduct a net back; that is, subtract the transportation charges from the downstream market value. One principal point of contention over the years has been how you do that. One of the issues in that general area has been whether the companies get a return on investment for the use of their tankers; that is, should they be compensated for the investment they've made in their tankers. And one of the sub-issues there, is how you take into account federal tax credits that the taxpayers got in using their vessels. That sounds like a complicated example, but it's typical of the kind of issues that arise in these audits. (Indiscernible) complicated issues and that's one reason these things take as long as they do to resolve. And so, there's this federal tax credit issue - how do you handle the company's federal tax credits. It takes a long time to realize that it's an issue, to realize that there are federal tax credits out there and that they apply to these vessels and that they might (indiscernible) to change the return on investment credit of the company's (indiscernible). That involves factual issues, how many federal tax credits can you specifically tie to the vessels, in which years were they gained, in which years were they used and legal questions. Are they properly served, are they properly used, or is it something that the state of Alaska really can include in its tax calculations. If they are used, do you use them all at once, or do you spread them over a number of years, do you spread them over the useful life of the vessel, et cetera. So that's the kind of thing that's discovered through this auditing process. It just takes a long time to (a) understand the facts and (b) (indiscernible) apply the tax to the theories and the legal doctrine.." (indiscernible due to background noise on tape.) CHAIRMAN VEZEY: "Please proceed, Mr. Hosie. Representative Porter, did you want to ask a question?" REPRESENTATIVE PORTER: "Thank you, Mr. Chairman. In your discussion of the Exxon case, obviously you're appealing a ruling in the Superior Court, was the ruling in the Superior Court - did it address the, in your opinion, of the relation back doctrine, as it would apply to this case." MR. HOSIE: "It did not, Representative Porter. That was a very short opinion and it simply held that the statute, AS .260, the three-year statute of limitations, on its face, required that the assessments be, both start within three years and rendered final within three years. That was the impact and the effect of that decision. Judge Cranston, the author of the decision, did not specifically address relation back, nor did he discuss other issues that had been addressed at the hearing level and were captured in the hearing officer's decision. Notwithstanding that, the parties agree that the applicability of the relation back doctrine is one of the key things the Supreme Court is going to have to address and, in fact, it was the state's first point for appeal and its first issue in the state's brief." REPRESENTATIVE PORTER: "You don't interpret then that the Superior Court decision rejected this (indiscernible) situation to apply to the relation back theory." MR. HOSIE: "I think that the Superior Court didn't consider it. And I think it should have. And I am quite positive that the Supreme Court will consider it because, I think, that is the dispositive issue in this case. And from the briefs filed both by the state and Exxon, I think that it's fair to say that the parties agreed that that's the dispositive in the case. Judge Cranston, the author of the opinion below, simply looked at the statute and said, `It means what it says, and it says what it means,' and therefore there's no amendments. He basically held that the statute was unambiguous, but the statute doesn't say a thing about amendments, never even mentions the word, doesn't say a thing about relation back. It's absolutely silent on that point. And if you look at the legislative history for the three year statute, you see it described as a housekeeping bill. And you see that it was estimated at having zero fiscal impact, so there's nothing in the legislative record that would suggest that the legislature consider this relation back issue in passing this housekeeping bill. The statute is silent, the legislative history is silent, and it's that silence that gives rise to an ambiguity." MR. BOTELHO: "It might be also important, Mr. Chairman, to point out that if you look at the other statutes of limitation found in the Code of Civil Procedure of the state, which you enacted, you will find no mention of relation back, and yet that doctrine is one that is universally accepted. Of the statutes that deal particularly with tax matters found in Title 43, which don't mention it either, are entirely consistent with the other statutes of limitation, whether they're for contract or for tort, again make no reference, and yet it is a universally accepted doctrine, now reflected in the Rules of Court of the Supreme Court, Civil Rule (indiscernible)." CHAIRMAN VEZEY: "Thank you. Representative Green." Number 387 REPRESENTATIVE GREEN: "Thank you, Mr. Chairman. Your example, I know we've talked about the fraud already, but your example of the relation back doctrine in this car repair case, there was fraud included there. Does relation back only apply to fraud cases?" MR. HOSIE: "No, it applies to all civil cases. It's a general common law doctrine that pre-existed the Rules of Court in Alaska. It was captured in Rule 15(c) of the Rules of Court when they were promulgated, but it's a longstanding uncontroversial doctrine that applies broadly in all civil cases; be they fraud-based or tort- based or breach of contract-based. It's not at all a novel notion." Number 397 REPRESENTATIVE GREEN: "Was that doctrine mentioned at all in the Superior Court case?" MR. HOSIE: "It was not, to my recollection, mentioned in the opinion and it was argued to the Superior Court, but the Superior Court really didn't reach that issue directly, including at the threshold point that the statute itself, 260, was unambiguous and barred the relation back doctrine. And that decision was reached; notwithstanding that the statute doesn't say anything about relation back or amendments and notwithstanding that there's nothing in the history - the legislative history - for that piece of legislation addressing either of those points. And the threshold issue before the Supreme Court will be, was Judge Cranston right when he ruled that this statute is unambiguous, and I feel quite comfortable that the Supreme Court will conclude, that given that the statute is silent on this issue, it is ambiguous. Either way you go, you have to imply something into the statute, because it doesn't say it directly and as soon as you're in the business of implying something into a statute, you must recognize that it's ambiguous, you're interpreting it." Number 412 REPRESENTATIVE GREEN: "One follow up to that. You've said that this is a doctrine of common law and that it's unambiguous, it's been used - did you say it has been used or it is implied in several other cases?" MR. HOSIE: "Yes." REPRESENTATIVE GREEN: "The reason I'm asking this is that something that seems to be so important, certainly you call it the key in this case, is not mentioned in statute, is not mentioned, and is not apparently, and was disallowed in the Superior Court. I'm concerned about the implied situation that doesn't seem to have been worthy of being put in any statute or any other reference that you've made." MR. HOSIE: "Representative Green, in part, the answer is, that because it's such a long established common law notion, there frequently are no statutes that support this relation back doctrine. In most states there are no statutes that say `and amendments were laid back' just because it's a longstanding common law notion. And I think that the taxpayers agree that it is a longstanding common law notion, but they say it doesn't apply in Alaska in the tax context, because the statute of limitations, Section 260, doesn't permit amendments and relation back, even though it's silent on that point. They read the statute as precluding this common law doctrine. And that was to be fair to the taxpayers, the way the Superior Court ruled below." CHAIRMAN VEZEY: "Thank you, Mr. Hosie. See what happens when you ask for questions. I've interrupted your train of thought, so before you do get started again, I want to say we do have a very full crowd here this morning and if some of the staff people would be so kind as to maybe give up their seat to some of the public or other agency people, because I know we have speaker boxes in our offices and we can listen down there. So, if we would just try to cooperate and be as courteous as we can to all the people that we have here today. Please continue, Mr. Hosie." Number 444 MR. HOSIE: "Thank you, Mr. Chairman. Turning to the legislation itself, Senate Bill 377, and starting logically with Section 1. Section 1 clarifies a longstanding division interpretation of the statute of limitations in Alaska. It says that amendments are proper, if made after the statute of limitations has run, so long as the dispute was begun before the statute of limitations runs. So this clarifies and declares that the longstanding division interpretation of 260 is indeed the right interpretation. To take a brief detour. That division policy was articulated in the early 1980s and was the subject of a 1984 Attorney General's Opinion and the Opinion addressed the precise question here; which is, can amendments be made after the statute is run. And the Opinion concluded that such amendments were proper, and that was in 1984. And from that point forward, this issue has been in the administrative process, working its way through - through the Superior Court level and now to the Supreme Court level and it's simply taken this long to get the case to the Supreme Court and the Supreme Court hears oral argument next Wednesday, May 18. And presumably, we'll get an opinion sometime within a year, perhaps 14 months after hearing oral argument. And so Section 1 (a) clarifies that the division's interpretation, a longstanding interpretation, is the right one and that amendments are proper so long as the parties were actually in dispute before the statute ran. "Section 2 sets forth a change in the law and the change is prospective - it applies (indiscernible) and it says, as Mr. Attorney General, Bruce Botelho, mentioned earlier, that going forward, the Division of Audit and the Department of Revenue will have five years to make all amendments. This statute unambiguously puts a five year cap on the amendment process. So, if the division wants to go through discovery and uncover new facts, it has to do that within five years and make all amendments within five years, and if it waits too long it loses the right to amend. Section 2 addresses the collection problem. I've been focusing thus far on the three-year statute of limitations issue which is the issue before the Supreme Court. The collection problem is a slightly different, but related problem, and under Alaska law, the state, via the Department of Revenue has a limited number of years to collect on a tax judgment, to collect the taxes due. And the question arises, well how many years from what? The statute tells you how many years - six - but there's some ambiguity about from what. The prior law suggested that the trigger for the six year period to start to run was the issuing of the assessment. This statute changes that and sets forth a series of triggers - the latest of which is likely to be the final step in the adjudicatory process; that is, once the dispute's over and you know what the actual final tax bill is, at that point the state's six years start to run. And so once you know what you have to collect and once you're no longer fighting with the taxpayer about what's owed and what's not owed, you've got six years to go out and get your money." CHAIRMAN VEZEY: "It would help if we, and you confused me just a little bit, because you jumped from Section 1 of the bill before us to Section 2, could we try to just address just one section at a time and then maybe take questions on that, before we go on to the next." Number 494 REPRESENTATIVE PHILLIPS: "Thank you, Mr. Chairman. Mr. Hosie, does the state have the ability to be flexible during that six year time or after that six year time in the collection process?" MR. HOSIE: "In the sense of stipulating to a longer or shorter period?" Number 498 REPRESENTATIVE PHILLIPS: "I'm thinking primarily to a longer--would that be an option open to the state?" MR. HOSIE: "I think there would be nothing in the law to preclude the state from approaching a taxpayer and asking for an agreement to extend the period. And if such an agreement were given and it were in writing, it would probably be valid and extend the six year period. And so that could be reached through an accord between the parties." REPRESENTATIVE PHILLIPS: "Thank you." CHAIRMAN VEZEY: "Mr. Hosie, you're confusing me now. The six year period is referring to Alaska Statute 43.05.260." MR. BOTELHO clarified it was 270. CHAIRMAN VEZEY: "I'm sorry, 270 to do with collecting (indiscernible). The five year proposal on the audit limits goes back to 43.05.230, and 230 contains a paragraph (c) that specifically states that the parties can agree to agree to extend the time period. Now are we cross-referencing those two?" Number 515 MR. HOSIE: "Mr. Chairman, to some extent I think we are. Let me see if I can clarify. Section 1, subpart 2, that sets forth the prospective five year rule, addresses the current three-year statute of limitations and the amendment to the relation back problem. This section says, going forward, you can amend, but only for five years. When the five year period comes and goes, the division loses its ability to amend." MR. BOTELHO: "In essence, Mr. Chairman, if this were enacted, the legislature is making a specific finding to abandon the relation back doctrine." CHAIRMAN VEZEY: "Representative Davidson." REPRESENTATIVE DAVIDSON: "Thank you, Mr. Chairman. That was exactly my question. So, when the state then agrees to give up its right to relation back doctrine, doesn't that have possibly some very incredible loss to the treasury consequences?" Number 529 MR. HOSIE: "In fairness, it could. It could, but there are several things that mitigate against that and some of them are in this legislation - we'll get to them in a minute - but the legislation will establish a different method of determining taxable value that's designed to be simple, more efficient and far more clear, and will make it much easier for the division to conclude the process within five years. And so the structure will change to make it much more easy to conclude the process within five years and that helps. The other thing that's happened, is that the oil world and the oil business is fundamentally different today than it was in the early 1980s. In the early 1980s, it was a chaotic market, it was a private, silent market; whereas now, oil prices are like normal commodity prices, like gold prices or (indiscernible) prices; you can open the Wall Street Journal and you can find out what West Texas (indiscernible) is selling for today, what it would cost you to go out and buy that oil today. And so you have these public electronic sources for oil prices that simply weren't around in the kind of detail they are now, back in the 1980s. And so the evolution of the market - it makes it much easier today to value oil than was the case back in the 1980s. And both of those things, I think, will make it quite possible for the division to conclude the amendment process within five years. It's my understanding that this has been discussed extensively with Commissioner Rexwinkel, and he's confirmed that with his staff and they feel quite confident and comfortable that they can live with the five year amendment rule." REPRESENTATIVE DAVIDSON: "But if it's such a longstanding common law notion, why would the state -- you said it applies in all civil actions and now we're going to have a civil action, by the state, where it no longer applies. What's the trade-off? I don't understand why all of this law, all of a sudden, is not to our benefit as a state to say `Okay, we'll just wait for five years, then or give you five years.'" Number 558 MR. HOSIE: "It is a compromise with the industry and gives the industry certainty. The industry wants an absolute window of time in which it can be audited and the audits amended. It says that certainty is important for the ability to do business and so, Representative Davidson, you're absolutely right when you say this is a departure from existing law and a departure from the law in most other jurisdictions. It is." REPRESENTATIVE DAVIDSON: "Does it become a precedent then for the loss of this doctrine to other civil actions?" Number 564 MR. HOSIE: "No, particularly not where the state is the plaintiff and that raises a very good point. In Alaska, the law is very clear that a statute can be read in derogation of the state's rights. It can be read to limit the sovereign's right only if it explicitly does that. The state has inherent powers of sovereign and legislation that limits that power has to be explicit. You can't read a limitation into the state's authority from an ambiguous statute. You can't imply a limitation. That is the law in Alaska and that is a critical point in the pending Supreme Court case because Exxon, of course, looks at Section 260, which is ambiguous, and says `Oh, since it doesn't explicitly allow relation back, it's not there.' Wrong. Wrong premise. If it doesn't explicitly disallow relation back, the state's sovereign powers are preserved." Number 576 MR. BOTELHO: "It might be worth adding, Mr. Chairman, those statutes of limitation or statutes of repose have existed for many, many years - to the last century - is a relatively recent innovation that statutes of limitation apply to the sovereigns, at all. For the most part, again, common law, government was never barred. It's required specific legislative action in each of the state (indiscernible) federal government to impose limitations on government in its ability, particularly in this area, to collect taxes. And this legislature did so in 1976. Actually that language or language similar to it, first appeared, based on my recollection, in the 1930s in the Territorial legislature. These have been picked up over the years, but the point is, that historically, the sovereign wasn't limited at all. And therefore, in the interpretation of statutes of limitation, even today as they apply to government, courts are directed or obligated to resolve ambiguities in favor of the state, not against it, whether it pertains to tax statute of limitations or other limits of actions, and if one looks at Title 9, you'll find specific references to actions involving the state, which in some respect embody that deference. And, Mr. Chairman, if I might, having launched onto this treatise, urge the body perhaps to look at other statutes of limitation found at AS 09 - 10 details with limitations on actions, and is a follow up to Representative Green's question, why with an issue as important as relation back, there's no reference to it. The statutes don't answer the question why, but certainly make clear that there is no reference in any of the statutes of limitation found in Chapter 10 that mention the doctrine of relation back." Number 604 REPRESENTATIVE JOHN DAVIES: "Mr. Attorney General or Mr. Hosie, either one, I have a question about the rationale for the statute of limitations on collections. Usually these seem to have to do with providing certainty. What is the uncertainty in a collection case, where presumably the amount that's owed is understood and adjudicated to its end?" MR. HOSIE: "It is an uncertainty question, but the uncertainty, is not whether this money is owed, but whether the creditor collects, goes through the steps to collect. And limitations on the right to collect are quite common and are seen in the civil area, generally. Often they're as long as ten years, and so if you reduce a civil case to judgment, you can have up to ten years to collect the money that a court has found you are deserving of. But the policy call underlying the statute is that if you're going to go after someone to enforce on a judgment, you should do so within a certain period of time and that hence, the six year rule for taxes and the longer rules for other kinds of actions. So it addresses the uncertainty of the collection process." Number 620 REPRESENTATIVE DAVIES: "If the state initiates the process for collections, is there a set of actions that the state can go through and has completed everything that it can do, and then does the statute then, toll if they've done all those steps?" MR. HOSIE: "I believe that it is tolled, but I'm quite honestly, not sure. I've not looked at that precise question. But if the state is going through the process and if something goes wrong, there would be a good argument for tolling." Number 628 MR. BOTELHO: "Mr. Chairman, the situation arises here and as I have mentioned before, became implicated in the overall discussion about the statutes of limitation as a result of a lawsuit brought by Tesoro. Tesoro had had an assessment issued by the Department of Revenue. There had been a decision and Tesoro had appealed that assessment and it was still being litigated at the time the six-year statute on collections, in their view, ran out. You'll notice the language today says, it's six years from the date of assessment. The assessment is not the final determination of a tax. And the Department of Revenue's view on that was, you can't start collecting until you finally know what the tax is. You need to go through - you have to have a final decision. Otherwise, you're collecting an unknown. Tesoro disagreed and went to Superior Court and said, `Look time has run out - it's been more than six years since the assessment was issued; therefore, we don't have to pay.' The Superior Court heard that argument and rejected it saying, `that flies in the face of common sense' and the implicit concept that the time is tolled, it stops running until, and it doesn't start running until there's been a final determination (indiscernible). And that case went to the Supreme Court. And last year, the state and Tesoro settled the case, 13 months after oral argument in the Supreme Court. Actually, we began our settlement negotiations 13 months after oral argument in the Supreme Court and we ultimately settled 17 months after oral argument in the Supreme Court, without a decision by the Supreme Court. The bill embodies, in essence, the decision of the Superior Court, but also more importantly and consistently, our interpretation of how that collection statute is to work. The time does not start running on the six years until there's been a final determination of the tax owed. And I would note, as well, that the largest taxpayer in the state, BP, has made clear, I think, that it has been willing to waive, and I think, publicly announced that in fact, in the newspapers this morning that they were prepared to waive that statute with respect to taxes in dispute with BP on essentially, the same principle. Mr. Chairman, I hope I've answered Representative Green's question." CHAIRMAN VEZEY: "Yes, thank you. Representative Porter." Number 663 REPRESENTATIVE PORTER: "Bruce, we've had briefings along the last couple of weeks on these issues and some of them have been with proprietary information and some of them have not. So, if I get into that area - I will not ask - but let me know. I guess, preliminarily, the Tesoro case was not appealed so that is the law of the land?" Number 668 MR. BOTELHO: "It was appealed to the State Supreme Court, it was settled while the Supreme Court was deliberating. That is, they heard oral argument, which is the last step preceding the issuance of a decision. Finally, obviously both sides, the state and Tesoro, recognized that as time was running, something was holding up the process. It might suggest that there was a division of opinion within the Supreme Court, not ultimately resolved. Accordingly, it was in the interest of both parties to settle because of that uncertainty." REPRESENTATIVE PORTER: "How long of a period of time was that?" MR. BOTELHO: "Thirteen months - we started our discussions; that is, Tesoro and the state jointly, 13 months after oral argument. We ultimately settled with Tesoro 17 months after oral argument, without decision." REPRESENTATIVE PORTER: "The $3 billion of claims that exist, is it proper to ask publicly how those split out?" MR. BOTELHO: "Yes, what I cannot identify for the committee is any taxpayer specific information. Approximately $1 billion, slightly over that, is tied to the three-year statute of limitations, and approximately $2 billion is tied directly to the six-year statute of limitations. Actually, those numbers are probably a couple months old, and those numbers are increasing daily." Number 686 REPRESENTATIVE PORTER: "Would it be fair to say then, that the Exxon case that will be presented Tuesday, I guess, addresses one-third then, of those total claims?" MR. BOTELHO: "That's correct, Mr. Chairman." CHAIRMAN VEZEY: "Thank you. Representative Davidson." Number 689 REPRESENTATIVE DAVIDSON: "Thank you very much, Mr. Chairman. Gentlemen, is there any kind, because we're always talking about the time crunch in these civil matters, is there any statute that allows for the Supreme Court or the entire legal process to bring to the floor or place a higher priority on cases that affect the public treasury, and if there is not, would it be in our best interest to consider such a statute?" MR. HOSIE: "Representative Davidson, there is a procedure to ask for expedited treatment in a case where....(tape ends abruptly.) TAPE 94-60, SIDE B Number 000 NOTE: Testimony of first person listed on notes for Side B is incompletely recorded; side begins abruptly in the midst of testimony.) MR. HOSIE: " - for expedited treatment, and that may or may not be granted." Number 025 MR. BOTELHO: "The difficulty with putting expedited consideration on this or any other matter, is the fact that this body, and, for that matter, the United States Supreme Court, has also imposed standards in terms of time. The right to, under our Constitution, both state and federal, the right to a speedy trial, controls to a very large extent the calendars of our courts. In addition, by court rule, children's proceedings have precedence over other matters. When you're dealing with the lives of individuals, our system has tended to put priority on those matters above issues of property disputes over money. And I think that's been an appropriate priority in our system. I will note, however, that some states have developed separate tax courts that are devoted exclusively to resolution of tax disputes such as ours as one way of avoiding that kind of conflict in deciding what the time priorities should be of the courts." REPRESENTATIVE DAVIDSON: "Would it be in Alaska's interest to consider such a provision, a separate tax court, do you think?" MR. BOTELHO: "I'm of two minds. I think the system that we have in place is generally one that works quite well. Certainly if one were looking at giving that court additional responsibilities it might make sense. I suspect that we would not find enough business to keep the justices or judges busy full time, if the focus were exclusively were on, really, a small number of taxpayers; though, admittedly, dealing with incredibly large amounts of money. I guess that's my view. I could not justify it as a tax court alone." Number 056 REPRESENTATIVE NORDLUND: "Just to clarify the five-year absolute bar - that was something that was added to the bill after it was originally introduced, is that correct?" Number 059 MR. BOTELHO: "That is correct." Number 060 REPRESENTATIVE NORDLUND: "Is it appropriate to say that this was a concession on the part of the state?" Number 061 MR. BOTELHO: "Yes it was. A significant one, but also not an unreasonable one." Number 065 CHAIRMAN VEZEY: "Thank you Mr. Hosie, and Mr. Botelho. Before we go on out of Section 1 completely, I guess the one question that keeps coming to my mind is, that I would interpret our current statute as being a three-year limitation on auditing. I would compare that to Internal Revenue Service (indiscernible.) We say that we're going to grant a five-year statute of limitation on audits in the future, and the state is going to abandon its relation back doctrine that it has - and, you touched on that briefly, but I don't quite understand how we said in 1976 that we're going to have a three-year statute of limitations, and now we say five - I mean, if we're not honoring the three, why would we honor the five?" Number 088 MR. HOSIE: "Mr. Chairman, the state has honored the three. Because the statute of limitations simply requires that the dispute start before the three years has run. It doesn't require that the dispute both start and be finished within the three-year period. And, in effect, Exxon has argued in the Supreme Court case, that the process must not only start within three years, but must conclude within three years. Because the consequence of not getting it done is that you lose the right to correct the taxes upward, even if the evidence suggests that that's right, and the number can only go down. Statutes of limitations govern the initiation of litigation. They do not govern how long a case should take once it's begun, or how it should be litigated once begun. Once the parties are in an active fight, different rules apply. There are rules in the civil court that provide timing deadlines for the process. There are regulations in the tax area that permit a taxpayer who feels that the process is going too slowly to complain directly to the commissioner. A taxpayer who feels that the process is going too slowly can ask for an immediate formal hearing. They have as much control over the timing as does the department. And so, the short answer, Mr. Chairman, is that the state absolutely has lived with the three-year statute of limitations. And there is no dispute between and amongst the parties that if the state didn't get the initial assessments out within three years, it would have lost its right - putting aside fraud - to assess it all." REPRESENTATIVE SANDERS: "In changing this limit from three years to five years, what is to make us believe that next year we won't change it from five years to seven years? Or ten years? And, if that's true, why not change it to ten years today?" MR. BOTELHO: "The legislature always retains the authority to change the laws based on its evaluation of the circumstances. One has to trust that the legislature exercises restraint in trying to, among other things, develop a comprehensive tax policy of the state or in any other area. I can't give you any assurance, that the next year the legislature might suggest that seven years would be right, or ten years; nor would I suggest today that there might not be circumstances which would lead the legislature to do so. One has to assume that there are checks and balances, not only between the branches, not only between the houses of the legislature, but simply reflecting the collectivity of this group and the various views that tend to put a restraint on change's process. We have come with this particular compromise as reflective of looking at a system that has been operating one way since 1976. We've heard the concerns of taxpayers. You will again hear from taxpayers. And I suspect that you will find that those taxpayers will recognize that whatever the ambiguity about the current status, that you will be making a finding that you are abandoning relation back, that it will be a five- year fixed period. And that beyond that taxpayers have a certainty that their assessments will not increase beyond that period. It's, as I say, a significant compromise. I dare say, however, that it is possible that a future Commissioner of Revenue might appear before a future legislature and tell you that five years is not enough. There's probably doubt that that would be the case, but I don't foreclose that. I do not have a crystal ball. I think one has to count on the wisdom on the legislature to make the ultimate determination. And obviously that wisdom includes the ability to reject any change from what we have today." REPRESENTATIVE DAVIDSON: "So, if it's a fair evaluation of our current situation, where it appears there are disincentives for timely payment, what in your professional judgment pushes the industry response to forward proceedings? Now, with the passage of this legislation, there is an absolute, no more assessment or adjustment of taxing of (indiscernible.)? Where are we?" MR. BOTELHO: "It strikes me that there are several events that have influenced the ability of the Department of Revenue to move quickly in making decisions, issuing audits and ultimately assessments within the five-year period. Mr. Hosie has mentioned the first, and perhaps in many respects the most significant. And that is, just the evolution of the industry itself, so that you do have widely reported prices, which give us a good shorthand for the value of the crude oil that comes out. You have a very sophisticated revenue staff, one that has grown not only in size but also in sophistication. If one compares it to the state of affairs at the time oil first started flowing from Prudhoe Bay, when you were dealing with one auditor to do all the taxes dealing with oil and gas, and a separate auditor to deal with DNR, and seeing a dramatic increase to three people the following year, compared to what we have today; we have a knowledge base which the state has invested in, and a staff that can get the job done. The third major development has been more specifically regulatory in nature, and that is the development of regulations which try to put in proxies for value that would eliminate the need for detailed auditing. "Let me give a couple of examples. The first, and it's partly embodied in this bill, is the concept of adopting a forward-looking methodology for oil valuations, similar to that which we currently have in place and have been working under for four years now, on the royalty side. We have actually three different methodologies, all of them having lots in common. One with ARCO, one with Exxon, and one with BP, and each of the remaining producers on the North Slope have elected to report on the basis of one of those three methodologies. We have had no conflicts with the industry since we adopted that methodology. The Department of Revenue has been working closely with the industry to develop exactly the same concept, so that we can shorthand the kinds of conflicts we've had before. "Next, I would point out that we have developed a body of knowledge which we did not have before. We've invested tens of millions in getting that body of knowledge in our royalty litigation. The (indiscernible - Amerada-Hess?) case which first was filed in 1977, and was settled, at least the first part, dealing with oil valuation in 1992, that was the final settlement with Exxon, has been one that has provided us with a way, again, of understanding the industry; a database which has allowed the Department of Revenue itself to speed up the auditing process. "The final regulatory change that I would mention that allows us to keep up, was the adoption in late 1990 of an interim tax regulation. That is, the basis for which the companies now are required to file interim payments. And those are based on spot. The importance of that is several fold. First of all, it shows a trend to relying on systemic measures of value rather than individual auditing to try and capture the last dollar or the last cent. The second is that it reflects the fact that since there is widespread agreement that spot is a good measure that the difference between what the department would get on a final payment and an interim payment is largely minimized. Spot's the value, that's what you're reporting on, you're not going to see $100,000,000 cases arising in the revenue context in terms of disputes. For years, I would say, certainly at least (indiscernible.)" REPRESENTATIVE ULMER: "Two questions about Section 1. With regard to the five-year period, it was suggested to me by industry that perhaps the one in which that language is constructed it might not preclude a new assessment from being issued after the five-year period of time. The language says after that five-year period, the department may not increase an assessment under this subsection. Yet the suggestion is here that there may be a loophole in this language that would allow the Department of Revenue, even after five years, somehow, to issue a new assessment. Even though, not an (indiscernible) assessment. Is that your reading of the language?" Number 280 MR. BOTELHO: "It is not. It is possible that we might issue a new assessment which reduces the amount in dispute, and that happens very regularly now, and we're not suggesting a departure from it. New information which the taxpayer brings forward, which has the consequence of us deciding that there has been substantiation of the taxpayer's position, would regularly result in a new assessment, a new amended, or, refer to it as an amended assessment, it would have the effect of decreasing. And hence, the language is specifically crafted to recognize the ability of the department to reduce assessments but not to increase it. We do not see it as a mechanism, I don't think there is any suggestion here, nor do I believe it can be fairly read to suggest, that the department may issue some new assessments after the five-year period that has the effect of increasing the amount." Number 296 REPRESENTATIVE ULMER: "My second question relates to the contrast between how Alaska does it versus how other states or the IRS does it, in terms of the three-year assessment. I'd like you to explain to the committee how different this process is in Alaska from other taxing jurisdictions, particularly oil tax states, or from the IRS; is the three- year statute of limitations with regard to assessments being interpreted differently by the state of Alaska than it is in other states or by the IRS?" Number 306 MR. HOSIE: "The answer is no. That the division's long- standing interpretation largely accords with the law in other jurisdictions, both on the state level and the federal law. (Coughing, indiscernible.) The federal law is very different than the state law. It doesn't provide, for example, for an informal conference process. Deadlines are different. And federal law has a specific sentence in it that says, once the dispute's started, the statute of limitations is tolled. There is no parallel explicit language in Alaska law, and that's one of Exxon's principal arguments, that the absence of that explicit power to toll (indiscernible) statute, means that the 1976 legislature made a policy decision to void the relation back doctrine in a tax context and make sure that these things had to be completed in three years. And so the federal law is fundamentally different, but provides for the result that the state advocates here. On the state level, various state courts have wrestled with this problem, from the 1930s to as recently as last year. And with one exception the courts have ruled in the states' favor, ruled that relation back is proper; that once the dispute starts you can amend until the dispute is over. The one exception is Montana. The Montana Supreme Court ruled, quite explicitly, that no amendments were proper after the statute of limitations had run. And the language in Montana is very much like the statutory language in Alaska. Why did the Montana court rule that way? Well, the Montana court has a unique rule of statutory construction and interpretation. Unlike Alaska, where ambiguities are always read in favor of the sovereign, in Montana the opposite rule applies. And if you have an ambiguous tax statute, you must read it in favor of the taxpayer and against the sovereign. And that was the driving point for that decision. They had a statute that they admitted was `susceptible to two constructions.' They then applied the rule of construction, saying that ambiguity must be read in favor of the taxpayer and against the state, and accordingly concluded that amendments were not proper. "Alaska has the other rule of construction, which is far and away the more common rule, and that the state's inherent sovereign powers are preserved unless the statute very explicitly gives up those powers and rights. And so, this will be largely the substance of the Supreme Court fight, but the law weighs far more heavily on the state side." Number 349 REPRESENTATIVE PHILLIPS: "Bruce, every year the state spends millions of dollars in the process of tax litigation. Would you surmise that the passage of this new methodology might reduce the amount of money that we are spending in our litigation battles?" MR. BOTELHO: "Without doubt." REPRESENTATIVE PHILLIPS: "Thank you." Number 356 REPRESENTATIVE JEANNETTE JAMES: "Referring to Section 1, my question is, in talking about the referencing back provision, the language says, in what we're setting for, not the future, but for the back, so, I am assuming that when we make language for what's behind us that we have some things specifically we're covering, and the language says the department may increase or decrease the amount of tax due by issuing or amending an assessment. Now, that doesn't say, necessarily, to me, that that only relates to the referencing back provision, it looks like you can do it for anything. It looks like that it's even more broad than that. Are there to be understood that there are some convictions and some assessments that may not have totally fell into the requirement of relating back?" Number 370 MR. HOSIE: "The statute, I believe, is broader, as you point out, than the relation back doctrine. The relation back doctrine has some limits. And one of the limits is that the amendment has to involve the same general issues already in dispute. And so, if you're suing the garage about an auto problem, you can't add an amendment that involves a property dispute you might have about a fence, with the owner of the garage. They are two different cases. This statute, this provision, doesn't address that limitation. Although, it shouldn't be an issue in the tax area, because, by definition, when the Audit Division reviews taxes and issues and assessment, it puts at issue the entire tax year. The entire constellation of issues involving how much tax is owed. And the amendments necessarily relate to those underlying tax issues for that same tax year." Number 385 REPRESENTATIVE JAMES: "On the follow-up, there are two specific kinds of taxes that we're talking about. One is income taxes, and the other is the severance taxes. And the income tax is an annual filing and the severance tax is a monthly filing. It appears to me that some of the same information that you might be questioning or getting into filing up in an income tax question might be some of the same information that you would be needing to determine a taxable amount in the severance taxes. I guess my question is, if you find something in one of those cases that applies back to the other one, does the relation back doctrine fit? And do we need this broad language to cover all cases? Why are we putting the broad language in when it's for things that have happened in the past?" Number 395 MR. BOTELHO: "I think first it's important to point out as Representative James has identified that this particular amendment and indeed this statute of limitations applies to two taxes. One of them being the production tax, that is the reference on line 12 on page one, to AS 43.55, the other to AS 43.21. We know that as the separate accounting income tax. I think it's important to point out that that tax has not been in effect for 13, actually 14 years - 13 years in our state, it covered the period 1978-1981 when it was changed. This statute of limitation does not apply to our current income tax, corporate income tax, which has a separate statute of limitations based on the federal model, that is found in Chapter 43.20. So, there isn't the implication of playing back and forth that you might be anticipating if in fact we are talking about a production tax and our current corporate income tax. (Coughing and other noise - indiscernible) so we wouldn't have that kind of interplay. That was clearly the case earlier when you had both the separate accounting tax and the production tax running concurrently and basically raising some of the same issues. I'm not sure if I directly answered the question." REPRESENTATIVE JAMES: "Just another question, then, I have here on some of the things we've been discussing. You mentioned the $3 billion taxes that are outstanding that you feel are at risk if we don't pass this legislation. Do you have a ballpark figure of how much of that $3 billion - is it all taxes? Or is some of it penalties and interest? Or is there any kind of a relationship (clearing of throat in background, difficult to hear)?" Number 425 MR. BOTELHO: "I think it's a very appropriate question. The $3 billion is largely taxes and interest. The relationship is, for each dollar of tax, approximately $1.60 in interest. That's the ratio right now. Obviously, as time progresses, the ratio becomes greater. That is to say, the interest is accumulating daily, obviously, and that number for each additional period of time that we're talking about will tend to diminish the basic tax vis-a-vis the interest accumulated." Number 435 CHAIRMAN VEZEY: "And the interest rate is 12 percent?" MR. BOTELHO: "The interest rate right now is 11 percent compounded. And we've actually, earlier, until that legislative change was made, I believe during the 1990 session, the rate was eight percent simple. There was an earlier period when it was actually six percent simple." Number 440 CHAIRMAN VEZEY: "And I believe there's a 25 percent penalty? Where does that (throat clearing in background - indiscernible.)?" Number 441 MR. BOTELHO: "There is a 25 -- There are penalties involved in the number. I think it would probably be inappropriate to mention those numbers, only to say that they are rather a small amount, insignificant amount of the total, and also interest does not accrue on penalties." Number 445 REPRESENTATIVE DAVIDSON: "Mr. Attorney General, what is magical about the two dates included in Section 1? What were the specific reasons or considerations both from the state's perspective and rationale for choosing these two dates? If you could, please, give us your opinion, or why you think that was convenient also for the industry?" MR. BOTELHO: "Actually, in our proposal to the Senate Labor & Commerce Committee, we had proposed tax periods ending before January 1, 1995, in Section 1, a(1), and in Section 1 a(2), for tax periods beginning December 31, 1994, that was our proposal. During the course of the committee hearing, however, industry representatives had urged the committee to move it back starting this year. And, in consultation with the Commissioner of Revenue, it was his view that that was an accommodation that could be made given what I described earlier are the enhanced ability of the department within a five-year period to make the collections, it is his view, and I think is clearly one that I share, that the department has the capacity to make sure that in this tax year, with the returns being filed, that we can complete the audit cycle within five years. And hence the willingness to allow that date to be moved up to this year as opposed to beginning in tax year 1995." REPRESENTATIVE DAVIDSON: "So there was no loss or gain for either party as regards to those specific dates?" Number 461 MR. BOTELHO: "I believe that there was a gain to industry in the sense that they know that certainty will come a little faster. Obviously, if it's a five-year bar on assessments, that is to say, no increased assessments after the five-year period, they have that guarantee starting with this tax year that in five years they will have that certainty. The benefit is simply that it's been extended to this tax year as opposed to beginning next year." Number 483 REPRESENTATIVE HUDSON: "Mr. Attorney General, I'm trying to understand this relationship between the three-year statute of limitation and the six-year for collection statute of limitation, and relate that to the $3 billion that's been stated at risk. Are any of the assessments that were issued by the state prior to the third year at risk because of the sixth year? What I'm trying to figure out is, does the $3 billion include assessments that were made during the three- year period of time, which both sides seem to agree, at least that's there, that you have that period of time, is the $3 billion assessments made after the third year in these various cases on, that you're claiming, during the other types of settlement?" Number 496 MR. HOSIE: "I believe the answer to be that some of the dollars encompassed in the $3 billion relate to assessments that the parties would agree were timely; that is, made within the initial three-year period. A larger portion of the money relates to amendments, to assessments, that were made after the period. So I think there is a little of both." Number 501 REPRESENTATIVE HUDSON: "So of the $3 billion, approximately, how much was made before - or, you know, timely - and how much would you say is at risk because it was made through the contentious period, after three years?" Number 504 MR. BOTELHO: "Slicing the pie, Mr. Chairman, first of all, as we indicated before, you have $1 billion that are directly related to the three-year statute; that is, amended assessments made after initial assessments and $2 billion that are affected by the six-year collections period. I think you've asked us to slice the pie further and to identify of the $2 billion how much of that also is implicated by assessments that were made after the three- year period - is that the correct question? Let me turn to Dick Brewer who is at Legal Audit Services, who may have that answer right now." Number 513 RICHARD BREWER, Assistant Director, Oil & Gas Audit Division, Anchorage, testified regarding SB 377. "There is some overlap, Representative Hudson, but for the most part the $2 billion, $1 billion stands." REPRESENTATIVE HUDSON: "Is the six-year collection - we've got the dispute, three companies say, that's it, no more assessments; the state says, no, as long as you're appealing, we can increase the assessments, and we've done that, apparently. And now I understand, at any rate, that maybe the six-year bar is what's potentially jeopardizing those that were made timely within three years. Is that correct?" Number 525 MR. BREWER: "Yes. Exactly. They were made timely, they were made in a timely fashion as far as we're concerned. However, they are subject to a six-year statute problem, yes." REPRESENTATIVE HUDSON: "And there is a value to that, but we don't know what it is yet?" MR. BREWER: "That is correct." REPRESENTATIVE HUDSON: "Thank you. Please continue, Mr. Hosie." MR. HOSIE: "Turning back to the specifics of SB 377, and moving on to Section 3, bottom of page two, this relates to several topics that the attorney general has touched on a few moments ago, and it's a section authorizing the department to promulgate new regulations addressing the question of how one values oil and downstream destination markets, and the section specifically authorizes the use of the methodology that employs spot prices. Those are the prices, those are current market prices, those are the prices that you see in the electronic databases, such as Reuters and Telerate, and they're the prices that the industry tracks, relies on, uses, in valuing oil for their own purposes. The purpose of the section is to simplify and clarify the process with the hope that there will not be a continuation of these long-standing expensive tax disputes. The regulations are designed to explicitly set forth how the oil is to be valued, using terms and mechanisms well known to the industry, and prices that are easily tracked by all concerned. This system is designed to roughly parallel, as the attorney general mentioned, the market basket system that was arrived at through the negotiated settlements of the royalty dispute, the (indiscernible - Amerada Hess?) case, most recently in April of 1992. That royalty market basket approach which applied effectively from 1992, uses spot prices in the downstream destination markets, which is precisely the approach that this section authorizes. And so, with going forward, there would be roughly parallel systems between royalty and tax for valuing the same oil at the same place downstream. "Now, that raises a question, and perhaps a problem, that has been articulated with this bill, and that is, if royalty numbers are sensible going forward, why not for the past? And let me take a minute and speak to that. There are two reasons why the royalty numbers for the past are not appropriate for tax. There is one very specific and one more general. The specific reason relates to a contract entered into in 1979 by the Department of Natural Resources. Under that contract, the state was limited, for royalty purposes, to the federal ceiling price for ANS crude oil. It didn't matter if the producers got more than the federal ceiling price; for royalty purposes, the state was capped at the ceiling price. With the benefit of full hindsight, that was not a great deal for the state. The state did not share in the upside when the producers got something above the ceiling price, and the state believes that they did. The state, in the tax side, never made that deal. There's no such contract in the tax side, and, to the contrary, there are specific tax statutes and regulations that give the state the right to participate in the upside. That is, if the producers in fact realize more than the federal ceiling price, the state is entitled to its proportionate share of that above ceiling price realization. And so, in asking, or in suggesting that royalty values for the past are appropriate for tax, the industry is in essence saying, you made that mistake in the royalty context, why not live with it in the tax context? There's no need to, and it wouldn't make good policy. "Second, and more generally, the royalty case turned on a 1959 contract drafted by an oil industry lawyer. The state's rights came from that contract and that contract alone. And the contract had two brief very ambiguous provisions about how royalties were to be calculated and paid. And, as I say, that was the source of the state's rights in that litigation. A 1959 ambiguous contract drafted by an oil industry lawyer. In fact, in 1980, Judge Allen Compton, now Justice Allen Compton, looked at that contract and said, having an oil company lawyer draft it was just like having the fox watch the henhouse. And so that was a problem in the royalty case. And it had the effect of depressing the royalty values because it created risk. It created risk. "The other thing that depressed the royalty values is, that was a jury trial case. And as a consequence, things had to be simplified, all decisions had to be cut in the producer's favor. You had to sell the result to a jury. And so the overall effect was a lowering of the royalty values. And so in saying that royalty values were appropriately taxed, industry is saying that you have to live with those (indiscernible - infirmities?) that were unique to the royalty contracts. And for those reasons, the use of royalty values for the task really aren't appropriate, in any sense, for a tax." Number 589 CHAIRMAN VEZEY: "Would you apply that prospectively?" MR. HOSIE: "We would not, for this reason. Prospectively, in the royalty case, the parties negotiated a different valuation system that used actual spot prices in the actual downstream market values. That was different than the system set forth in the 1959 lease contract. And so, prospectively the royalty system uses something that is very much like that set forth in this piece of legislation, SB 377. So it is possible to have parallel systems going forward, but that parallelism for the past comes at very great cost to the state. Because there were problems within the royalty case that simply aren't there in the tax side." CHAIRMAN VEZEY: "But, in the future, it would be possible to have a royalty assessment value, and a tax assessment value, that were parallel?" MR. HOSIE: "Roughly parallel. Yes, Mr. Chairman, that is exactly right. They should be roughly parallel." Number 601 CHAIRMAN VEZEY: "You solve one problem you've automatically solved the other." MR. HOSIE: "Mr. Chairman, that's largely right. There may be small differences between the systems, in part because there isn't just one royalty methodology now, as the attorney general mentioned, there are three, with some variance, but their similarities far outweigh their differences. And so the tax regulations may be slightly different, but they will share the same conceptual approach using downstream spot prices. They start at the same place, and they should arrive at very near the same place." Number 607 REPRESENTATIVE GREEN: "You refer to spot prices. Is there another posting of prices with crude oil?" Number 609: MR. HOSIE: "There is, generally referred to as posted prices for Lower `48 domestic crude oil. There were no posted prices for ANS until Shell posted on the North Slope in January of 1984. The reason for that is, there's really no market for ANS oil on the North Slope. That crude oil goes elsewhere, to be refined and consumed. And so the Alaska system has always been fairly unique, quite different, just given that it's a unique situation, to have such a large field in such a remote location." Number 615 MR. BOTELHO: "It might be important to mention, for some: the posted price is simply, and the experience that I know Representative Green is well familiar with from his background, but, the posted price was simply a refiner going into the field, an oil field, and saying, this is the price I'm willing to pay for this volume of oil on the field. It literally, historically was the posting of a sign, announcing what the refiner, separate from the producer, was willing to pay to get a quantity of oil. And, as Mr. Hosie has pointed out, that posted price experience largely has been absent in the North Slope. Different than anywhere else in the country. Shell did it only briefly, and obviously also Shell was only posting for a very limited amount of oil." Number 628 REPRESENTATIVE GREEN: "Is it historical that the spot value and the posted price are the same, or is there a variance?" MR. HOSIE: "They now are pretty much the same. That has not always been true. That started to become true in 1985, and it happened sooner on the Gulf Coast than it did on the West Coast. In the early 1980s, posted prices often were static for months on end. They didn't change with changes in market conditions, whereas the spot price was the daily market price. It goes up and goes down. So if there is a refinery fire, or a fire in a field in west Texas, you will see that reflected in the spot price immediately. A spot price moves just as a gold quote would move. Whereas the posted prices were long-term administered prices announced by the would-be buyers, as the prices they were willing to pay. And those prices, in the early 80s, did not move with market conditions. They were not, as most people think about the notion `market prices' at all. The posted prices are most analogous to the government prices announced by the Saudi government in the early 80s. The so-called official sales prices, OSPs, or government sales prices, GSPs, and those were prices simply announced by the Saudi royal family as the price for its oil. But those prices were typically not market prices. Sometimes much higher, sometimes much lower, for various political reasons. And so, a posted price is not a market price, was not a market price in the early 80s, but slowly became a market price as the markets evolved, until, I would say, 1985, everybody involved in the industry - tax collectors, states, oil companies and refiners - accepted spot prices as market prices and as the way to measure the worth of the crude oil. And in fact when an oil producer or a refiner goes out into the market today to buy oil, almost without exception, they pay a spot price. It's a market price." Number 652 REPRESENTATIVE GREEN: "So, you're saying that the reference, the bench mark crudes are not necessarily utilized anymore, it's just the spot market price for whatever crude might be available?" Number 662 MR. HOSIE: "Well, the legislation gives the department the discretion to select the crude oils to be used as the bench mark crudes for this process. That they may pick one or two crudes for the West Coast market and a different crude or crudes for the Gulf Coast markets, because the two are different. That would be an exercise of agency discretion. To look at the various crudes out there and pick the best bench mark. For instance, in the royalty settlements, if memory serves, up to five crudes are used and charted in various degrees to come up with an aggregate number that is believed to be most represented of ANS market value downstream." Number 665 CHAIRMAN VEZEY: "I tell you what, this is going to be quite a bit of discussion, I foresee. It is 10:30. Why don't we take a 15 minute at-ease and come back at a quarter to eleven." The State Affairs Standing Committee recessed at 10:30 a.m. with the hearing to be continued to 10:45 a.m. that day. TAPE 94-61, SIDE A Number 000 The House State Affairs Standing Committee returned to order at 10:49 a.m. CHAIRMAN VEZEY: "I call the meeting back to order. It's nine minutes until 11:00 on May 13. I would remind everybody that this is Friday, May the 13th. The next person on our list was Representative Phillips and she hasn't returned yet, so, Representative Porter, you had a question?" REPRESENTATIVE PORTER: "Yes, thank you, Mr. Chairman. On Section 3, a couple of questions. But let me first see if I have an overall understanding. The totality of the section basically says that we will establish a value for oil through this methodology every year, and that that will remain constant for a year; it will be revalued shortly before October 30, and that will be then established as the value for, prospectively, for a year. That will be done by a standard regulation development process?" Number 035 MR. BOTELHO: "That is correct, Mr. Chairman." Number 038 REPRESENTATIVE PORTER: "How long a period of time do you think that that process - would you envision that that process would be?" Number 039 MR. BOTELHO: "First of all, Mr. Chairman, I think it's important to note that it may well be that the department will not -- again, the language, specifically, found on page two, at the beginning at line 29, is that `before each October 30 the department shall annually review and determine if any of the adjustments are necessary;' it does not require that annually the department change the regulation. This is probably a good entree really to discuss in somewhat more detail the royalty methodologies. This is an attempt, basically, to parallel what we have called the openers to allow for adjustments on the royalty side. Mr. Chairman, with your indulgence, I'd ask Mr. Hosie to spend just maybe two or three minutes explaining in more detail, how the royalty side works, and how this parallels that provision currently." Number 060 MR. HOSIE: "Mr. Chairman, the royalty market basket approach uses various bench mark crudes. There is a selection of crudes for the West Coast, and a slightly different selection for the Gulf Coast. To illustrate the West Coast basket involves a crude called (indiscernible), West Texas Sour, a crude called (indiscernible) in line 63, which is indigenous California crude, and (indiscernible) crude, which is produced offshore in California. Those are the crudes that make up the market basket. The spot prices are assessed for those crudes and that market basket spot price is then used as the downstream destination value. There are slight differences or there can be slight differences in the precise makeup and weighting of the various crudes in the market basket in each of the three royalty settlements. Each of the big three producers has a slightly different settlement, given that they were negotiated deals. Then, that downstream spot-driven market basket number is netted back to Pump Station #1, the place at which both the tax and the royalty obligation adhere. As a consequence, one needs to deduct tanker transportation charges from the downstream value. Those tanker transportation charges are also calculated somewhat differently under the three royalty settlement methodologies. And so, this tax system would be similar in its use of a downstream market basket approach. It would be similar in its use of spot prices, as reported in the public and the electronic trade press, and it would differ, I believe, in attempting to achieve some sort of uniform transportation deduction. But there would be small differences between the royalty baskets and the tax baskets. But those differences are the subject now of regulations being promulgated and discussed with the industry generally." Number 104 MR. BOTELHO: "Spencer, if you could comment about re- openers in the - specifically, re-openers - what do we mean by the term? How does it work?" Number 105 MR. HOSIE: "Certainly. Given that oil markets change, and the world changes, it was viewed as important in the royalty case not to lock the state into an inflexible, never- changing system. Some flexibility is important, because you want to track what actually happens in the marketplace. And you might have picked a crude which came out of step with market prices, for whatever reason. Perhaps if it was a foreign crude the government which controls the pricing for the crude could announce an artificial price, or someone might keep the crude off the market, if it were a foreign crude. And so, there needed to be flexibility to adapt to changes in the marketplace. And for that reason, the royalty settlements explicitly gave the parties the right to reopen in certain events and, in effect, renegotiate the deals to make sure that the market basket did what it was designed to do, which was, arrive at a reasonable proxy for ANS spot prices. That's the market price for ANS oil, which I think everybody agrees should be the basis for both tax and royalty now." Number 127 MR. BOTELHO: "In particular, Mr. Chairman, each of the settlement agreements provides for a periodic re-opener. My recollection is, all of them have a three-year periodic re- opener regardless. And the first re-opener period occurred with ARCO some months ago. Actually, the overall, re-opener provision, (indiscernible) provide for a very limited period to try and reach resolution informally; that doesn't work, we'd ultimately go to baseball arbitration, that is, both parties make their best offer and a panel, chosen from a particular list of specialists in arbitration would be required to elect which of the two positions is more correct. We did have the re-opener with ARCO and in a matter, I think, of less than two weeks we were able to reach agreement on a slight change to the formula to reflect activities on Pipeline 63 crudes, as I recall. There is another provision which provides for what we call government action re-openers. And this contemplated event could have happened in the past, and may be anticipated in the future. Examples would be the dramatic impact that perhaps price control reimposition might have on the market, or the requirement that there be double-hull tankers, was another one discussed extensively. Again, we can't, in the interests of uniformity in our tax system, negotiate such agreements with individual taxpayers. What we have done instead is make clear that there be this annual review to make sure that the market basket is working as it should, and basically have a parallel for re-openers by requiring the department not only review, but make adjustments, as required." Number 171 REPRESENTATIVE PORTER: "Mr. Chairman, if I may follow up, then. In (c) of the section, it says the department may average or assign different weights to the oil selected under (b) and the department may adjust the amounts calculated under (b), to account for differences of oil types and different destination areas. It seems like those two things are fair and equitable things to do. When you say `may' you imply may, or may not. Why shouldn't that be `shall'?" Number 181 MR. HOSIE: "Mr. Chairman, for instance, if ANS is one of the crudes selected in the market basket, there would be no need for quality adjustment. Similarly, some of the crudes picked may be very close, and so there may be no need for quality adjustment. For other crudes picked, say, a foreign, very light, very sweet crude, there would have to be a quality adjustment. And I think that the parties all understand that the object is to arrive at a market basket that very closely approximates ANS crude oil in terms of all its physical characteristics. The object is not to pick a crude oil, or mixed crude oils, that are dissimilar to ANS oil." Number 193 REPRESENTATIVE PORTER: "Well, if I may, under (b), you have that option, to select within the state, or outside of the state, or a combination thereof. So, if you have only selected ANS oil, then the first line would seem to be moot. Because you don't have different oils to weight." MR. HOSIE: "That's exactly right." REPRESENTATIVE PORTER: "But if you do, then why shouldn't those be the ways that you equalize those selections?" Number 202 MR. BOTELHO: "Mr. Chairman, first of all, when we talk about weighting the oils, what we're talking about is a conscious parallel, again, to the royalty settlements, where the basket that Mr. Hosie referred to, that would include (indiscernible), include the (indiscernible), Pipeline 63, Abu Dhabi, and such - they're not weighted equally. That is to say, they are not all each given 20 percent weighting. We try to reflect and be able to change the actual activity in the market and be able to drop out a particular crude, if in fact it's no longer being traded. To require averaging or assigning different weights, you almost have to say Shell average, or assign different weights, is somewhat inconsistent. If you have to average all three, you're in essence, it could be argued at least, assigning..." Number 226 REPRESENTATIVE PORTER: "Well, I think that it assigns the option, to average or to assign weights, so..." Number 228 MR. BOTELHO: "Yes. If your understanding of the word `may' and `shall' is the same, which is what, I, maybe we're not conflicting..." Number 235 REPRESENTATIVE PORTER: "I read this to say, you may do these equitable things to your calculations, or you may not. And I don't know if that's what the legislature wants to say." MR. BOTELHO: "As long as it is understood, Mr. Chairman, that the department is free to select only one crude?" Number 245 REPRESENTATIVE PORTER: "That's the way I read it." MR. BOTELHO: "I suspect that that is not a major issue for us. Similarly, with regard to providing for differences in oil types and destination areas. The difficulty obviously is to avoid the ability of a taxpayer to generate an argument next over whether the state has provided the proper weight to be given each crude, or whether it has provided for the proper differential..." REPRESENTATIVE PORTER: "...that discussion seems implicit in the whole process. While we're on a roll, just one more question if I may, Mr. Chairman. The last line: For the purposes of this section, current value includes spot or current prices or assessments publicly reported? Considering the dispute we have over assessments, wouldn't market transactions be a better...?" MR. BOTELHO: "Mr. Chairman, the word assessment here is in an entirely different context. It isn't referring to tax assessments." CHAIRMAN VEZEY: "I'm sorry, I didn't hear that statement." Number 254 MR. HOSIE: "If I might add something, Mr. Chairman, if the question went to the point, is an assessment something other and different than a spot price, there is a small difference. A spot price is usually a transaction driven price. Somebody goes out and buys oil, and that transaction results in a price. Frequently, those transactions are reported in the spot price (indiscernible) those deals are reported. Other services don't report on a transaction- specific basis, but simply look at the market overall, and arrive at an assessment of spot prices given their survey of transactions. And so, it's just a distinction that tracks the way the information is reported in the trade press, largely." REPRESENTATIVE PORTER: "Is there a better (persons talking over one another, exchange is indiscernible) word for that than assessments?" MR. BOTELHO: "Market assessments." MR. HOSIE: "Market assessments. And they're largely synonymous." Number 269 CHAIRMAN VEZEY: "Though, it (indiscernible) say or market assessments, I mean, that's what your intent is." MR. BOTELHO: "Yes, Mr. Chairman." MR. HOSIE: "Precisely." REPRESENTATIVE PHILLIPS: "Mr. Chairman." CHAIRMAN VEZEY: "Are you through, Mr. Porter?" REPRESENTATIVE PORTER: "Yes, thank you." CHAIRMAN VEZEY: "Representative Phillips." Number 271 REPRESENTATIVE PHILLIPS: "Thank you, Mr. Chairman. I would recommend that the committee make that an amendment, so that there is no ambiguity whatsoever about the meaning there. I do have a question for Bruce. And that is, this is such a common sense approach of changing the methodology that we're using. It seems to me to be a very good idea. Why did it take us so long to get to this point?" MR. BOTELHO: "Mr. Chairman, I think a variety of reasons. I know, even when I served as Deputy Commissioner of Revenue, in between 1984 and 1986, we had been working on regulations not entirely unlike this. I think a variety of factors: the on-going litigation at that time over royalty values, and the concern on both sides, the tax side and royalty side, that anything done by the state to firm up a particular approach, given the instability of the market, and the lack of understanding of the market, could result in the state getting lower than, use the term, correct value, or good value. And also you had major differences of opinion within industry itself about how one should value oil. And so, it wasn't the industry operating as a monolith. Even today, you have widely varying values as a consequence of widely varying costs and transportation, as an example. And even that, today, remains somewhat of a concern. I think at this point people are comfortable with the market, they have confidence in the use of spot price, both within industry and the state, they have experience now with the royalty settlement that has been used in this approach for the last four years, and believe it to work. That level of confidence and comfort, I think, has persuaded the department and industry to be engaged in a discussion over the last several months, to try and reach this point. It's not to say this could not have happened a couple of years ago. I think before that time it would be highly, it would have been very difficult to do so." MR. HOSIE: "To add that slightly, when the Amerada-Hess case was being litigated, when the royalty case (indiscernible), it would have been difficult to work with the industry in approaching the problem collectively, given that there was the lawsuit about how the thing should work. And so, until that lawsuit had been resolved, it was hard to work with the industry on a collaborative basis. And that lawsuit wasn't resolved until April 1992 as to the oil valuation issues. "One other point to make on spot prices. I don't mean to suggest by the testimony here today that there is something wrong with spot prices in periods earlier than the 1980s. There was a spot market through the late 1970s. In fact, in 1979, ARCO and Union, two very significant West Coast refiners, collectively bought 70 million barrels of foreign crude oil on the spot market in calendar year 1979. There has been a spot market since the 70s, with large volumes of crude oil traded in it. What's happened, over the time, is that the electronic data services have gotten better at coalescing the information and tracking the information. And so now, everybody has the same sheet of music. And that wasn't true in 1979, 1980, and it became true over the passage of time. But conceptually, spot prices were no less market prices in 1979 than they were in 1985, than they are today. They have always been a market price. Whereas the posted price or a government selling price may or may not have been a market price. It just depended where the market was relative to the posted price or the GSP price. And so the notion that's common to both the pending tax regulations and the past royalty settlements, is use market values, use actual market prices as your basis. It's a common sense notion. If you were to go out and buy ANS oil today, in Long Beach Harbor, what would it cost you? And that number tells you what that stuff is worth." CHAIRMAN VEZEY: "Thank you. Representative Davies." REPRESENTATIVE DAVIES: "Thank you, Mr. Chair. To the point of the question of the weight calculation, subsection (c), it seems to me that if we were to change the word to `shall' that we would have to get rid of the word `different', because we may want to assign two or more the same weight, to those oils. So I would suggest a language something like `shall determine a weighted average of the prices for the oil selected,' or something similar, and get rid of that word `different'. But the question I wanted to ask earlier was, in this whole section where we're simplifying the evaluation, do we also have provisions in here that simplify the problem of the transportation costs? The net back to the point where it's metered. Is, generally, the point where it's metered, is that pump station #1 - is that where we take...? And do we take care of the federal tax credit problems? These other transportation issues?" MR. HOSIE: "Mr. Chairman, no. This legislation does not speak to the transportation element, that part of the net back puzzle. It speaks only to the downstream destination value aspect of the valuation exercise. The department has promulgated regulations that do address the transportation elements, and those are now being discussed with various industry groups, and particular producers and taxpayers. But this legislation does not speak to the transportation aspects. In answer to the second question, the general point evaluation is the least automatic (indiscernible.) That's the point at where -- and there's been years of dispute over that as well. But, generally speaking, that's where the royalty and the tax obligation attach, for general purposes. But, as I say, that's been disputed before." CHAIRMAN VEZEY: "Representative Green." REPRESENTATIVE GREEN: "Thank you, Mr. Chairman. When we broke, we were talking on the spot vs. posted prices and I agree that if a person is going to go buy a cupful or a tankful on the market, it would be a spot price transaction. But isn't it also a fact that on volumes, that just as you are doing here, on an annual adjustment, when you're talking about large volumes, that you want to come to some sort of an agreement that doesn't fluctuate as a small quantity might? And isn't it also a fact that spot prices because of their nature, dealing with small quantities on a quick - come in, buy, and get out - generally, if not always, are higher than posted prices?" MR. HOSIE: "Mr. Chairman, the relationship between the two varies over time. For example, there have been times when spot prices are significantly below posted prices. To use a foreign crude example, spot prices for foreign crudes were very much higher than foreign posted prices, GSPs in 1979 and 1980 and most of 1981, but then in October of 1981, the relationship flipped. And suddenly the foreign posted prices were much higher than spot prices. And that continued to be the relationship for some years. And so the relationship does change, both for domestic crude and foreign crude. Over the period 1980 to about 1984, generally speaking, spot prices for domestic oils have been slightly higher than posted prices. The industry, in looking at that problem in years past, concluded that the bias - the downward bias on posted prices -reflected the impact of the federal windfall profits tax. That was a 70 percent tax effective on the value of oil, and as a consequence, integrated oil companies, that being companies that both produced and refined the oil, had a very dramatic incentive to keep their production oil prices a little lower. Because if they could move a dollar of profit downstream to the refining operation or the transportation operation, they didn't pay the 70 percent windfall profits tax. And so, in looking at that problem in years past, the industry itself in its documents, which we've now read, and the experts, concluded that the downward bias on posted prices relative to spot, was in large part a function of the windfall profits tax applying to crude oil production profits, and not refinery profits, and not transportation profits. The windfall profits tax, in effect, became ineffective in about 1984, when crude oil prices dropped, and is no longer a factor, and in part, that's when the two spot prices and posted prices, came together." REPRESENTATIVE GREEN: "If I might." CHAIRMAN VEZEY: "Please, continue." REPRESENTATIVE GREEN: "Thank you, Mr. Chairman. Then, I am sorry that I am slow, but if that's the case, and if that's the fair way to evaluate what the true price of ANS is, on some sort of a market basket approach from spot crude, then why would it not be equivalent for the taxes as it is for royalty. Because if there's a change, that if the spot price may be actually sometimes higher than the sales over a long period, such as is coming from the North Slope, that would behoove the state just as much if it's higher than if it's the actual price, because they're going to get it through the royalty. There may not be that same incentive if we're doing it on a tax basis, and so would you please explain to me one more time why whatever is established for royalty, wouldn't also be established for tax?" Number 435 MR. HOSIE: "Certainly, Mr. Chairman. We're speaking prospectively, now? Not for past periods? For two reasons. One, there are three different royalty numbers, given that there are three slightly different royalty settlements with the big three producers. And so, you have three different numbers, and that doesn't work for tax because there is a requirement of uniformity. You have to come up with one number. So it's going to be at little different than at least two of the royalty settlements by definition. Two, through the process of drafting the regulations and discussing the regulations with the industry, the agency may decide to use a slightly different basket. And I think the issue would be, isn't that within its just discretion? Or should it be ordered to be in lockstep with the royalty market basket? So, I think there is a desire to preserve some flexibility to work with the industry to come up with a basket that is suitable as viewed by both parties. And in fact, the regulations as promulgated as they've been discussed, would involve six crudes, if memory serves, for their tax basket, on the West Coast, not just five. And they weight a little differently. It's just a way of tweaking the problem to get a result that is as close to ANS spot prices as you can, and work through the process with the industry so that everybody is comfortable that the thing is going to work the way it's anticipated to work. But they will be different than royalty, in part, because the royalty numbers themselves are different. There are three different ones." Number 450 CHAIRMAN VEZEY: "Mr. Hosie, I don't mean to interrupt, but, I mean, we all agree that, I mean, the spot prices is going to be the most volatile of the markets that we follow. It doesn't have to be, but that would generally be - or are we not thinking along those lines?" MR. BOTELHO: "Perhaps, Mr. Chairman, you would substitute the word most `representative', not necessarily the most `volatile'; it will reflect the value in the market. Again, a principle which industry and the state both agree should be the determinative basis, at least for royalty purposes. So there's nothing radical in the sense of what we're talking about here, is exactly the basis we have settled on the royalty side as a measure -- Let me see a little more about it. We agree on a base dollar number, a base royalty number with each of the taxpayers, what the market basket is tracking is not to tell you directly what ANS is to be reported for royalty purposes. What we're going to measure with the basket is the degree of change in the market. Taking that composite basket so that no one basket that goes askew is going to not be reflective generally of movement of oil in the marketplace over a period of time. So the basket's purpose is, for indexing purposes, to track a separate dollar amount that we have agreed with each company, each producer, should be the base number. And that, again, the - I can't remember the specific month that is our beginning month, but the basket isn't itself what tells us they will pay. It is the movement of the basket that serves as the index for the base dollar value. And my recollection with the ARCO settlement, which was the first one, was sometime in early 1990, I believe March, 1990, a fixed dollar per barrel which set the market basket, then tracks the movement, the fluctuation in the market, something that both in ARCO's case they and we could simply look daily to see what the average was, and know that day what was to be owed; simply taking that number times the number of barrels produced. And that is essentially how it works with Exxon and BP settlements and, as I mentioned before, all the other producers are able to elect one of those three. And that's precisely how the basket is intended to work on the tax side. It'll be a slightly different basket. "Now, having said that, I think that Rep. Davies may have raised the issue, or you, Rep. Green, and that is, there are three components to calculating - getting back to this value at the well head, which is in tax statute terms, value at the point of production - if you're net backing. You first of all have to solve the problem, what was the received at the destination point. So that's one component, the distant problem. The intermediate problem is, how much did it cost to transport that oil from Valdez, in essence? And under current tax statutes, producers are entitled to deduct reasonable costs of transportation. And the third element, netting back, are the pipeline tariffs costs. Now, we have settled the problem with the pipeline tariff major dispute, as you may recall, but that resulted in a settlement in 1985. So that component is fixed. There are seven different pipelines running through, maybe only six now, but there were seven pipelines running through taps. I mean, they weren't separate holes, but in fact seven different tariffs, and today, there are at least six, as I recall. Each of them report a tariff and each producer elects, negotiates a contract with the pipeline carrier, based on that tariff. That problem is taken care of. The second problem, the far end problem, is what this prevailing value regulation attempts to do, and that is, identify a price on that end. What we have not yet completely grappled with, and the Department of Revenue is currently working on, is how do we get at the reasonable cost of transportation? The industry, as a whole, has widely varying approaches to transportation. And, on a per barrel basis, I think the dollar amount between the lowest and highest could be as much as two and a half, three dollars a barrel. What the department is trying to grapple with is how you deal with, if you obviously simply average those differences, there's going to one company that's going to end up having to pay still a lot more than another, and another that's going to get a windfall, from the average. And so it has been a difficult question to wrestle with. It's one that we're trying to do in order to satisfy this complete methodological approach to taxation, so that we can avoid the need to audit company specific in the kind of detail we've had to do before. But we haven't cracked the nut yet. We're working on it. And I would say again that the royalty methodology approaches, does incorporate transportation, but it also varies from producer to producer. And is another reason why it would be difficult simply to say, just use the royalty methodology. There are three different methodologies. They treat this question differently. And in the interest of uniformity, the Department of Revenue has to approach it in a way that would equally, not necessarily equally impact taxpayers, but treat them equally in the tax code." CHAIRMAN VEZEY: "That enough, Representative Green. More?" REPRESENTATIVE GREEN: "No, I'll...Thank you." CHAIRMAN VEZEY: "Representative Nordlund." Number 541 REPRESENTATIVE NORDLUND: "Thank you, Mr. Chairman. Just to clarify for the record. It's my understanding that the industry is in support of Section 3 of the bill?" MR. BOTELHO: "Mr. Chairman, I think that's probably a question most appropriately directed to industry. My understanding is this is something that industry would like to see, and I think, again, certainly this administration would like to see as a way of working towards much more harmonious environment between industry and the state." CHAIRMAN VEZEY: "Representative Davidson." Number 548 REPRESENTATIVE DAVIDSON: "Thank you, Mr. Chairman. Mr. Hosie, Attorney General, if in fact we've only cracked the transportation nut, and we're not really sure what all - I guess we know what all is in there, but we don't know how to establish the true value of oil then, because we don't have a handle on this, as far as Section 3 is concerned. Would you please, first of all, tell us to what extent past assessment appeals have dealt with transportation disagreements between the state and industry; why we should, at this point, pass this Section 3 if, in fact, that large transportation nut is only cracked and not fully established as far as how it affects the value of oil? And secondly, up to this point, what about the transport of natural gas liquids? Have we gotten anything for the transport of that through the pipeline at this point? If it's all part of the milkshake as we heard before that comes out and goes down through the transportation process including in the tankers and goes downstream where it's beyond Alaska's reach to extract value, then why are we in a hurry to do this if in fact we're absolutely putting a cap on when we can go back and extract the value that was due the state treasury?" Number 572 MR. HOSIE: "Mr. Chairman, to answer the first of those questions first, looking at the past disputes, the various assessments and amendments to those assessments, there are transportation dollars involved. Those transportation component ranges, I would say, from somewhere between ten to 30 percent. It's not an insignificant portion, it's a fairly significant portion, but it's less important than the basic valuation issues. The principal dispute turns typically on how one calculates a return on investment, on ROI, for the vessels employed in the trade, in calculating the cost of the tanker services to move the crude from Valdez to the Lower `48 destinations. So there are transportation disputes with significant dollars turning on the outcome of those decisions. Second, as the attorney general mentioned, we have yet to crack the nut of how we come up with a uniform method for assessing these transportation charges. But, at this point, the division understands precisely what it is that various producers have done. They know which vessels are used, what it costs to operate the vessels, what it costs to bunker the vessels, where they go, what the trans-shipment charges are, what the docking charges are; that information is available and the division, as an institution, understands how the puzzle fits together now. That understanding did not come easily. And it did not come quickly, but it's the benefit of many, many years of work. But it now is something that the division understands. And as a consequence, can approach the transportation issue more quickly and more efficiently. We now know how the clock is put together. And it's simply a matter of calibrating how quickly the hands move around the dial. A third point: There is an ongoing dispute about natural gas liquids, the NGLs, which are part of the frothy milkshake, as the hydrocarbons come bubbling up the ground in the North Slope. To the extent that those liquids, those hydrocarbons are in the oil stream and go through the LACT meter, and downstream, they're counted in the overall volume, and taxes and royalties are assessed. The dispute now is whether those hydrocarbons are properly characterized as gas or as oil. And that distinction has significant tax consequences. If it's gas, there's a different tax rate, there's a different ELF, and there are certain processing upstream deduction charges that become an issue. And so the real issue there is, whether these particular hydrocarbons are properly characterized as being gaseous in nature or being oil. And that's something that's now being litigated, and it's something that this bill actually speaks to, in Sections 6 and 7. Is that responsive, Mr. Chairman?" Number 607 REPRESENTATIVE DAVIDSON: "I think it is. If I may have a follow-up there. In an integrated organization, where we go from exploration all the way down to oil spill containment, within almost the same corporate structure, in this transportation mechanism or element or component, how does one evaluate the cost of an internal construction effort of a tanker calculated into what the state loses as well as what monies are borrowed to construct that tanker? Do you see what I'm trying -- the financial servicing of a vessel, does that also go in? In other words, is the state losing a dollar on a dollar on a dollar because of all this compounded and compacted cost to industry that is easily transferred internally within an integrated corporation?" MR. HOSIE: "Mr. Chairman, I think there are two questions there, the first of which is, how do you go about determining the actual costs? How do you determine the actual deduction? After all, it's a vertically integrated company, Exxon builds and owns and operates its own boats, and Exxon can control the financing of those vessels and it obviously controls the operation of those vessels. So how do you crack that nut, and figure out what an appropriate deduction charge is? Well, there are two general approaches. One is to use actual costs, and the other is to use some sort of industry average. Thus far, the tax law has said you must use reasonable costs, and then the law goes on to define reasonable costs for the most part as being actual costs. So the exercise to date has largely involved looking at what it actually costs to build a boat. And looking at what it actually costs to operate the boat. And then from those actual costs numbers calculating your deduction. "The second question turned on how do you handle the financing charges? The cost of money charges that are inherent in any kind of capital intense business and products, such as building and operating a tanker? And some of the tankers we now see moving in and out of Valdez were built in the 1980s, and they cost about $80-$100 million (indiscernible.) To some extent, the money to construct those vessels was borrowed, there were interest charges, and those charges are part of the cost base in the vessel, so they do increase somewhat the deduction allowable. So, for instance, if Exxon sinks $80 million of its capital in building a vessel, that's a cost that's incurred. It's a cost of time, value and money and so it deserves to be compensated for that cost, so that's the return on investment component of the marine calculation process. It is a very complicated process. And again, that's why these audits have been so complicated and taken so long. And that's of course we have the amendment problem that we have." REPRESENTATIVE DAVIDSON: "So, the state, your shop, is comfortable with the fact that with Section 3, and then going back and relating the loss of the opportunity to go back and assess, we even have the expertise to deal with this in a way that does not shortchange the public treasury?" MR. BOTELHO: "Mr. Chairman, the answer is yes." REPRESENTATIVE DAVIDSON: "Thank you, Mr. Chairman." CHAIRMAN VEZEY: "Thank you. Representative Porter." REPRESENTATIVE PORTER: "Always looking for simple answers. Is it a reasonable assumption then that the goal of this section, setting transportation costs aside, is that all taxpayers will have the same value?" MR. BOTELHO: "Same day production, I think that is the most likely consequence (indiscernible)." CHAIRMAN VEZEY: "Did that (indiscernible) your question?" REPRESENTATIVE PORTER: "Sure did." CHAIRMAN VEZEY: "Representative Davies." REPRESENTATIVE DAVIES: "Following up on that question, you said on the same day of production..." Number 670 MR. BOTELHO: "Yes, and I should also add, it will also be affected by, there are other modifiers that should reflect the market in which the oil is placed. Obviously barrels going to the West Coast, quite apart from transportation, will have a different value than barrels on the Gulf market, as an example." Number 671 REPRESENTATIVE DAVIES: "All right. That was the question I was going to get to. You may have barrels produced on the same date that will go to different markets, and hence, they'll be sold on different dates as well as in different markets. And so, do we track all of that information? Each barrel as to which market goes to which date it's actually sold on?" MR. BOTELHO: "We do." REPRESENTATIVE DAVIES: "Which boat it went on, and all that?" MR. BOTELHO: "Yes, we do. It's determined barrel by barrel, day by day, drop by drop." REPRESENTATIVE DAVIES: "If I might follow up on this, then, it would seem to me then it does make sense if we know each barrel by barrel, the actual date on which it's sold, that it makes sense to value that on the spot market. That is, the market that most closely reflects the value of that oil on the date that it was actually sold." MR. BOTELHO: "Mr. Chairman, that is correct. And in fact that is the experience or the experience of putting together the Amerada Hess case where the parties really had to come up with common nomenclature, common tracking elements, that is, the tankers, the destination location, being able to account for litering and other interim transportation costs. By contract, I think the experience from the royalty litigation has created a database that has become common between the industry and the state that allows for the kind tracking we're talking about, easily. And again, one that also makes it quite easy to use this methodological approach to setting a value over which there will be no dispute." TAPE 94-61, SIDE B Number 000 REPRESENTATIVE GREEN: "...it will be given for a royalty position and also there is a change now, you say, that that wouldn't affect what the value would be prior to any other ramifications of the company. But this barrel came from company A and went to a location and a value was assigned to it. Why wouldn't it be the same for the tax or the royalty?" Number 013 MR. HOSIE: "It will be very close. The only difference will be, if the tax market basket differs either in composition of crude oils or in weighting from the pre- existing negotiated royalty market baskets. But across taxpayers, the same barrel at the same time in the same place will have the same value, so that similarly situated taxpayers will be treated similarly." Number 024 REPRESENTATIVE GREEN: "Okay, so, for a taxpayer, for that barrel, it would be the same." MR. BOTELHO: "In the same market?" REPRESENTATIVE GREEN: "Yes. It's the same barrel that gets onshore." MR. BOTELHO: "I'm sorry. Mr. Chairman, just a clarification. You want to make sure that the same company delivering one barrel to one destination is going to pay exactly the same thing in taxes as well." REPRESENTATIVE GREEN: "Well, at least it would be subject to the same value on that barrel subject to tax to that company as was given for the amount for royalty in payment rather than in kind." MR. HOSIE: "Mr. Chairman, the short answer is, no, not precisely. Because the royalty market basket, there is not one royalty market basket. There are three, and they differ between and amongst themselves. And the tax basket ultimately adopted may use different bench mark crude oils, and may assign different weights to the crude oil, so there may be a difference, maybe it's cents, maybe it's a nickel, between the royalty destination value on the same day at the same time, and the tax destination value for the same barrel at the same place and the same time. So there may be a small difference in downstream values that's a product of slightly different weighting, on the tax side, or using a slightly different mix of crude oils in the market basket. So that we can't promise identical values downstream. But they're going to be very close." REPRESENTATIVE GREEN: "Then the question still remains. If we're talking about how long it takes to come up with a value so we need to extend the statute five years because it's a complex situation, are we making it more complex by doing this? Why isn't there a value that can be traced, as we've said, and that value used. Now, granted, the tax situation -but it's the same barrel, from the same company, and how that tracks his transportation costs back to the pipeline is going to be different - all those aspects are going to be different. I understand that. I just don't understand why there would be a difference on day one for barrel one from company A that it would be different for tax or for royalty." MR. BOTELHO: "Again, Mr. Chairman, let me try a cut on it. If we're talking about oil delivered to Long Beach -- Right now, if Exxon, ARCO and BP were all placing oil under their respective royalty methodologies at Long Beach, they'd come up with different values, because each one of them has a separate market basket, slightly different. And tax methodology will have a basket. And that basket may or may not reflect a royalty basket for any one of them. The answer will be whether that ARCO, Exxon and BP in the Long Beach market delivering oil in the same day will have the same, those same barrels, delivered that day, for all three taxpayers, to have the same destination. For tax, under a common methodology, applicable equally to all three. I may not be getting through." CHAIRMAN VEZEY: "Did you conclude your question, Representative Green?" REPRESENTATIVE GREEN: "Yes." CHAIRMAN VEZEY: "Representative Davidson." Number 101 REPRESENTATIVE DAVIDSON: "Thank you, Mr. Chairman. I still, there's something that I'm not getting here that I feel is important. It relates to natural gas liquids and the cap on the time, so I want to ask the question like this: Are there NGL volumes that have gone through the pipeline, for which the state has not received consideration? As far as, being part of the transportation cost? In other words, were those natural gas liquids transported as part of the volume and not computed - I mean, did they get a free ride? Up to this point, do you have any idea of the amount of that natural gas liquid that has gone through for which the state has not received consideration?" MR. HOSIE: "Mr. Chairman, it is my understanding that all volumes that go through the LACT meter and go through taps are counted. So taxes and royalties are paid on those volumes as oil. And so, the state has received the tax payment and a royalty payment for that volume of NGLs that's an indistinguishable part of the overall crude stream. So, there have been no barrels free-riding south without the state getting its share of royalties and taxes. There is a dispute, however, as to whether those NGLs, when they're part of the overall milkshake stream, are viewed as gas or as oil, and because that initial characterization changes the tax rate and other things, it really matters which they are. And so the characterization dispute - is it gas, or is it oil? is ongoing. But no barrels have had a free ride thus far. Some may pay an additional tariff in years to come, but they've paid something thus far." REPRESENTATIVE DAVIDSON: "Thank you." CHAIRMAN VEZEY: "Representative John Davies." Number 144 REPRESENTATIVE DAVIES: "It seems to me that in order to answer the questions being asked, that we need to know more explicitly why it is that - to go back to your Long Beach case - why it is that the royalty value is different for the three different companies for a barrel produced on the same day and transported and sold on the same day at Long Beach. Why are there three different valuations for the oil at Long Beach on the royalty side?" MR. HOSIE: "Mr. Chairman, because each was negotiated separately in the context of litigation with each of the three (indiscernible) producers. And so, there was a separate negotiation with Exxon, a separate negotiation for BP and a separate negotiation for ARCO. And because they were separate negotiations, and because it was in the context of litigation, there are differences between the various approaches. The similarities far outweigh the differences, but there are differences, and it was purely a function of the fact that they were negotiated resolutions of an ongoing piece of litigation." Number 172 MR. BOTELHO: "Mr. Chairman, to expand, the market baskets in each case are different. There may be different weightings. They result in, obviously, in each bilateral negotiation, you have the input of the company. We're trying to reach agreement about how much weight should be given to which crudes, and again, while there are a lot of, again, overlaps about what should be in the basket, there are not, they don't entirely overlap, and there certainly were differences of views with each of the companies about how much weight should be given each. Consequently, and of necessity, the outcomes would be different at each place. Having said that, my guess is, and I think Mr. Hosie is correct, you will find, while there will be a difference individually between using the hypothetical Long Beach situation between the tax value and the royalty value with any given company, the difference is going to be minuscule." Number 200 REPRESENTATIVE DAVIES: "Mr. Chair, one last follow-up on that. Would it be fair to say that the reason why companies would be willing to negotiate a slightly different number, could be that the companies are differently situated at Long Beach, with respect to their transportation issues, their litering issues, their production issues, their internal integration issues, all those things would be different for the different companies." Number 202 MR. BOTELHO: "Mr. Chairman, that is certainly correct. Obviously, you also have the differences in timing. Each of the companies is very sophisticated in its own evaluation of what is taking place in the marketplace, and they do business differently, and as a consequence also their corporate view of what is happening in the market would lead them to negotiate differently what the basket should look like, and what the base number should be, how one deals with transportation, and the like. I think Representative Davies is correct when he indicates that it really has to do with each company being uniquely situated?" CHAIRMAN VEZEY: "Mr. Botelho, if I may, are we treating the oil company like a utility, in that we're not pricing our oil at the, say, at the spigot, at Valdez terminal? We're pricing it at the final destination? We're treating how they get it from A to B, treating it as utility?" Number 218 MR. BOTELHO: "Mr. Chairman, that analogy would be partially correct. Certainly with regard to TAPS pipeline tariffs, because those are set just like a utility. There is a Federal Energy Regulatory Commission which determines what rates may be charged; they must be reasonable rates; they also provide for a return. And so, the analogy is quite correct (indiscernible.) There are actually rate hearings. The tariffs are set each year. They are subject to challenge by persons using the individual carriers, or who have a substantial interest in it, and in fact there are ongoing proceedings even today, regarding certain issues related to the TAPS pipelines. The remaining features I think would be a little more difficult to directly analogize, to rate making proceedings, because, I think it would be fair to say, that most utility commissions are not looking to the markets to determine a value, as it were, and that it really is what the tax scheme requires us to do. We're trying to find a proxy for value while we're in the market, and one that would apply across the board. Utility rates also are generally directed at individual companies and we are looking at something that would be industry (indiscernible.) But I think the general concept obviously, is trying to categorize, trying to eliminate the need for in-depth, intensive, individual company by company review of every transaction in favor of something that is a close proxy to these basic values is certainly (indiscernible.) Mr. Hosie may want to expand on that - and, Mr. Chairman, you may not want any expansion on that." CHAIRMAN VEZEY: "Representative Hudson." Number 260 REPRESENTATIVE HUDSON: "Thank you, Mr. Chairman. It strikes me that this whole question of transportation costs, Bruce, is one of the major things that could fail to reach concurrence as to the price and the taxes that are owed. I'm beginning to suspect that that may be the major thing that elongates this whole process, which makes it difficult to settle it. And I'm assuming, at any rate, that the production costs are fairly easy to assess and come to conclusion; the TAPS costs are fairly easy to understand, you said that's almost regulated; and so then, it comes down to the question of, you know, what the costs or values of, say, tankers and rehabs and crewing and all of those types of things -- Are there any other aspects on the downside of this thing? Why wouldn't we, for example, have taxed this back at Valdez? That is, stop everything at Valdez, and not take into consideration any transportation costs; just simply said, we'll assess our taxes at the Valdez point of loading." Number 279 MR. BOTELHO: "Mr. Chairman, I think that's a very good question. You need one element. You need to know market. You need to know what the value is in the marketplace. And the marketplace, by and large, is not at Valdez. So you need, either, by proxy, that is, you come up with some way to account for transportation on a generalized basis, an average, weighted average, or whatever, to each market, as part of this net back, or you can take the historic approach of the Department of Revenue, and that is to go company by company, and actually determine what the reasonable cost of transportation is with respect to that company, taking into account the return on investments, the capital costs involved with the shipping itself, the crew charges, the bunker charges, and the like. The reason we haven't bitten that off is that, in this process, we're not far enough along in solving that problem to present it to you as the legislature to solve yourselves. I think our view is that is certainly where our focus of attention will go once we have gotten, having solved the pipeline portion of it, and now trying to deal with the end destination portion of it, obviously, our focus of attention will be on what we can do to either standardize transportation costs or, at the very least, figure out how we can streamline the taxpayer by taxpayer approach to transportation. All that is something we can see happening easily within a five-year period." Number 309 REPRESENTATIVE HUDSON: "Do you feel you have the resources -if I might, Mr. Chairman - do you feel you have the resources to adequately assess the state's position on the downstream side? Particularly the transportation costs of the vessels, and all that type of stuff?" MR. BOTELHO: "Mr. Chairman, we do. And let me make clear, we do not rely exclusively on in-house expertise for a large part of the oil and gas litigation budget has been dedicated to finding some of the leading experts in the country on this issue to assist us in evaluating. And they have been key personnel also in trying to devise ways to streamline the system overall. They've not simply been there to further aid us in our litigation, but also to try and see how we can prospectively solve problems." CHAIRMAN VEZEY: "Please proceed." MR. HOSIE: "Thank you, Mr. Chairman. Turning to Section 4 on page 3, we find the amendments actually appearing on page 4. These amendments speak to an issue that we haven't really touched on today yet, which is, what is the correct processing cost for a barrel of gas liquids? There are gas processing facilities on the North Slope. They were very expensive to build. And the costs of those facilities is to be spread over these barrels of gas liquids produced. And the question is, how much should the proper deduction for each barrel be as assessed against the state? That's being litigated now, on the royalty side. The state takes the position that the proper deduction is something in the vicinity of 56 to 60 cents a barrel. The industry argues for a much higher deduction, ranging from three to perhaps as high as four dollars and fifty cents a barrel. This simply works a compromise. At a dollar per barrel plant liquid produced, as the proper gas processing charge. It is a compromise. It's a little higher than the state would like, and significantly lower than the industry would like." CHAIRMAN VEZEY: "Mr. Hosie, Mr. Botelho, I think it's probably a good time that we break for lunch at this time and we'll start up on this subject when we get back. It's about five minutes until twelve; why don't we all be back here by 1:30." The House Standing Committee was at ease until 1:32 p.m. of that day and returned to order at that time. CHAIRMAN VEZEY: "Mr. Hosie, you had just got through going briefly through Section 4. I think you finished your remarks. Are you ready for questions or would you like to make some more remarks?" Number 373 MR. HOSIE: "I had finished with the remarks, Mr. Chairman, so we're ready for questions on Section 4." Number 375 CHAIRMAN VEZEY: "Are there questions from the committee on Section 4? My question is, this seems a little odd, compared to some of the other things that we're doing, in calculating values. On the transportation aspect, and the pipeline, we have a regular tariff. On the shipping, from the terminal of the pipeline, to the destination point, we are calculating something similar to a tariff. We're doing it on a cost basis, and we argue over auditing what costs are legitimate. Here we're just setting a flat rate per barrel. Now, if we could do that at the well head, or at Pump Station 1, we could eliminate an awful lot of auditing requirements. Why are we taking this approach here all of a sudden, as opposed to our cost evaluations that we do in virtually all the other aspects that you've talked to us about?" Number 389 MR. BOTELHO: "Mr. Chairman, the provision here is reflective of specific industry dialogue as a consequence of this bill going through the public process in the legislature. And, in particular, in the last three weeks, industry representatives, recognizing that the governor was intent on having a bill be acted upon by both the House and the Senate, seeing the bill as a vehicle to resolve other outstanding issues that have been in contention, we were not adverse to considering those kinds of issues because if we could deal with them now it would avoid us having to litigate over it or having to invest substantial auditing time. And as a consequence this particular provision was one presented to us which we reviewed and we're satisfied made the right tax choice. I would also want to say, I think, I need to be guarded in what I say because obviously this is an issue that arises both in the royalty side and the tax side, and the royalty one is in litigation, and obviously remarks made here can be used as evidence in the other proceeding. Hence, my reticence about being overly direct with you. But our view is that the language presented here, and, specifically, the dollar charge, has to be read in tandem with the provisions dealing with the condensate distillate and gas processing plant definitions (indiscernible) sections which have the consequence of treating for tax purposes these gas liquids as gas rather than oil. As I say, the issue arises on the royalty side as well. We're litigating specifically over that issue. It's quite clear that if you enact this bill, it could have some bearing on it, but I would like not to make much more in the way of specific remarks, at least in open session, because of the potential consequences to our litigation posture on the royalty side." CHAIRMAN VEZEY: "I'm not quite sure if that answered my question, because, I guess more simply put, why do we try to set a price for work being formed in this instance, when in every other instance that I'm aware of, we go through and evaluate costs, and argue over what costs are legitimate?" Number 432 MR. HOSIE: "Mr. Chairman, I think the answer is that this gas processing cost relates to a fixed number. It's a fixed investment. (Indiscernible) cost, what it costs to construct and that number is now known. The question is, how should that cost be spread over the barrels of liquid produced? And so, we have a known number, and so the question becomes, how much of that cost should be borne by the state? And so it's not a situation where the numbers are fluctuating as prices in markets (indiscernible), or as tanker transportation charges will fluctuate as bunker prices go up and down. And so this one narrow element seems suitable for this kind of fixed number approach." Number 444 CHAIRMAN VEZEY: "Well, that is an answer, but...you implied that this is a fixed expense, not subject to fluctuation to the producers, to the operator of the plants. You implied that, say, tankerage is not a fixed expense. And granted, it is not set in concrete, but - I'm still not sure that I understand why it is equitable just to arbitrarily set a ceiling. Obviously, it can be lower. It cannot exceed one dollar. So there has to be a basis for determining if it's going to be lower." Number 454 MR. BOTELHO: "If you're willing to recess into executive session, I will be glad to discuss this matter fully. As I indicated to you, to do so in open session makes the information available to people we are litigating against right now on this very issue. And to do so in open session would have the consequence of immediately adversely impacting the financial status of the state." Number 460 CHAIRMAN VEZEY: "I'm not interested in any special knowledge you have, or any proprietary knowledge you have, it's just the philosophy of why are we trying in this particular instance -if we're going to do this here, why don't we try to negotiate a price for our oil at the spigot at Valdez, or at Pump Station 1, instead of backing out all the transportation costs?" Number 467 MR. HOSIE: "Mr. Chairman, I think there were two reasons. One, the value at the point of production will depend in large part on where the barrel of oil goes. The barrel of oil that goes to the Gulf Coast..." Number 470 CHAIRMAN VEZEY interjected, "That's a very poor assumption to make. I mean, a commodity is - you don't control the price of a commodity, except for transportation cost. To say that a barrel of oil at Prudhoe Bay is worth less just because you can get another barrel of oil cheaper somewhere else, isn't really true. The difference is, the market that is where it is consumed. You have transportation, handling, and storage charges between the point of production and the point where it's consumed. But if we can assign a value to processing gas liquids out of gas, so that the gas -- the gas is being used. It's a useful product at Prudhoe Bay. The gas liquids have to be removed in order to use the gas. If we can do this here, why can't we just back out transportation costs and just say that Prudhoe Bay oil has got a value at the North Slope?" MR. BOTELHO: "Mr. Chairman, if the assumption is that this dollar reflects the value of these gas liquids, I think there's a misunderstanding..." Number 487 CHAIRMAN VEZEY interjected, "I interpret it as reflecting the value of the cost of getting it out of the gas stream." Number 488 MR. BOTELHO: "It is the processing cost, exactly, that is the ceiling (indiscernible.) There is nothing that you could preclude or would preclude the legislature from deciding that it wanted to fix a value at Valdez. You could decide that it is a fixed cents per barrel coming out of the pipeline at Valdez. You could do so at the well head, as we would say. At North Slope as well. That is, those are permissible decisions which this body could choose to do. Right now, however, the tax structure you have, is one that looks at value at the point of production. And in order to arrive at that, because there are no sales at that point of production, is to look at the downstream market, or markets, where those sales take place. That automatically forces you into this net back scenario. For the most part, there are few sales, at Valdez, that would be a proxy for this value at the point of production, where you could run through. The legislature could depart from that and simply say, any of a number of schemes, and decide that Valdez should be the point where you measure the value. You could do so. I think it would be difficult to do so, unless you were looking at something like a fixed cent per barrel approach, because you don't have transactions that are taking place there that would give you a sense of what the market is doing. Obviously, another approach would be, simply to do a proxy on transportation to these various markets. And that's obviously one of the things that is implicit, both in the royalty settlements and is something again that the Department of Revenue is looking at in trying to satisfy this transportation component of the net back. So, if we've suggested that you couldn't do something at Valdez, you could. There's no doubt about it. You have the authority. It would require I think a significant departure from the underlying tax structure. There's nothing wrong with that at all. There are some advantages, frankly, for being able to have a set number. But to the extent that you're trying to capture the concept of value, you need to do it in relation to the market." CHAIRMAN VEZEY: "The concept that I am having trouble grasping is that when it comes to backing out transportation charges or trying to determine the value of the commodity that we're selling, or taxing, as the case might normally be, and we're talking taxes here, we are very flexible as to how we determine what those costs between final marketing and production are. And we are not consistent from one taxpayer to the other. According to your testimony, we have different things that we've agreed upon that make the (indiscernible) come out to a different answer. But here we're saying that we're not going to allow anything above a ceiling of one dollar. It doesn't say you're going to allow a dollar. You may allow a number that's less based on, I would assume, a cost evaluation, a cost audit." MR. BOTELHO: "That is correct." CHAIRMAN VEZEY: "Why are we putting a ceiling of one dollar -if their costs are two dollars, why don't we treat it like transportation instead of treating it like some sort of a production penalty, or something?" Number 532 MR. BOTELHO: "Mr. Chairman, I think there are several answers, and certainly Mr. Hosie may have his own views on this. First of all, it has to be seen in the totality what the state has indicated in this package, is it's willingness to give up its litigation position that these gas liquids are oil; that, instead, they be treated as gas. The consequence of it is, first, generally speaking, well, there's a different and lower tax rate for gas than there is oil. The next concession is there's also a different economic limit factor, which is a further benefit. The quid pro quo in making this determination is to put a ceiling, based again on our own evaluation of the fixed costs, of a dollar, so that we do not have to litigate with producers, processing costs. Just as we have reached agreements, again, on the processing costs related to oil on Prudhoe Bay. Not reflected in what we're doing in this bill, but in fact we have such agreements as to the maximum amount which a producer may deduct for the cleaning costs, making the oil marketable at Prudhoe Bay. (Indiscernible) this is a parallel to that." Number 552 CHAIRMAN VEZEY: "Your answer is, it's just an arbitrary compromise." MR. BOTELHO: "My answer is, it is a compromise. I do not believe it was arbitrary." CHAIRMAN VEZEY: "Well, by arbitrary, I mean, that's where the number fell. It was not..." Number 555 MR. BOTELHO: "The state would have preferred, Mr. Chairman, a lower number, I think you will find other members of industry that would like to see a higher number. My suspicion is that you would hear testimony by people who would like to say that there should be no ceiling at all, it should reflect whatever a producer might suggest it should be." CHAIRMAN VEZEY: "I think one more question, if I may. We write statutes, we like to think that there won't be a change every three or four years, and maybe they'd stay in place for 10 or 20 years. Some of our Title 43 statutes have been in place since 1949." MR. BOTELHO: "That's correct." CHAIRMAN VEZEY: "Don't you think we should address this so that that number will slide as inflation ebbs or wanes?" Number 565 MR. BOTELHO: "Mr. Chairman, I think that is something that, again, falls within the realm of reasonableness. I would note on the other hand, however, we are dealing here with a fixed cost and known cost. You would index, normally, when you are expecting fluctuation. But the question here is being able to - to put that processing cost in part to allow producers to recover their investment in the facility used to clean the liquids; that is, to clean the gas, for marketing. Mr. Hosie, do you have anything to add?" MR. HOSIE: "Nothing to that." CHAIRMAN VEZEY: "Thank you. Representative Green." Number 573 REPRESENTATIVE GREEN: "Thank you, Mr. Chairman. You indicated earlier that you would be willing to go into Executive Session because if there were statements made publicly it might influence litigation. What is your feeling toward the fact that this piece of legislation is being rushed through the process -- I dare say it's been very enlightening to the people that were here, but there are a lot of the legislature isn't here -- and that, by doing something as important as this on a fast track, is there any possibility that the outcome of this legislation would also have an impact on the court's decision?" Number 584 MR. BOTELHO: "Mr. Chairman, to the extent that the committee is uncomfortable or the three committees sitting here in concert is uncomfortable with these additional provisions, obviously it's free to delete. We have used the bill as a vehicle to resolve disputes that we have with the industry. And to the extent that the committee is uncomfortable with its level of knowledge about (indiscernible) reflected in the bill, these issues clearly are important enough that if the committee believes it most desirable to hold off, then those provisions should be deleted. I say this with some reservation, obviously, because I think the industry has worked with us in good faith to arrive at some improvements in our overall relationship. Our goal here isn't simply to have good relations; obviously, we have a duty first and foremost to make sure that the taxes are collected as they become due. And that is our primary purpose here. At the same time, to the extent that we can accomplish it in a way that minimizes conflict over issues arising out of our current scheme, we should do so. That's what is reflected in the bill. And what is reflected here. Obviously, I think it would be helpful, and I trust that the committee will be hearing from certain members of industry, I think it would be important to hear from all members of industry. Again, the benefits don't directly impact every company in each of these provisions, but I think collectively reflect our efforts to try and solve problems that have come to our attention as a result of the focus publicly on this bill, and their view that this bill could be a vehicle to resolve additional disputes." CHAIRMAN VEZEY: "Thank you. Further questions? Further questions on Section 4? Representative Sitton? I'm sorry, I had Representative Davidson down, I'm sorry Representative. Representative Davidson." Number 611 REPRESENTATIVE DAVIDSON: "Thank you, Mr. Chairman. So, you made the statement that the state's position was that you would look to see that dollar figure lower. So I'm assuming, then, that there was loss and not gain as far as the state was concerned. So, I would like to ask, how is it that you have quantified what those losses are? And how is it that the industry has quantified what those gains were? I'll start with that." Number 619 MR. BOTELHO: "Mr. Chairman, one can look at the current tax rate, making the assumption that these liquids are oil, one knows the volume that has flowed since the injection of these liquids into the pipeline in the mid-80s, and thus can know with some degree of certainty what that dollar amount is. And one can also calculate the, taking the similar volume, the identical volume, and taking it at the lower gas rate, and you have that differential, and you can factor again the dollar ceiling, or using the dollar amount, as the ceiling for deductions for processing costs, and know the gap. And then the next issue you look at is your litigation risk, your position vs. that of the industry. What are the practices in other states? And what do the experts have to say about the treatment of those gas liquids? And make a decision about whether this is a reasonable settlement or not, and whether and how much the state is giving up to reach that reasonable settlement. We can also make the projection forward looking in terms of the anticipated amounts of gas liquid expected to be produced. Those projections are modified regularly to reach similar conclusions." Number 642 REPRESENTATIVE DAVIDSON: "Mr. Chairman, if I may follow. I know that the industry can do what they wish with their natural gas liquids, but does that mean that we've given up some opportunity for value-added product by allowing a situation here -- are all of these natural gas liquids then after processing, how they will be transported, if they are processed on the North Slope?" Number 647 MR. HOSIE: "Mr. Chairman, the natural gas liquids will be transported as an indistinguishable portion of the TAPS common stream. And it's just a question of figuring out what portion of that common stream consists of these recovered natural gas liquids. So they will pay freight as they go down the TAPS system, but they're just part of the overall oil stream." REPRESENTATIVE DAVIDSON: "And the freight that they pay on that - would that make the tariff that the state pays on its royalty oil, does it make it a cheaper rate? Or because there's a greater volume of things that benefit the other party, and not the state, or how does that work?" MR. HOSIE: "Mr. Chairman, if your question is, does including the NGLs into the common stream going through TAPS have a tariff consequence, I believe the answer is, that largely it does not. It may have a quality (indiscernible) consequence for the people who take the crude out of the pipeline at North Pole refinery near Fairbanks because of the overall gravity of the stream. But in terms of the base (indiscernible) tariff, I don't think there is any significant consequence by including the NGLs in the common oil stream. It does lighten the stream some, however. The specific gravity goes up." REPRESENTATIVE DAVIDSON: "Thank you." CHAIRMAN VEZEY: "Thank you. Representative Sitton." REPRESENTATIVE SITTON: "Thank you, Mr. Chairman. I want to make sure, Mr. Chairman, that with all these questions I don't get lost. Am I correct in understanding that the industry supports Section 4, right?" MR. BOTELHO: "Mr. Chairman, I think it is fair to say that for the most part the answer would be yes. I think you will find that there will be companies who will disagree with the dollar ceiling. I think you will have others who will say that it is an appropriate trade-off for the state's willingness to recognize these gas liquids as gas rather than oil." CHAIRMAN VEZEY: "Further questions on Section 4? Representative Bettye Davis." Number 673 REPRESENTATIVE BETTYE DAVIS: "Thank you, Mr. Chairman. I would just like to follow through on the question that was asked by Mr. Sitton. On Section 4, what we were doing with the gas liquids, our stand that we are taking is that this has already been done by other states already? Are we the only one that treat it different?" MR. BOTELHO: "Mr. Chairman, my recollection is that Alaska has been unique in its position on this. Is that correct?" MR. HOSIE: "I think that's fair." REPRESENTATIVE B. DAVIS: "Thank you." CHAIRMAN VEZEY: "Further questions on Section 4? Could we move on to Section 5?" MR. HOSIE: "Certainly, Mr. Chairman. With that, let's turn to Section 5, which begins, or at least the amended portion begins on page 5 of your draft legislation. Subsection (d). This reflects a particular problem unique to the Cook Inlet region, where a certain company takes gas and uses it as a feedstock in the production of urea and ammonia, principally for fertilizers. Section (d) provides that the gross value at the point of production for that ammonia and urea feedstock set equal to an amount negotiated in a pre- existing royalty settlement agreement, to which the state and that producer are a party. Essentially, that's what it does." REPRESENTATIVE PHILLIPS: "Mr. Chairman." CHAIRMAN VEZEY: "Representative Phillips." Number 689 REPRESENTATIVE PHILLIPS: "On page 5, line 29, the first word on the line, `Paragraph'. It seems to me this would be better if that word were `Section.'" Number 692 MR. BOTELHO: "That's correct." TAPE 94-62, SIDE A Number 000 CHAIRMAN VEZEY: "You mentioned in your testimony that we do have a viable market for Arctic Slope crude and we really don't need, I took your testimony to say we don't need to look at the world market crude (indiscernible) for the Arctic Slope crude." Number 029 UNIDENTIFIED SPEAKER: "Basically that's correct. You don't have to look elsewhere. There was enough cash sales in the market place back in the early periods and there is enough knowledge of the spot market today to look at ANS. We'll agree with the attorney general and with Mr. Hosie on one point, and this was the question about whether you could value it at the well head, and really, the value has to be worked back from the marketplace. It has to be worked back from the Gulf Coast, East Coast, West Coast, or wherever the crude goes because that affects the value. You can only place so many barrels of ANS on the West Coast before the market is full. And the next viable market for ANS is probably the Gulf Coast, and the net back value from the Gulf Coast is going to be lower than the West Coast. Now, I'll draw an analogy. Mr. Hosie has talked about the spot market and tried to value, in the late 70s and early 80s, a hundred percent of the ANS crude had a very thin spot market. The point is, the more crude that could have come onto that spot market would have driven the spot market price down because it was a thin market. So you can't take and look and find that there was 20 million barrels that sold at $20 a barrel, and a thousand barrels that sold at $30, and then value all of the ANS crude based upon this other crude, the thousand barrels that sold at $30. Because that was not the market price at that period. It was the market price for maybe some guy who had a refinery who had a crude outage. He needed crude that day and there was somebody with a ship that day in the vicinity. What's he gonna do? Shut down the refinery or buy that crude. That's not an arms-length transaction, first of all, you got somebody with a lot of power; the guy with the crude. And, somebody in a pretty bad position; a refinery with no crude. These things will help. Am I willing to pay for them by Section 1? Absolutely not. Do I think they're the right thing to do anyway? Absolutely yes. But not in Section..." Number 068 CHAIRMAN VEZEY: "You are confusing me there because I thought I heard you say that we don't need to look at foreign crude to evaluate Arctic North Slope crude." Number 069 SAME UNIDENTIFIED SPEAKER: "You don't have to but if you go back, and I'll go back to the royalty settlements, and a statement was made by the attorney general that those who entered into in the past several years and they seemed to be working well, and what I hear from the folks on our side is that they are working well. And what that basically does is, it's a formulary approach that puts different types of crudes in with different percentage of the total hundred percent allocated each of those, adds them up, and you come out with a value. And it's a close approximation as to what is happening directly in the market with respect to ANS sales. So, it's a substitute that seems to track well." Number 082 CHAIRMAN VEZEY: "So, I would interpret your testimony meaning that you would not advocate repealing Section 3 on this bill." SAME UNIDENTIFIED SPEAKER: "I am opposed to 377 as long as Section 1 is in there." (short break on the tape) Number 084 REPRESENTATIVE DAVIES: "...that portion of liquid hydrocarbons extracted (indiscernible) that could have been extracted through mechanical separation by a prudent operator (indiscernible). How do you know what that is?" MR. BOTELHO: "Mr. Chairman, good question. And the process engineers, the production engineers have to look at that, look at the stream and decide. And, in all candor, I am not sure how difficult a question that is. I am not sure how illusive a question that is. I am not sure how great the room for differences is. I am told, and it's my understanding that it's a fairly easily applied objective standard that's been around for a long time. But I can't say that I know that as my personal knowledge." Number 109 CHAIRMAN VEZEY: "Are we on Section 7?" Number 110 MR. BOTELHO: "Mr. Chairman, I believe that this section takes up a subject that we are not prepared to talk about. That is, you may be, but I am not. I think that brings us, presumably, to Section 16, Mr. Chairman." Number 119 MR. HOSIE: "With that, let's move to Section 16, which starts on page 10. Section 16 simply clarifies that Section 1 of this legislation is declaratory of existing law. To put that plainly, that the division's longstanding interpretation of the statute of limitations; that is, that amendments relate back, is the proper interpretation and that legislation, Section 260, wasn't designed to create a new and harsher rule for the state of Alaska in tax proceedings. This is a clarification of a prior piece of legislation and a recognition of a longstanding departmental division policy." Number 136 MR. BOTELHO: "Mr. Chairman, you will recall that this was in an earlier version, expanded into some two and a half pages of findings which no longer accompany this bill." CHAIRMAN VEZEY: "Representative Bettye Davis." Number 142 REPRESENTATIVE B. DAVIS: "Actually he answered my question. I was going to say, did this take the place of the findings that was in the original bill? Would this imply that this is the same?" MR. BOTELHO: "Mr. Chairman, that is correct." REPRESENTATIVE B. DAVIS: "Because I thought that was one of the compromises that you made with the industry was to remove the findings." Number 148 MR. BOTELHO: "Mr. Chairman, and the compromise was to leave this language. We had both this language and the findings. The compromise was to delete the findings." Number 152 REPRESENTATIVE B. DAVIS: "Could you clarify to me then, what is the difference because I see it as the same. You just don't have the two pages but you're referring back to it anyway." MR. BOTELHO: "Mr. Chairman, once again, the compromise was simply the insistence that the findings be deleted. I am not in a position to speak for why, from the other negotiator's standpoint, the deletion was satisfactory and this remained. We obviously felt very strongly that both the findings and this section be retained. The compromise was to have the findings deleted and I agreed to do so." CHAIRMAN VEZEY: "Representative Davidson." Number 168 REPRESENTATIVE DAVIDSON: "Thank you, Mr. Chairman. Mr. Attorney General, what is the effect of the deletion of the findings?" MR. BOTELHO: "Mr. Chairman, courts look to findings to have some sense, maybe broader sense of the purpose the legislature had in mind when it enacted law. So you find them not employed with great regularity, but over issues that are particularly complex, they provide some framework much as you use letters of intent. The Mental Health Lands dispute against something very complex, had extensive findings. To recite the history, how did we get to where we are right now? Why is it necessary for this legislation to be enacted? And basically that is the purpose of findings. We obviously sought to have that explanation available to the court and with its deletion our one safeguard again, in terms of giving guidance into the courts and having to resolve not only the three-year but the six-year statute is, of course, not in litigation any further, but might very well be soon. Section 16, I guess, is the final safeguard we see to making sure the courts understand (indiscernible.)" CHAIRMAN VEZEY: "Representative Davidson, please continue." Number 196 REPRESENTATIVE DAVIDSON: "So is it a fair statement to say that absence section of findings, we are giving less guidance to the court, this would probably tend to encourage and prolong litigation rather than resolve it more quickly. And the reason I ask the question is, we remember back in Section 1, we said now after five years, it's over as far as assessments are concerned. So I don't see how, by deleting the findings and thinking about that five years back there, and now here we have come down to a situation where we've encouraged more uncertainty as far as giving the court some kind of guidance." Number 212 MR. BOTELHO: "Mr. Chairman, I suspect that, or I shouldn't say I suspect, the court could look at the act and simply say that given the expressed departure from prior practice in Section 1, that that already sheds some light on the legislature's view of what the existing law is. Mr. Chairman, I am not entirely certain that I can, that I have the entire gist of Representative Davidson's question, but I consider this feature an essential feature of the legislation which the administration was willing to compromise on, that it is an essential element." Number 225 REPRESENTATIVE DAVIDSON: "Well Mr. Chairman, excuse me. This seems to be very crucial to what we're doing here because it seems that we're restricting the court's ability to get to the bottom of quantifiable value or how we reach finality in these matters of what is owed the treasury. I think that it is, I don't know, that we should pursue this more." MR. BOTELHO: "Mr. Chairman, if I might speak to that. The deletion of the findings has not rendered this legislation ambiguous or unclear. Section 1 is explicit. The five year rule is explicit. The rule that you can (indiscernible) for pre-existing cases is likewise explicit. This Section 16 makes it even more explicit that this act is designed to create (indiscernible) prospectively and endorse an existing division policy (indiscernible). And so the findings are not likely to encourage litigation or weaken the state's position in litigation. This bill, unlike the pre-existing Section 260, is not ambiguous." CHAIRMAN VEZEY: "Representative Phillips." Number 248 REPRESENTATIVE PHILLIPS: "Thank you, Mr. Chairman. Bruce, between Section 16 and Section 17, one of them stating specifically identifying declaratory existing law, and then Section 17 having the two new effective dates in. There is no conflict between those two, is there?" Number 255 MR. BOTELHO: "We do not see any, that's correct." Number 256 CHAIRMAN VEZEY: "Representative Bunde, do you have your hand up?" Number 257 REPRESENTATIVE BUNDE: "No, sir. Thank you" Number 258 CHAIRMAN VEZEY: "Okay. Moving on to 17." Number 259 MR. BOTELHO: "Mr. Chairman, Section 17 simply makes clear that this bill will apply to currently pending actions; that is, litigation with taxpayers. That is the long and short of that section." Number 265 CHAIRMAN VEZEY: "Questions?" Number 266 MR. BOTELHO: "Mr. Chairman, Section 18 is the one retroactive provision of the bill and that retroactivity provision applies to the, in essence, the gas liquids question, and is the section which would provide the economic benefit to taxpayers as a result of our willingness to treat these gas liquids as gas rather than oil." CHAIRMAN VEZEY: "Section 19." Number 288 MR. BOTELHO: "Mr. Chairman, again, it provides for the immediate effective date of all those sections pertaining to oil and gas taxation. The remaining sections are affected by Section 20 which provides for an effective date of July 1, 1994. My recollection is that when it says, `Take effect immediately under AS O1.10.070(c)' that it makes it effective 90 days after the Governor's signature (indiscernible) I believe it is two thirds of the vote and it becomes effective at the time of signature." Number 289 CHAIRMAN VEZEY: "Well, we have gone through the bill. Do you have any other general or specific comments that you would like to make?" MR. HOSIE: "With the Chairman's indulgence, two points that have not been touched on in any detail this morning, and I'll keep it brief. First, this bill does not mean that the taxpayers necessarily will pay the assessed amounts. It is not about the merits of the assessed taxes, whether in fact they are owed or not owed. What this bill does is give the department and the state its day in court. That's all. If the taxes are not proper, a court will so rule and they will not be paid. Second, if the taxpayers are right and if adjustments can only come in their favor after three years, that creates a tremendous incentive to delay. Because if the taxpayers can drag it out past three years, the music stops and the number can only go down, regardless of what the new evidence shows. Regardless. And so there's a tremendous incentive to delay and that perverts the process to some extent. The process should be and is about determining the correct tax due, the proper tax. After three years, under the taxpayer's view, the process is no longer about determining the correct tax. Instead it's about how successfully the taxpayers can chip away at a pre- existing assessment. And that's not how it is designed to work. I have nothing further. Thank you Mr. Chairman." MR. BOTELHO: "Mr. Chairman, thank you for the time you have devoted to this issue already. I am certain you will have (indiscernible) very enlightening information to come from various taxpayers or taxpayer organizations. I would only ask that if there are additional amendments proposed during the course of the testimony that you take today, that we be given an opportunity to comment on the impact that that proposed modification or modifications might have. Other than that, Mr. Chairman, we are certainly prepared to answer any additional questions and to allow others to appear before you now." CHAIRMAN VEZEY: "Okay. Earlier there was a question asked, if I understood it correctly, to the effect of, if the state loses in the case that's going to court next week, at the Supreme Court level, what would that do to its claim that it has so many billion dollars outstanding in back taxes. I believe the answer that you didn't know those numbers, you couldn't answer it. But more specifically, of all the, I believe, 42 cases that are pending, how many of those have the taxpayers not signed an agreement in accordance with 43.05.260, paragraph (c) (3), extending the tax liability period?" MR. BOTELHO: "Mr. Chairman, I think that would be a question best put to the Department of Revenue. I do not know the answer to that question." CHAIRMAN VEZEY: "Any questions of the attorney general? Representative Therriault." Number 339 REPRESENTATIVE THERRIAULT: "Yes. That last comment by Mr. Hosie. Your comment that industry would be encouraged just to drag things out past the three years, but now giving them the five years, it's the same thing. I mean all we're talking about is a different timing and I don't know if it is just that the two years extra gives the administration that much of a greater feel of comfort, but the argument you just made is to never have an absolute cut off date but yet, being proposed in this bill, by the administration, is a cut off date. So you can't have it both ways." Number 348 MR. HOSIE: "Mr. Chairman, that is exactly right. The five year cut off is a five year cut off and the division will have to conclude the audit and assessment process in five years. If it doesn't, it will lose the right to assess and collect the correct tax, regardless of the evidence discovered after the five years. And yes, there is an incentive to delay. But five years is not three years and 1994 is not 1979 or 1980, for all of the structural reasons that we have discussed earlier. But this five year rule comes with cost and consequence. They have to get it done in five years. And without question, the industry will understand that it's a five year rule and that if the process goes beyond five years, suddenly changes can only go one way, and that's in their favor." Number 361 REPRESENTATIVE THERRIAULT: "So the way the industry is interpreting the three year is that you have to make that assessment before the three year cut off and all cases have, some assessment has been made within that three year window. So, if the state should lose in court, what you're losing is only those increased assessments past the three year date. Is that correct?" MR. HOSIE: "That's correct." REPRESENTATIVE THERRIAULT: "So, when we start talking about the total outstanding tax obligation, six billion but this only potentially impacts three billion, of that only one billion is actual tax, but of that actual tax, what percentage now was after the three year period? Because it seems like what's being portrayed to the public is, that should the state lose in court, it's zero, we get zero. And basically, what we do is we just drop back to the assessment that was in the three year period of time which is clearly not zero." MR. BOTELHO: "Mr. Chairman, as I indicated early on, there are a billion dollars specifically at stake with the assessments in addition to those issued timely in the taxpayer's perspective; that is, within the three year period, we are talking about an additional billion dollars outside the three year period that's at risk." CHAIRMAN VEZEY: "Is that a billion dollars in taxes, or a billion dollars in taxes, penalty and interest?" Number 383 MR. BOTELHO: "That's taxes and interest. So what you're talking, again, is an indicated ratio of about one to one six, something in the neighborhood of $400 million in basic tax, and then an additional $600 million or so in interest on that." Number 387 CHAIRMAN VEZEY: "So that brings up a question in my mind, just trying to keep things in perspective. The amount of tax that we are disputing is in the range of one percent, five percent of the total taxes paid?" Number 392 MR. BOTELHO: "The amount in dispute in terms of tax is probably is in that range, five percent, and I think this is a very important point that you have raised, Mr. Chairman, and that is, taxpayers have made billions of dollars in tax payments to the state and while a billion dollars or three billion in tax and interest seems like a staggering amount, it is a relatively small percentage of the overall taxes paid by taxpayers, these corporate taxpayers, to the state. And your estimate, Mr. Chairman, of say five percent, I suspect is certainly within the range of what this is really about in dispute." CHAIRMAN VEZEY: "Any other questions of the - Representative Nordlund." Number 404 REPRESENTATIVE NORDLUND: "Thank you. Yes, I'm just wondering Mr. Chairman if once we hear from industry representatives if we might be able to have the attorney general and Mr. Hosie back up here to answer any further questions that we might have, or respond to industry's concerns." Number 408 CHAIRMAN VEZEY: "We could probably arrange that. We'll also be hearing from the Commissioner of the Department of Revenue, too." MR. BOTELHO: "Thank you, Mr. Chairman." CHAIRMAN VEZEY: "Further questions?" Representative Kott." Number 411 REPRESENTATIVE KOTT: "Thank you, Mr. Chairman. I want to get back to, digress a little bit, to the very beginning of our conversation here in the debate on this bill. We were talking about the relate back doctrine. Can you tell me when that doctrine was first implemented by the courts?" MR. HOSIE: "Mr. Chairman, that is a common law doctrine. It's been in existence in the common law for probably hundreds of years. It's a longstanding traditional doctrine, like the doctrine of equitable estoppel or tolling. It was recognized in this state, explicitly in the rules, in Rule 15(c) when the Alaska Supreme Court first promulgated the Rules of Court. But it pre-dates the Rules of Court as a longstanding common law doctrine and rule. And that's not unique to Alaska, that was true in the law of every state that I have examined." Number 426 MR. BOTELHO: "Mr. Chairman, just to follow up. The first time that the doctrine was explicitly articulated as a court rule really was in the process of developing the Federal Rules of Civil Procedure which took place in the mid- thirties. Initially in the mid-thirties is my recollection, maybe as late as the forties. That was the procedure also used by the territorial courts obviously of the territory of Alaska. Most states, although not all, have adopted some modification of the Federal Rules of Civil Procedure to guide them, and Alaska was no exception." Number 434 MR. HOSIE: "And, if I might add, we have cases on that point should you wish them provided." Number 436 REPRESENTATIVE KOTT: "Mr. Chairman, a follow-up. CHAIRMAN VEZEY: "Please." REPRESENTATIVE KOTT: "SB 511, I believe, was the original bill that was transmitted back in codifying the law back in 1976. And that bill, which is of the bill that we are changing today or least looking at the change, allowed for three exceptions. Why, perhaps, was this particular doctrine not included as one of those exceptions given the fact that it is a key component?" Number 442 MR. BOTELHO: "Mr. Chairman, my own view is that, again, the doctrine was so universally accepted that it didn't need articulation. Just as I pointed out earlier, you cannot find anything in Chapter 09.10 which outlines every other statute of limitation that the state has today governing any kind of conduct. You'll see no reference at all to the doctrine of relation back. Yet the courts have universally applied that doctrine to those other areas." Number 450 MR. HOSIE: "And if I might add, Mr. Chairman, it's not really an exception to the statute of limitations. That's an argument that Exxon has advanced consistently in the case now pending before the Supreme Court. They say the statute has three explicit exceptions. It doesn't have four and relation back is a fourth exception. It is not an exception. The exceptions are situations where the statute doesn't apply. For example, if a taxpayer commits fraud, or for example, if the taxpayer enters into a written agreement to suspend the statute of limitations. Those are exceptions to the statute. The relation back doctrine addresses a different question which is, what happens if you file your case or serve your tax assessment in a timely basis but amend it later? It's a different issue, it's not an exception issue. And to the extent that taxpayers have characterized this as an exception issue, they have mischaracterized it." CHAIRMAN VEZEY: "Representative James and then Green." Number 462 REPRESENTATIVE JAMES: "Thank you Mr. Chairman. Just a couple of things. One of the problems that I'm having is the description of what you call an assessment. And what is the audit portion of the procedure and what is the assessment portion of the procedure? And in reading some of the things that I have in my files here about the numbers of additional assessments that were issued, and whether or not you are in an audit process or whether you're in an assessment process. And it would seem to me that, yes, when you go from filing an assessment and you go through an audit process that maybe there might be some things that you might find that would be changing. But what I see as troublesome is that there are these continual new assessments, not part of an audit, not working towards an end result, but continually doing an additional assessment. And every time you do an additional assessment it amounts to more preparation by the taxpayer to contest the assessment as opposed to going through just the normal audit process and finding new and more material. And then proceeding even further than that, because I did find in the statutes someplace an Attorney General's Opinion which defined an assessment as a final billing for taxes. And that would be what I would consider a final billing. But there is also, if the (indiscernible) statute of limitations is about to run out, and you have the opportunity to do a jeopardy assessment, so that you've got it high enough, which is a typical IRS trick. If they can't get it done in time they just give you a big one and then you've got to fight this big one all the way to the end. And so I guess that I'd like to have you define for me, what is the difference of an ongoing audit and finding additional information, and periodically giving new assessments." MR. HOSIE: "Mr. Chairman, the processes overlap. You have an ongoing audit and you have an initial assessment at some point in that process. But as soon as the first assessment goes out, the discovery process doesn't stop. The division continues to look for evidence, continues to look for documents, continues to talk to witnesses. That's an ongoing process. It's the basic preparation of the case for resolution. And during that process, the amendment may be assessed as new facts are learned and as the auditors develop a greater understanding of what, in fact, happened. And so it - the process - it all goes together as a whole. There is not a separate audit period that is the only time when the auditors get to look at the company's documents and ask questions. That's ended with an assessment that then goes directly to court. It's more that the assessment marks the initial bill to the taxpayer, that then starts the adjudicatory process. The taxpayer, receiving an assessment, can either pay it, which ends the process, that's it, you pay it, it's over. Or you can not pay it, hold onto the money and say `I am not going to pay it, you're wrong.' And that's the dispute resolution process. But during that dispute resolution process the Audit Division continues to get information to bolster its position, to test the correctness of its own assertions. And that continues with the formal hearing. The statute AS 43.05.240 (b) & (c) provides that the formal hearing officer may subpoena witnesses, take new evidence all to determine the open, quote `correct tax due' closed quote. So the process, even at that point, is about getting to the right tax amount." MR. BOTELHO: "Mr. Chairman, I think it's also important when Mr. Hosie says the taxpayer can simply pay the tax assessed at whatever stage of the amended assessment. That is not to necessarily imply that the taxpayer has conceded. The taxpayer can stop the clock and the amount by filing with the initial assessment, paying that amount and filing a request for refund. The taxpayer is entitled to a hearing and the maximum which the state may hold the taxpayer to is the amount already paid. Taxpayers have always had that opportunity, that is to stop the clock, to stop the interest running, by simply paying the assessment and filing a request for refund. Why haven't they done it? Well, in fact some taxpayers have done exactly that. Most, however, and again I think the question is best placed to industry representatives, but our view is that most have not done so, historically, because the interest that they could earn on keeping money in dispute as opposed to turning it over to the state for the state to manage that money, was really losing value. Our interest rate, beginning 1991, was a disincentive for the industry to have to make available. That changed with the 11 percent compounding. And I think it also coincides with a lot more energetic efforts both on the part of the state and the industry to resolve these tax disputes. But the underlying point I'd like to make is that the clock could have stopped running on these longstanding tax disputes a long time ago, the taxpayers simply had to pay and make a request for refund and the maximum the state would be allowed to collect was the amount already paid in, that it was really a ceiling from which the taxpayer could work downward. I think the other concern, and it's certainly a legitimate one, about seeing amended assessments time after time. It's a reflection, obviously, that the process is ongoing and new information is constantly coming to light, but I should also point out, again, that taxpayers and the structure have a right to go immediately to formal hearing and get the matter over with immediately. There is one taxpayer that has consistently done that and that taxpayer, and it is a large taxpayer, has by and large managed to resolve most of its outstanding disputes with the state. Other taxpayers have elected not to use that process and instead have preferred to use the informal conference process which has no fixed time limit and has the consequence of dragging out over a long periods of time. But there again, a taxpayer has the right, at any time, to go to the commissioner and say, `At this stage, I'd like to forego my informal conference proceedings and move directly to formal conference. Please appoint an administrative law judge to hear the case.'" CHAIRMAN VEZEY: "Thank you." REPRESENTATIVE JAMES: "I'd like to follow up, Mr. Chairman, if I might. The troublesome part for me is that the language in 260 is very explicit, it says that the assessment must be made within the three year time frame. But even more complicated to me then, is the issue that in 270, it says the six year clock starts ticking when the assessment is made or the three years, whichever is the latter of the two, you know, at that time, that starts the six year. So I guess the biggest problem I have is the term `assessment.' What does an assessment really mean? Because that seems to be a critical thing that is listed in both of those statutes as to what sets off the clock." MR. BOTELHO: "Mr. Chairman, I need to defer to Mr. Hosie." Number 567 MR. HOSIE: "Mr. Chairman, the assessment is simply the initial bill to the taxpayer. There are different kinds of assessments under the different kinds of taxes. To illustrate under now repealed 43.21, the separate accounting tax regime, the first assessment was known as a desk assessment and it was an assessment based only on the documents given to the state by the taxpayer. But that's still called an assessment in the code. Most generally it's just the initial and preliminary bill to the taxpayer and it's the legal document that starts the process. It's really the trigger - it starts the process just the way a complaint in a civil action starts the civil case going. It's not to say that it's the last word or the final expression of the assessed amount, it simply starts the process. That was something the Supreme Court explicitly recognized in the recent Budget Reserve Fund Case, the Hickel v. Halford case. They said an assessment starts a quasi-adjudicatory process, it is just like a civil complaint. It is the trigger for all of these things and there is some room for ambiguity." Number 583 MR. BOTELHO: "Mr. Chairman, would it be helpful to the committee to actually see what an assessment looks like? I would be glad to give you a copy so you had some idea what it looks like. Some of you may have seen one from the IRS, I'm not sure." (some laughter.) Number 589 CHAIRMAN VEZEY: "It certainly, you know, if you would like to present one to us, we'll certainly distribute it to the committee. I personally don't have any desire to see any more of them, but that's alright. Representative Green." MR. BOTELHO: "Thank you very much for your time." CHAIRMAN VEZEY: "We have another question, if you have a few moments." MR. BOTELHO: "I do, Mr. Chairman. I have all day." Number 591 REPRESENTATIVE GREEN: "Thank you, Mr. Chairman. I'm sorry to go back on this common law (indiscernible due to static). It seemed to me early on, Mr. Hosie referred to the fact that a lot relies on the common law relation back doctrine and you mentioned that common law is commonly used, such as estoppel. Can you explain to us what may or may not carry forward as acceptance of common law? I'm thinking of a man and a wife live together for a while, common law said they were married after a certain length of time. Or adverse possession. Are those automatic that they are incorporated in state law or do they have to be established by some other method than state law?" Number 601 MR. HOSIE: "Mr. Chairman, they have to be recognized by, in the first instance a court, a judge has to look at it and say, `Alright, in this state we recognize common law marriages.' And that establishes the common law marriage. And that common law marriage doctrine exists until a statute is passed that says, in this state we will no longer recognize common law marriages. And so the common law co- exists with statutory law. Of course the statutory law always governs. But there are many common law doctrines that serve to fill in the gaps of statutory law. There certainly isn't a statute that addresses every possible issue or claim that could arise and courts commonly refer to common law to fill those gaps. And relation back is one example. Equitable estoppel is another example. This is particularly true in the tax area where the courts have always recognized that the power to tax is one of the most important powers of the sovereign, and that you can't see a limitation in that power unless it's explicit. And so, the common law doctrine there would be sure to survive unless the legislature explicitly said no, we want a different rule; we'll live with the limitation." Number 616 REPRESENTATIVE GREEN: "If I might follow-up on that. I'm confused and I'm sorry about this. But I thought you said earlier that it was an implied law here that judged no court, or that no case law has been established to imply that to the state of Alaska." Number 620 MR. HOSIE: "Mr. Chairman, I can't remember if there is a specific Alaska case that recognizes the common law relation back doctrine. There are many cases from many other jurisdictions including the federal jurisdiction that do. That's just the rule. I've seen nothing that suggests that Alaska would have a contrary rule. And the doctrine did exist in the state prior to the formulation of the Alaska Rules of Court, specifically 15(c), that made it explicit and a court rule. I mean, it didn't arise for the first time in this state with the passage of Alaska Court Rule 15(c). That simply recognized what had long been present and I am sure that I could find either a treatise or a case that says that." Number 635 MR. BOTELHO: "Mr. Chairman, in fact the Civil Rule 15(c) as published, has a long list of Alaska cases that deal with the applicability of that doctrine on statute of limitations, so there is extensive Alaska case law on it as well, not in the tax arena. Not dealing with this specific statute, but a variety of those that arise in the civil context." REPRESENTATIVE GREEN: "Thank you, Mr. Chair." CHAIRMAN VEZEY: "Thank you. Representative John Davies." Number 636 REPRESENTATIVE DAVIES: "Thank you Mr. Chair. You had mentioned the possibility of paying and then requesting a refund. I had two questions that relate to that. One was, if a taxpayer does that and then requests a refund and is subsequently is granted a refund, what is the interest rate on the money?" Number 642 MR. BOTELHO: "My recollection right now is the state is required to pay back on a rate equal to that being charged, that is 11 percent compounded." Number 644 REPRESENTATIVE DAVIES: "So at the present time it would be 11 percent compounded, and in the past it would have been the..." Number 645 MR. BOTELHO interjected: "It would be for whatever rates were in effect at those applicable times, that's correct." Number 646 REPRESENTATIVE DAVIES: "If this situation -- I guess I could make a question -- why is this situation not symmetrical in the sense that, if the taxpayer requests a refund, isn't that also establishing a state of conflict over what was due and so why wouldn't discovery continue during that state?" Number 649 MR. BOTELHO: "Mr. Chairman, it would. The state is obviously able to use whatever evidence becomes available to show that the amount paid are amounts of money which would be retained by the treasury. The general principle, and not unique to Alaska, in terms of being able to ask for a refund, is that making payment on the assessment sets the ceiling of the government's entitlement to the money." Number 656 MR. HOSIE: "I could add one point to that, Mr. Chairman. There is a United States Supreme Court case dealing with the federal tax area and the refund context that is precisely on point to the pending Supreme Court case here. And the federal supreme court case, a corporation filed a claim for refund. And there is a federal statute that says if you want to file a claim for refund, do so within two years or you'll lose your right. They filed within two years but the claim they filed was defective, it was fatally defective, and their claim was going to be denied. So they amended it after the two year statute had expired. The issue faced by the court was whether that amendment related back to cure, if you will, their first filing. Supreme Court ruled that it did, under the relation back doctrine, analogizing to civil process and civil procedures. The significant thing about that case is that there's no explicit federal law that says in the refund context, relation back is okay. It was recognized as a common law doctrine. That is still good law today on the federal level. And that is precisely the situation we find ourselves in here. And to illustrate that further, what if the shoe were on the other foot? What if the taxpayer filed a claim for a refund in a timely fashion and then after the statute had expired, discovered that in fact, it had a larger claim for refund? Would it not want to amend to get the correct amount back? And if it did amend, would it not argue that the amendment related back? After all, the basic taxes were already in dispute." CHAIRMAN VEZEY: "Representative Gary Davis, did you have something?" Number 676 REPRESENTATIVE G. DAVIS: "Yes, Mr. Chairman, thank you. Mr. Attorney General, you mentioned that after the initial assessment, if the bill is paid, it's over with. Does that mean paid cash-in-hand or does that mean accepted and the six year payment starts?" Number 678 MR. BOTELHO: "Mr. Chairman, the concept behind the filing is that the taxpayer disputes the assessment, but chooses because it wants to stop interest from running or wants to stop the department from being able to issue additional assessments, either before or after the three year period. It simply pays the assessment, whatever that amount is. It stops, what it does, it simply stops the department from being able to get anything more." Number 679 REPRESENTATIVE G. DAVIS: "So it is cash paid?" Number 680 MR. BOTELHO: "Yes, it is." CHAIRMAN VEZEY: "Representative James." Number 689 REPRESENTATIVE JAMES: "Thank you, Mr. Chairman and Mr. Hosie, your example that you gave of the federal case in the tax court of where the taxpayer was allowed to amend the request for refund. And earlier you said that in this state, the court, when there is not implicit instructions, they lean towards the sovereign. In the federal courts for taxes, do they lean towards the sovereign or towards the taxpayer?" Number 691 MR. HOSIE: "They would lean toward the sovereign as well and not withstanding...." TAPE 94-62, SIDE B Number 000 CHAIRMAN VEZEY: "If there are no further questions, I want to thank both of you gentlemen very much for your time and your input. You've been very helpful. The time is 2:44, and we will take an at ease until 3:00." Number 008 CHAIRMAN VEZEY: "I call the meeting back to order. The time is 3:05, May 13, 1994. Continuing in our testimony on SB 377. I would like to go next -- we've heard about four and a half hours of testimony from the Attorney General's Office, I'd like to kinda change the testimony a little bit and go to somebody from industry. The first person on our sign-in list is Mr. Paul Sullivan. Mr. Sullivan, if you would care to join us up here." Number 028 PAUL SULLIVAN, GENERAL TAX COUNSEL, EXXON COMPANY, U.S.A.: "Mr. Chairman and the members of the State Affairs Committee and Judiciary, and Oil & Gas, my name is Paul E. Sullivan and I am the general tax counsel for Exxon Company, U.S.A. I want to thank you for allowing me this time to be heard on this very important subject. We had a very interesting thing happen here this morning. We had Mr. Hosie, when he started out, present the state Supreme Court argument to you. The only response I have is that this legislature should allow the state the opportunity to make its arguments before the Supreme Court. That's the right place for this to be decided. The attorney general this morning talked about checks and balances. I would point you to Sections 16 and 17 of this bill and tell you that the bottom line of those two sections is to take away from Exxon Corporation its right, its day in court, the ability to be heard before the Alaska Supreme Court, and to have that court decide what this statute means, what it meant back in '76 and what it means today, before any action on SB 377. There's been a lot of talk about amendments and I've only got one; delete Section 1. Mr. Hosie has spent a lot of time talking to you about relation back theory. He has pointed out to you that this is the heart of the state's appeal to the Supreme Court. He has said that it was not addressed by the Superior Court. Those of you who have been to law school may have heard the example that's used, what happens when a case..." Number 032 CHAIRMAN VEZEY interjected: "There's none of us that have been to law school, so thank you." (laughter) Number 033 MR. SULLIVAN: "Well, it's a simple little example. One neighbor sues another and claims that the neighbor borrowed his lawn mower. When he returned the lawn mower, it was broken. The response of the other neighbor to the suit is, 1) I didn't borrow your lawn mower, 2) if I borrowed your lawn mower, it was broken when I borrowed it, and 3) when I returned it, it wasn't broken. Now the court decides what it's gonna do with that. And if it decides that the neighbor never borrowed the lawn mower, then it never has to address the other issues. Basically, what happened in the Superior Court was that that court held that there was a statute which was plain on its face, which was unambiguous and which allowed for three stated exceptions. Those exceptions were: If the taxpayer failed to file a return, the statute did not run; the second exception was if it was taxpayer fraud; and the third exception, and one that has received little notice today, is where the taxpayer and the Department of Revenue enter into a written agreement to extend the statute of limitations. Three years has been talked about as a cut off date. I can tell you that in every instance where Exxon Corporation has been requested by the state, the Department of Revenue, to provide an extension, we have done so. I can tell you that on average, the state has had five to six years to audit. From 1978 through the last audit period they have done, 1987 -- 1989, I'm sorry. And remember, this is 1994. Why isn't there a problem with the 1990 return? It's because we've given extensions. In some years we have given extensions of up to six years which says that the department has had the three years under the statute plus another six years by agreement with the taxpayer, for a total of nine years to do the audit. Every assessment that came during that nine year period is a valid assessment. There is no issue as to the validity of those assessments. What we are talking about is any assessment received after the three years plus any period agreed with the taxpayer for extensions. That's one point I want to make. Another point: The attorney general talked about, somebody asked a question about changing the statute again in the future, and the attorney general's response was, that was a possibility but we could count on the wisdom of the legislature to make that decision on changing the laws. Prospectively that's okay. Retroactively, is questioning the wisdom of a prior legislative decision. One which is under review by the Supreme Court on Wednesday. The attorney general also talked about a knowledge and data base that the state has invested in but refuses to use in the tax cases. He says there's no conflicts with industry under royalty. I think he is pretty much correct on that. The question is, why not use these royalty values for tax purposes? The administration refuses to do that. The attorney general indicated that the taxpayers want to use it for this contentious period that existed the later half of 79 and the first half of 80 on the ceiling price issue on federal price controls. I can tell you that Exxon has never suggested that royalty values be used for that period. I can tell you that nowhere in any negotiations with the state on revisions to how you determine value, have we said that. I can tell you that we have specifically talked about excluding that period and using royalty values for other periods. The attorney general talked about other states and the IRS and the department's longstanding interpretation being consistent with these other state laws. The first point I want you to remember - none of these states, and the federal government change their law retroactively. That may be their law, but they adopted it prospectively. The attorney general, in response to a question said that litigation will be -- the question was, will it be less or more with this bill, and he said, without a doubt, less. At the same time, the attorney general says that future value may be the same as royalty but may not. The word `may' whenever I see it, `may' equals litigation. If nothing else, there will be litigation about Section 1 and its retroactivity and whether that retroactivity is constitutional. "Mr. Hosie talked about spot prices. Before the break he talked about 1984 forward and a developed spot market. When we came back from break he said he did not mean to indicate that there wasn't a spot market in the late 70s and early 80s. In the late 70s, two to five percent of crude oil traded on the world markets, and I'm not talking ANS, crude oil on the world market, two to five percent was traded in the spot market. The rest was under long term contracts. Now let's look at ANS crude in that period. Twenty percent of the ANS crude that was sold, and not transferred internally to a producer's own refinery, but sold, was sold for cash. And I'd ask you the question: Which is the more valid valuation for ANS? Which of those two is the more valid valuation? "We had some discussion about NGLs. I'm talking about this before I get to my testimony. The attorney general made a very telling comment. He made two. First, he said that this was a trade off in this bill; give me Section 1 and I'll give up NGLs. But later on he told you that the state of Alaska's position on NGLs being oil, is unique. Let me tell you the flip side. Every producing state, except Alaska, treats NGLs as gas. What is the value to a producer of having to defend against a position that is unique to the state of Alaska? I submit the only thing that is going to be saved by that section is litigation, period. So yes, there is one instance in this bill where litigation will be reduced. And that's NGLs. But all it's giving the producers is exactly what every other state already says; natural gas liquids are gas. "The attorney general said that Section 16, when we got into a discussion of the findings that used to be in SB 185 versus the declaration in Section 16 of this bill, he said it was a compromise with industry. Exxon is part of the industry up here. Exxon is not part of that compromise. Mr. Hosie says what they're asking you to do in this bill in the prevailing value section just gives the state its day in court. I submit that Section 1 takes away Exxon's day in court. I have a case which has progressed through the state's system. Assessment, protest, informal conference, formal conference, Superior Court, and is days away from the Supreme Court. And this bill will, if passed, allow the attorney general to fly up to Anchorage, hand the court this legislation and say, the case has been mooted because the law that you're being asked to review no longer exists. That is unfair. That is not right. "A question was asked about what is an assessment. An assessment is any bill the taxpayer receives while the statute of limitations is open. If I have extended the period an additional six years for a total of nine years, the Department of Revenue can issue me 200 assessments if they please during that period, each and every one them is a valid assessment. And I have never said otherwise. But once the statute of limitations, including any mutually agreed extensions to it has run, something I receive on a piece of paper is not an assessment. It is null and void and the statute says so and the superior court says so. Mr. Hosie near the end said, `What if the shoe was on the other foot? Wouldn't the taxpayer want to amend?' Without going into detail, the shoe was on the other foot, with Exxon. The attorney general and the Commissioner of Revenue said, `Sorry folks, the three year statute has run.' "I'd like to turn to my prepared comments. There are three things that I'd like to accomplish here today. I'm going to give you some concrete information to refute the section of the bill which states that this is declaratory of existing law. The declaratory of existing law is no different than the two pages of findings that were in the prior bill; they are the same. I want you to apply your own judgment and common sense to decide whether, what those former findings now incorporated into declaratory formal law, are true. Next I'm going to tell you what's actually happened in real cases and finally I'm gonna tell you about the negative effects that this piece of legislation could have for the state and for its taxpayers. Legislative bills with retroactive application affecting tax liabilities are very, very rare. They should not be adopted unless there are compelling reasons. And even then, retroactivity is normally quite limited. There is an example in states where the legislature meets every two years, where when they meet, they can make the law retroactive to two years ago on the basis that this is the first chance they've had to do it. That makes sense. This bill is merely an after the fact revision and a revised interpretation of the current assessment deadline statute. Interpretation is an issue that the Department of Revenue has flip-flopped on since 1978. They told you that their position has been longstanding and there has been a firm policy since 1984. I'm going to tell you and show you different. The Department of Revenue's 1989 interpretation of the three- year assessment (indiscernible statute issue, and that was issued in an Exxon formal conference decision, is not correct. And the Alaska Superior Court has told the department so, but that 1989 formal conference decision is the very first time where this interpretation was exposed to the world by the Department of Revenue. The department's ability to audit tax returns, you're being told, has been constrained by its audit resources. That's not true. The taxpayers have not contributed to the delays in the period required to issue tax assessments. I'm going to talk in detail about that. Arguments that substantial public revenues, this is the $3 billion that are at risk in pending litigation, in my opinion, cannot be substantiated. Statements being made by the administration that the decisions reached by the Superior Court in the Exxon and the Tesoro case, the Exxon case is on the three-year assessment statute and the Tesoro case is on the six-year collection statute -- there are statements that those are inconsistent. That's not supportable. In fact, the cases are not even related. Three years is enough time to analyze a taxpayer's return and determine the taxes due the state. The fact that the statute of limitations allows for further written extensions if necessary, does exist. And Exxon has always granted those requests so I don't see what the problem is. Someone earlier mentioned jeopardy assessments. That's the option. Go to the taxpayer, ask for an extension, failure to give an extension, deny all his deductions. Okay. You're protected. Put the burden of proof on him at that point. Let me document these points. As I said, you're being told to find that this bill is merely a clarification of a longstanding administrative interpretation that under the statute for years back to 1976, the Oil & Gas Audit Division of the Department of Revenue can issue new assessments or increase existing assessments at any time while an administrative appeal or judicial appeal, for that matter, is underway. We believe the division cannot do that under the existing statute. And we're not alone in our belief. The Alaska Superior Court has also decided that the division cannot do that. The state has appealed that decision. The final decision is expected in the next six months. The case will be heard next Wednesday and I am advised that the normal time period is four to eight months for a decision to be rendered by the Supreme Court. The court has also advised the parties that it was willing to take the case on the briefs and waive oral arguments. But that has not occurred. This is not a clarification of the law for you to affirm an administrative interpretation an Alaska court has already found to be inconsistent with the existing statute. The court has found that the statute is clear on its face and does not require clarification. "Furthermore, while the Department of Revenue says their position is a longstanding interpretation of the statute, I submit that no such longstanding interpretation or practice ever existed. Let's look for a minute at the history surrounding the Department of Revenue's statement on the statute. The division's original 1978 assessment against both Standard Oil and Exxon, both of which are dated August 15, 1979, the division stated that the assessments quote `may change as the result of any audit findings within three years of the date of this notice of assessment' unquote. While Exxon and the Alaska Superior Court disagree with even that statement, that the three years starts from the assessment date, you should note that those notices did not say that the assessments may change as the result of any audit findings at any time during the administrative or judicial consideration of a taxpayer's grievance. Yet, that is what is proposed in Section 1 of SB 377. This is a fundamental abrogation of due process and is not in the state's best interest. "The next statement that I am aware of, is one on October 16, 1984, and was referred to by Mr. Hosie, earlier today. Attorney General Gorsuch issued a formal opinion, addressing the interpretation of the assessment deadline statute. The attorney general advised that once the three-year assessment deadline had expired, an assessment should not be amended unless the audit staff can show good cause, including an explanation of why the issue was not addressed by the audit staff on the original assessment. The Department of Revenue never accepted that opinion as the definitive and binding statement of the law; and it said as much in almost those very words to the Alaska Supreme Court in a 1989 case. The department's refusal to accept the interpretation of the Attorney General's Opinion is also shown by the fact that the interpretation that the department now advocates is at variance with the 1984 Attorney General's Opinion. "Let's look at that 89 case. The case I just referred to is Standard Alaska Production Company and it sued the Department of Revenue, challenging the department's attempt to assess additional taxes after the three year period had expired. The Department of Revenue had also done the same thing with Exxon and with other taxpayers. Standard asked the court to declare that the department's interpretation of the law was illegal. The department told the court, and I quote `No official department view as to Standard's limitation claims has yet been formulated.' This is 1989. Despite the fact that an Attorney General's Opinion had been rendered on the matter in 84, the department emphatically argued to the Supreme Court in the 89 case that it had not yet made up its mind about the correct interpretation of the statute. And you know, the court relied on that statement and it sent the question back to the department for administrative review. It said the case was not right to be heard by the court until the taxpayer had been through their administrative procedures within the Department of Revenue. "Now let's look at what happened in Exxon's 1978 income tax case because that was cooking along at the same time as the Standard case. We thought Standard was ahead of us when they got into the court, it turned out they got thrown out of the court and now we were ahead of them in the administrative procedures. In our case, the Department of Revenue went to the unusual effort of inviting other taxpayers to submit friends of the court briefs on the three-year assessment deadline question to help the department formulate its position as to the proper interpretation of the statute. If I can hand this out to folks -- here is a copy of the letter that the Department of Revenue sent out in 1989. It was sent out on March 25, excuse me, 1988. On March 25, 1988. And the letter states, and if you read the bottom paragraph on the first page, `Your participation is invited in order to assist the commissioner in focusing on the broader implications of various possible rulings on the statute of limitations.' And now we know, in 88, a letter goes out, they weren't quite sure what ruling they were going to give, and in 1989 they tell the Supreme Court they've not formulated an opinion. Mr. Hosie says that is a longstanding policy from at least 1984. "Finally, on May 26, 1989, the department issued its formal hearing decision in Exxon's 1978 case, addressing the assessment deadline issue. This decision in May of 89, is the department's first solid expression of its current interpretation of the law, bringing to a close the uncertainty that it itself had maintained in the Standard Oil declaratory judgment action. In summary, the department did not arrive at its longstanding interpretation of the law until May 26, 1989. And any suggestion the department had some earlier longstanding interpretation simply cannot be reconciled with the above facts and those facts are indisputable. There should be no doubt that this legislative proposal attempts to completely change the statute under which taxpayers have conducted their business for the last 17 years. If anyone has had a longstanding interpretation and practice with respect to the existing statute, it is Exxon. The difference between our interpretation of the statute and the state's is that ours has been reviewed by the Alaska Superior Court and accepted while the state's interpretation, first revealed in May of 1989 was reviewed and has been rejected by the court. Judge Cranston stated in his opinion and I quote, `The court also finds that in the absence of an exception, the plain and unambiguous language of both the statute and the regulation clearly limit the division from issuing initial or amended tax assessments, later than three years after the return has been filed by the taxpayer' unquote. There are three statutory exceptions: 1) Taxpayer fraud, 2) failure to file, and 3) where both the taxpayer and the department have signed a written extension. This is not ambiguous. There are three explicit exceptions. If Mr. Hosie feels there is a fourth on relation back, let him take that argument to the Supreme Court next Wednesday. That is the right forum for this to be decided. "I told you before and I'll tell you again. Exxon has granted extensions whenever asked to by the Department of Revenue. And in several audit years, they were for periods of up an additional five or six years, giving the department eight or nine years to complete the audit. All of those assessments are valid. I am not arguing about those assessments. Judge Cranston said, `None of these exceptions apply or exist in the facts of this case.' Next you are being told that the division's ability to audit returns was constrained by audit resources throughout the 70s and early 80s and there is just no evidence that that is true. The public record will show that in every session of the legislature since North Slope production began, the Oil & Gas Audit Division, formerly the Division of Petroleum Revenue, has received virtually every dollar requested in the Governor's budget request. Adequacy of staffing has never been an issue. What accounts for the division's untimely tax assessments is the zeal of its audit staff. They want to up the assessments, up the ante, on taxpayers who exercise their rights to appeal assessments. Former division director, William Floerchinger admitted in a published interview, four years ago, that the Audit Division has made a practice to issue highball assessments. One of the department's own hearing officers told the legislature in 1986 that the common practice of the auditors is to make assessments that are very high as compared to the amounts to which the department later settles with the taxpayers. Let's face it, the division's standard operating procedure is to issue amended assessments based on new and ultimately discredited legal theories to gain leverage for negotiation. The inadequate staffing levels argument is not valid. "I think you have been told this week that taxpayers contributed to the delays in issuing tax assessments because they requested suspension of actions on assessments. During the litigation by another taxpayer who challenged the separate accounting income tax, Exxon did suggest delays while the court decided the legality of that statute. I won't lie to you. We did request delays. To me that made a lot of sense. Why spend money, time, and effort addressing issues that might be null and void if the underlying statute, the underlying law, was declared unconstitutional. Our letters said, we protest the assessment, let's see what happens on this case, and then let's move forward. If the law is found unconstitutional, why address assessments under that law? But even that did not impact the division's ability to conduct its audits and to make assessments in our case. I might have asked for a delay, I didn't get it. Prior to and during the time that the constitutionality of the separate accounting income tax statute was contested, the division conducted an extensive audit of Exxon 78 records. In other words, our request for delay was denied. The 79-81 separate accounting income tax years, the division also requested and Exxon provided written waivers extending the assessment deadline. This is an important point, again. The division had more than six years on average with Exxon to do the audits because we always gave the extensions. And for some years, the extensions were up to an additional five or six years. Additionally, during the pendency of that lawsuit about the constitutionality of the separate accounting method, the division issued several amended assessments, conducted the informal conference with Exxon under its appeals regulations, and issued its informal conference decision. So they weren't delayed. The case was very active while the constitutional litigation was pending. "Now in the 78 case, Exxon also asked for a delay one other time, and I'll hope you'll appreciate this one. That one occurred on the evening before a formal conference was scheduled, when the Department of Revenue handed Exxon, at about 4:00 in the afternoon, another revised assessment and over 200 pages of supporting arguments. This revised assessment changed the whole theory of their assessment of the crude value issue for that year. We were scheduled for formal conference at 9:00 a.m. the next morning. We asked for a delay in the hearing the next morning to let us read the material and it was not granted. The hearing went on the next morning. So, if they are telling you that I've asked for delays, they're right. Some were very reasonable, all of them were very reasonable requests. None of them were complied with. "You are being told to find that there is substantial public revenue at risk in pending litigation, which if the state loses its appeal in the Exxon case, will be contrary to the public interest since such revenues would be uncollectible. All I can tell you is that any estimates of dire consequences to the Alaska treasury, if you vote down this bill (as I hope you do) are pure speculation. If you don't vote it down, at least take out Section 1. "First of all, because of the confidential nature of the interactions with the department and the taxpayer, I cannot speak to other taxpayer's assessments that might be impacted by this bill; I don't know. The fact, though, the division might try to issue another highball assessment to Exxon or some other taxpayer today and then tell you tomorrow that there's even more at stake. In fact, there was an affidavit submitted one or two years ago by a member of the Department of Revenue who said there was $600 million dollars at stake. That $600 million is now $3 billion, and I can't account for the difference. Neither you nor I can tell if the assessments would be sustained on their merits, without knowing the merits of the state's late assessments. No one can know or even estimate what revenue, if any, might be lost if the current limitations statutes remained unchanged. And any estimates are rank speculation. "Next, you are being told that you need to pass SB 377 to resolve the alleged inconsistency between decisions reached by the Superior Courts in the Exxon and Tesoro cases. Now to suggest that legislation is needed to resolve these decisions in these two cases is clearly wrong and very misleading. The two cases involve two entirely different questions under two different statutes addressing two different subjects. One is the three-year assessment statute and the other is the six- year collection statute. Neither the attorney general nor the department view the questions addressed in these two cases as related, much less identical, and the best evidence of that is that although the state won the Tesoro case in the Superior Court, they did not even cite it in their briefs in the Exxon case. In fact, I'd ask you, why are we here? What are we doing here? The courts have already spoken on both of these statutes. The state prevailed on its interpretation of the six-year collection statute and Exxon prevailed on its interpretation of the three-year assessment statute. The attorney general has told you that two of every three dollars at stake under this bill apply to the six-year collection statute. Those dollars are not at risk. The court has said so. I guess the real issue is that the attorney general does not want to let Exxon have its day in court on the three-year statute. That's what I conclude. The proper forum for this issue is to be decided in the court. The Alaska Supreme Court will be hearing the Exxon case next Wednesday. Let them do their job. Don't change the law to usurp the power of the judiciary. This controversy over the three-year assessment statute has been going on for over ten years. We're about six months from having it finalized. We don't need SB 377, Section 1. "Finally, you're being told that three years is not enough time to analyze a taxpayer's return and determine the tax due to the state. Proponents of amending the assessment deadline statute claim that three years is not enough time, given the allegedly obscure and complex issues involved in determining the true value of a taxpayer's oil. That assumption is not substantiated. In fact, it is contradicted in Exxon's 1978 income tax case, which is to our knowledge, one of only two cases that the department has actually adjudicated to a final conclusion on the issue of crude value. Let's talk a little bit about that case. "Exxon's 1978 case has been the subject of two formal conference decisions addressing the value of North Slope Oil transferred to our own refineries. The second one was issued over a year ago, on April 9, 1993, and it established that if the Audit Division complies with the law in doing its job, the determination of value is not that difficult. The reason that it's taken nearly 15 years to get to the bottom of this in Exxon's case is quite simple. The division tried to ignore the law and Exxon properly and successfully objected. Let me explain. From the beginning, Exxon has consistently taken the position that the best way to value the oil that went to our own refineries was to use the values that we used when producers sold for cash to third parties. That was a good bench mark for the oil you kept. The division refused to accept that approach and insisted upon substituting hypothetical values for the oil, based upon its so-called market basket of imported oils. Most of the time consuming legal skirmishes in Exxon's 1978 income tax case involved the complicated problems encountered with this approach. Now, after all is said and done, Commissioner Rexwinkel signed, a year ago, a formal conference decision saying that the value that Exxon used in its returns as filed were, in fact, a proper basis for valuing the oil that Exxon kept for its refineries. What is more, and this is the supreme irony of the fourteen year legal battle on the 1978 case, is that when the department's methodology is properly applied, as the commissioner ruled, Exxon actually overvalued its oil. That's right. We paid more taxes on the crude value issue with our 78 return as originally filed, than the commissioner said we should have. Commissioner Rexwinkel's April 9, 1993, decision in Exxon's tax case further confirmed that Exxon had a right to rely upon the department's published formal hearing decision in the 1983 Amerada-Hess case regarding the use of North Slope's sales data in determining the imputed value of the oil that Exxon kept for its own refinery. In the opinion, the commissioner criticized the Oil & Gas Audit Division for refusing to comply with that decision. He said that he found it `disconcerting' that the division would attempt to ignore the Amerada-Hess methodology which Exxon dutifully used. He also criticized the division's expert witness for refusing to follow the analysis of the Alaska Supreme Court by repudiating the market value concept that is the core principle of the tax law. "In short, there is one simple explanation for why the 78 tax case has taken so long to resolve. The Oil & Gas Audit Division simply ignored the law in the Amerada-Hess case. If it had done what Commissioner Rexwinkel said it should have done and followed its own regulations as it was interpreted in the 83 case, the 14-year battle would never have occurred. Taxpayers should not be punished for the division's having ignored the rulings and regulations of its own commission. Yet to this day, that formal conference decision which was remanded to the Oil & Gas Audit Division for a final tax computation consistent with the opinion, has not been seen or heard from again. Ask the commissioner where it is. Who is delaying here? "In closing let me spend a few minutes talking about some of the effects of this bill on the state and its taxpayers. Even if Exxon did not have existing disputes with the state of Alaska, I would still be here telling you that passing this bill would be bad law. Bad for the administration of the tax laws of the state of Alaska and bad for taxpayers. It would be bad because it's likely going to increase an already overburdensome litigation situation on tax issues here in Alaska, since taxpayers will be required to defend against some entirely new and perhaps misdirected interpretation embodied in an assessment that today could be received fifteen or twenty or more years after the fact. That's wrong. We urge you to pass laws that will seek to resolve tax conflicts for both Alaska and the taxpayers. SB 377 does what no other state has ever done. It changes the rules 18 years after the fact. This bill calls for retroactive changes to 1976. That's wrong. That's offensive. And that's interfering with the decision of an Alaska court. That court said what the plain legal meaning of the current legislative language is. That decision does not square with what the division would like it to say, so now you have this bill to undermine that decision. That's wrong. That's interference with a valid court decision applying the laws adopted in previous sessions of the Alaska Legislature and signed by the then governor. Retroactive changes to a state's laws sends a bad signal to all business in general about the stability and the certainty of the business climate in the state. It will impact on business decisions in the future. This administration has held discussions with producers concerning what's needed for a commercially viable gas line. What you do with this bill will certainly be a factor in at least one company's internal valuation of such a project. A taxpayer is entitled to a final resolution of his or her tax liabilities in a reasonable period of time. That is not happening under the current law. But the gridlock is not caused by the current law. It is caused by the Oil & Gas Audit Division and the Department of Revenue, issuing assessments that are totally inconsistent with the plain meaning of the tax law. Don't change the law, change the practice. As the hearing examiner said in his opinion on our 78 case, which was adopted by the commissioner on April 9th of last year, quote `The division's position of not using available market data whether for ANS or other transactions which are evidence of the value of ANS in the market is disconcerting.' I agree. If this bill becomes law, we will have more issues like this, not fewer. We will have longer periods before resolution, not shorter. We will both have to utilize more of our manpower and financial resources resolving these assessments, not less. As I've said before, and I'll say it again, that is not right. Don't promote tax gridlock in this state. Take a step to end it. Reject Section 1 of SB 377. Thank you for the time you have taken with me. I'm prepared to respond to any questions that you might have." CHAIRMAN VEZEY: "Thank you Mr. Sullivan. I would like to ask you to elaborate just briefly if you would. You have expressed your opposition to the whole bill, to Section 1 specifically. I didn't hear you comment on Section 1, paragraph (a) (2)." MR. SULLIVAN: "Section 1, paragraph (a) (2) - that's the prospective?" CHAIRMAN VEZEY: "Yes." MR. SULLIVAN: "Well, I guess I'd have a couple of comments there. One was mentioned this morning, I believe, on page 2, line 4, it talks about the department may not increase an assessment under this subsection. I believe it's left open the question about issuing a new assessment. And that's something that should be clarified prospectively. Let me also point out, as I have in my testimony, that conceptually nothing has changed about the ability of the taxpayer and the state to enter into written agreements to extend the five year statute. You could extend the three. The extension is still in the law, even with this change. So the five years is not five years certain. It means at the end of five years you either give the Department of Revenue an extension or get a jeopardy assessment. If they're not done." Number 688 CHAIRMAN VEZEY: "Thank you. You didn't specifically comment on Section 3, the prevailing value for oil. I guess you did." MR. SULLIVAN: "Well let me comment on it this way. You can't sugarcoat a bad bill and make it a good bill. Section 1 is a bad bill. Any bill that includes ...." (tape ends) TAPE 94-63, SIDE A Number 000 MR. SULLIVAN: "...whether any change needs to be made. That's the way it is in royalty. That there's an agreement, there's a reopener, a sit down session, agreement or baseball arbitration, and prospective application of any change. This one looks like it's retroactive. And I'm already opposed to retroactivity." CHAIRMAN VEZEY: "Thank you. Are there further questions from the committee? Representative Brice." Number 016 REPRESENTATIVE BRICE: "Thank you, Mr. Chair. Quick question. Why haven't (indiscernible) forced the issue and gone ahead and asked for the formal conference up-front, just to get the thing out of the way?" MR. SULLIVAN: "Very good question. Let me give you a hypothetical in response, and see if you'll agree with me. Let's say you go to your house tonight and there's a letter from the IRS and it says `We just looked at your tax return and you owe $100,000 of additional taxes beyond what you paid.' You've got a couple of choices, there's a phone number to call or now that you've got this, you've got the right to run right to court. I think you'd pick up the phone, you'd call and try to find out what it's about and then you'd try to meet with an IRS agent, and try to settle it out - maybe it's just a big mistake. The system in Alaska, that maybe the commissioner will explain to you later, but it starts out with the return and the audit and the assessment. And then you're right - the taxpayer has a choice - he can go informal conference or formal conference. The formal conference is very, very much like a trial. The state hires counsels, outside counsels, and experts. The company hires outside counsels and experts. There's discovery, there are depositions that are taken, and it is that record from the formal conference, that goes up to the Superior Court on appeal. You don't get a new trial on the facts. What we try to do when we get the assessment, is go to informal conference and point out there's a math error; we think you've misunderstood the documents that we gave you that led you to issue this portion of the assessment. We might provide - we figure out that they don't understand something, and you put the same information you've given them, you explain it to them again. Many of these issues go away at the informal conference. Having finished resolving everything that you can, and a lot of time, that's a lot of it, you then focus on the issues where there's a true legal conflict between you and the state on the interpretation of the statute. That's what you take to formal conference. It makes sense. That's what we do." Number 067 CHAIRMAN VEZEY: "And the tribunal or the adjudicating counsel at the formal conference is?" Number 069 MR. SULLIVAN: "The hearing officer appointed by the Commissioner of Revenue, who happens to work for the Commissioner of Revenue, and then the taxpayer and the state -the DOR's counsel, which would be the Attorney General's Office, those lawyers present their cases to the hearing officer. He renders a formal conference decision, and if the formal conference decision is in favor of the taxpayer, it is fixed and final - not appealable by the state. Because basically, the Department of Revenue is saying that the Department of Revenue was wrong. But the taxpayer may appeal it if it's adverse to the taxpayer. But the record from the formal conference is what is brought up to the Superior Court." CHAIRMAN VEZEY: "So this formal appeal process is not in accordance with the Uniform Arbitration Act or the rules of the American Arbitration Association?" (The response was inaudible). CHAIRMAN VEZEY: "Further questions from the committee? Representative Porter." Number 092 REPRESENTATIVE PORTER: "Thank you, Mr. Chairman. Would you agree, generally disagree or something in between on the quid pro quo between the dollar cap on processing for gas and the definition of (indiscernible.)" Number 098 MR. SULLIVAN: "Let's look at that. Mr. Hosie made a comment. His comment was, as I recall, that this was a compromise, that the dollar a barrel - the state says that the number is more like 56 cents, the companies say it's three to four dollars. And then we have language that says that it may not exceed a dollar. Now I read that as saying it might be 56 cents. But it can't be three or four dollars, so I don't see this compromise here. May not exceed a dollar includes 56 cents, but it doesn't include two, three, four dollars. I see absolutely no compromise and absolutely no value." Number 116 CHAIRMAN VEZEY: "Representative Brice." Number 117 REPRESENTATIVE BRICE: "Thank you, Mr. Chair. At the start of your testimony, we'd had a brief discussion about the idea of the relation back theory. Could you explain again why you don't think that it's an applicable doctrine in this case." Number 123 MR. SULLIVAN: "You're asking me to give Exxon's side of the Supreme Court case that's going to be heard next Wednesday. I will provide you with the briefs, if you would like them. We have outside counsel handling that. We disagree with the state's interpretation of the relation back theory. The Superior Court disagreed with the state's relation back theory. But I think it's about the only thing that the attorney general has to argue before the Supreme Court. Mr. Hosie said they are very confident about their position. I would submit that it would very appropriate for you to allow them to bring their position before the court. If you pass this bill, that will not happen because this bill takes away all of my rights to be heard in the Supreme Court. I have no rights, once you pass Sections 16 and 17, declaring that Section 1 - stating that Section 1, is declaratory of what the law was, and Section 17 saying that it is applicable to cases pending before the courts. I'm out of there. The attorney general will go up and hand them SB 377 and say that there is nothing for you to decide and that is not right." CHAIRMAN VEZEY: "Is that all, Representative Porter? REPRESENTATIVE PORTER: "Yes, thank you." CHAIRMAN VEZEY: "Representative Ulmer." Number 154 REPRESENTATIVE ULMER: "Thank you, Mr. Chairman. Well, on that point, you said earlier that the day in court controversy, it's kind of an interesting way to frame the question. I mean you're saying that you're being deprived of your day in court by this legislation because it, in essence, says that the state may continue to have its day in court on the merits of the assessments and the collection issues. So, one's a process point, the other is a substance point. And I think it's something we ought to clarify for the committee. If the statute is not adopted, a timing question, a process issue, precludes the state from having its day in court in terms of the merits or the substance or the validity of the assessments. And your day in court is limited strictly to an interpretation of a procedural limit on the ability to actually get at the merits of the case. So, they're not exactly equal and I think that that's what we're trying to struggle with here as we strike a fair balance between the industry and the state. You know, I don't think anyone sitting around this table, likes the idea of retroactivity; although, I think in fairness to you, you should know that this legislature as already adopted a statute this session that retroactivity precludes private nuisance lawsuits, for example. I mean, we're quite willing to do that, unfortunately. But, I think the question here is a procedural point. We're not changing the rules, so to speak, in terms of what taxes are owed. We're changing the rules just in terms of how much time you get to debate over what the taxes are owed. So, I don't know, I'd appreciate your comment on that, but you can't blame the state for trying to bring some certainty and guarantee that it will have an opportunity in court to collect the taxes." Number 192 MR. SULLIVAN: "Mr. Chairman, let me give three points in response to that. The first is, if I'm not incorrect, the private nuisance lawsuit issue - the attorney general came before a committee reviewing that bill and argued that because of the retroactivity, it was not the correct thing to do because it was probably unconstitutional. I think I'm right -we may have to check. Second, I will agree that a procedural change within the year, is just that. But a change which goes retroactive 18 years is the equivalent of changing the underlying law, because 18 years after the fact, many of the people who worked on issues that might be raised tomorrow if you pass this bill today, are no longer with Exxon Corporation. Many have retired, some may have passed away. Records on issues, that I haven't got the foggiest idea what they might be, have been moved several times in relocations, et cetera. So, it's not procedural. It is going to the heart of the matter. I think those are the points I'd like to make." Number 218 REPRESENTATIVE ULMER: "It may go to the heart of the matter in the sense of the evidence and the freshness of the material that needs to be presented in deciding it, but it doesn't go to the question of whether or not a fundamental right to sue, a cause of action, is being altered. And I guess that's the distinction, isn't it, between the private nuisance example and this example. It goes to the question of whether or not the right that an individual has to sue, based on the merits of that case versus the rights simply on the timeliness or the freshness or the staleness of the evidence." Number 228 MR. SULLIVAN: "There is a fundamental right which is being abrogated by this legislation. That is the right to rely on the laws. The law is what the law is, and the Superior Court has stated what the law meant. And we had a right to rely on that law. Passing this legislation, if it were done today, I might get another assessment tomorrow. I did get assessments that came eight or ten years after the year to which they related. I was in trouble to begin with on those, because of the books and records, and corporate memory, and people who had retired and didn't remember the transaction and it was not fresh - it was stale. That's why you have statute of limitations, so that I know where there may be differences of opinion between Exxon Corporation and any state or federal or foreign government, and I can gather the records while they're still fresh, I can gather the people while they're still fresh, and I can defend myself. This doesn't allow me to do that. This type of legislation does not allow that." Number 248 REPRESENTATIVE ULMER: "Back to Representative Brice's point though, if that was a real concern to Exxon, it seems to me that you would have gone to the formal hearing process, the formal adjudication, to bring closure when you had a higher degree of certainty about what the evidence would be. And, I'm not sure whether in your response, you were suggesting that you don't feel as though there's due process associating with the hearing officer procedure in the Department of Revenue. I don't know whether you're suggesting that or not." Number 257 MR. SULLIVAN: "There are some concerns in that area. They are unrelated to this bill and what's before us today. We received a total of, if I remember correctly, eight assessments with respect to our 1978 year. We started out with timely assessments, where we would analyze them, protest them, analyze, and then get another one, analyze it, protest it, analyze it, protest it. And then we got ones that were untimely, where we analyzed and protested and included in the protest that this was not a valid assessment because the statute of limitations had run. In the administrative process within the Department of Revenue, we agreed to accelerate the question on the statute of limitations by what's called bifurcating the case. It was timely assessments issued with respect to ROI that you've heard about in ANS crude value, and we said, `Okay, we're going to put these over here and work them, but we're going to accelerate this question on the statute of limitations, because it is at the heart of getting the year closed.' So that was taken through informal and formal on an accelerated basis. We did try to accelerate the issue. That still meant we didn't get an answer out of the formal conference until May of 1989. We immediately went to the Superior Court. There was about a two year period before a decision in, I think, in 1992. And then the state appealed it." REPRESENTATIVE ULMER: "Were due process issues raised in that litigation?" MR. SULLIVAN: "I believe they may have been." REPRESENTATIVE ULMER: "Okay, because I know in some proceeding, I wasn't sure whether it was yours, that the due process claim had been raised and that the court had ruled that there were no violations of due process in the hearing officer procedure. And that, as a matter of fact, a number of them had been decided against the state which re-enforced the state's determination (indiscernible) that there wasn't a due process problem. Thank you, Mr. Chairman." CHAIRMAN VEZEY: "Thank you. Representative Davies." REPRESENTATIVE DAVIES: "Thank you. The attorney general, also indicated the third method - second method, I guess, for stopping the clock which was to pay the assessment and then file a claim for a refund. Would you comment on your view of that process." MR. SULLIVAN: "...assessments were any where near the taxpayer's internal analysis of the ultimate liability, that would probably occur. However, where they are significantly inflated, I don't know about other corporations, but we don't have the money to put on deposit with a lot of states, awaiting the process to get it back. I'll give you an example in the federal arena. Exxon was presented with an assessment from the federal government that incorporated an issue involving the value of Saudi crude. Many of you may have heard of the Saudi Pricing case. In any event, the assessment was multiple billions of dollars. We chose, in that instance, to go to the tax court - to get to the tax court all you do is file a petition - if you want to go to the court of claims, you have to pay the tax and sue for a refund. You have an alternative system, of going to the tax court. We went to the tax court because we did not owe those dollars, and they were so substantial that we weren't going to pay them. We had a recent decision in our favor on the Saudi Pricing case. That was a multi-billion dollar case. In the state arena, same thing. If the tax is somewhere near the liability, then you'll seriously look at the opinion of paying and going for refunds. Where there are huge differences between your analysis (indiscernible) and assessment, it's going (indiscernible)." REPRESENTATIVE DAVIES: "A follow-up on that specific point. When a company in its financial (indiscernible) claims that it has sufficient reserves to meet its potential liabilities in these court cases, when you make those statements, do you take into account your assessment of the risk of you losing those assessments?" Number 328 MR. SULLIVAN: "Many, many companies do them many, many different ways. A lot of companies, who have been around for a long time, might just have a (indiscernible) statistical average of what's happened over time (indiscernible). I can't speak for industry or for business in general." Number 333 REPRESENTATIVE DAVIES: "So, I guess what you're saying then -you said there's a cash flow problem with doing that, so it must mean that there isn't actually a bank account somewhere that has the amount in it (indiscernible) the total liability that you might be exposed to. Is that correct?" Number 337 MR. SULLIVAN: "That is a correct statement. There is not." Number 338 REPRESENTATIVE DAVIES: "Thank you. And then the last question I had has to do with Section 18 and I wondered if, apart from the fact that there is a Section 1 in this bill, could you comment on Section 18." Number 341 MR. SULLIVAN: "That's the NGL's. And as I think I told you and we've had prior testimony from the attorney general that said that the state's position on NGL's is quote `unique' unquote. Every other state treats them as gas, so whatever effective date you want in there. All this does is, it gives certainty, I will agree with that, it gives certainty. It certainly says that the state of Alaska is no longer unique. It's like the rest of the states. It's treating natural gas liquids as gas, but if that's a compromise, the only thing it's doing is removing litigation, wherein we would show that natural gas liquids are gas." CHAIRMAN VEZEY: "Thank you. Representative Nordlund." REPRESENTATIVE NORDLUND: "Thank you, Mr. Chairman. Mr. Sullivan, you mentioned that there, or admitted basically, that there are certain sections of this bill that would help lead to lessen the amount of litigation in the future, but you said that Section 1 was going to lead to additional litigation." MR. SULLIVAN: "I suspect." REPRESENTATIVE NORDLUND: "And I know of at least one case that you won't need to litigate if that section passes, but what further litigation are you talking about. I didn't follow that. I wonder if you could comment on that." MR. SULLIVAN: "Well, I suspect that serious consideration would be given by one or more companies, to challenge the constitutionality of SB 377, if passed (indiscernible) Section 1, to the constitutionality of a retroactive change in the law for 18 years." CHAIRMAN VEZEY: "Representative Hudson." MR. SULLIVAN: "There may also, excuse me, Mr. Chairman, may be litigation in terms of a particular 78 case as to whether we have a property right in a decision of the Superior Court, in support of the constitutional challenge." Number 371 CHAIRMAN VEZEY: "Representative Hudson." REPRESENTATIVE HUDSON: "Thank you. Mr. Sullivan, in layman's language, what is, as simply stated, the principal question before the court. You've indicated that if this bill passes, it takes away your rights to proceed in the courts. Maybe you could just help, me at any rate, if you could tell me, what is that question." Number 376 MR. SULLIVAN: "The question before the court is essentially, did the Superior Court - is the decision of the Superior Court correct? And the decision of the Superior Court was that this statute - the assessment statute - was plain and unambiguous on its face, and not subject to any other interpretation. That it specifically, the statute and the regs, had three enumerated exceptions: Fraud, failure to file, or a joint agreement between the taxpayer and the Department of Revenue to extend the statute. And that under those circumstances, three years means what it means. That there is three years from the date the return is filed for the Department of Revenue to audit and issue an assessment. And that any assessment that came after that period, is invalid. So, it's an appeal by the attorney general from a decision, which he disagrees with, to see if the Supreme Court will agree with him." CHAIRMAN VEZEY: "Mr. Sullivan, do you have an idea of how many - what the total number of assessments that the state of Alaska has against Exxon right now, in terms of oil property tax or severance tax?" MR. SULLIVAN: "The number of outstanding assessments?" CHAIRMAN VEZEY: "Yes." MR. SULLIVAN: "We have received assessments for the 78 to 81 income tax, we closed through 78 production, assessments for 79 through 89, and for the modified apportionment income tax 82 through 87, but that does not mean that there is one assessment per year. I use the example of 1978, wherein we received eight separate assessments with respect to that one income tax year. Four or five of those were timely and three or four, I can't remember, were after the statute had run, according to Exxon and according to the Superior Court. Let's go back again and make the point. There are two Superior Court decisions. One of them is on the six-year collection statute and it holds that the state's interpretation that the statute stops for the period of the administrative appeals in terms of final determination of liability, that the state is right. There is another one that says that three years means what it says and you can assess within the three years or any extension thereof mutually agreed in writing. And after that, any subsequent assessment is untimely. Both of these statutes that you're being asked to change have been to the court and decisions have been rendered. And based on the attorney general's split that two-thirds of the dollars are in the collection statute and one-third is in the assessment statute, I guess another way of looking at it is, the state won two-thirds and the taxpayer won one-third, right?" CHAIRMAN VEZEY: "Representative Ulmer." REPRESENTATIVE ULMER: "Thank you, Mr. Chairman. Just one last question. When you first began, you mentioned that this provision may not be different from other states, but what is different is that in other states, the legislature did not go back later and declare it to be the law. That that is the way it's been in other states and there just wasn't an issue about how it was to be applied. Now, in this case, the industry is representing this as retroactively changing the rules of the game. The state is representing it as, in essence, blessing past practices. Basically, a statement on the part of the legislature that the legislation means what the state says it means, as opposed to what the industry says it means. The state is basically - the attorney general has come to us and said, this is what we think it means. You have indicated that if this was a longstanding policy, there is some evidence of the record, why it was not a longstanding policy, in terms of the Department of Revenue saying that they haven't made up their mind what their official policy is, but that's different than saying that that's what the attorney general's ruling is that that's what the law has always been in Alaska until the Superior Court came along and said that isn't what the three-year assessment statute means. The Superior Court all of a sudden says it means something else. The attorney general says the Superior Court is wrong - it's always meant this, not that, and they're going to court, you're going to court, to get the Supreme Court to say, it means what the attorney general says, it doesn't mean what the Superior Court judge said it means. That's where we really are. And, I guess, what's very confusing to legislators, when the framing of the issue is retroactively changing the rules of the game. It's that just somehow that the tax laws are being changed, which, of course, they're not." CHAIRMAN VEZEY: "Representative Ulmer, could you please lead into a question somewhere?" REPRESENTATIVE ULMER: "Thank you, Mr. Chairman, I'm trying -I'm trying, honestly. The framing of the issue as retroactively changing the rules of the tax law; that's what I'd like you to speak to at this point, if you would, because I see it as declaration of the law in a way that you do not like and the attorney general does like. How is that consistent with your describing it as changing the rules by which the taxes are calculated in the state of Alaska?" MR. SULLIVAN: "Well, let's take an example. I got my first assessment on 78 and in that assessment it says `this assessment may change within a period of three years from the date of this assessment.' Let's suppose that three years and one day later, now knowing the issues in the assessment for which I have to keep corporate records because they're in the assessment and these are issues that are going to be talked about, and throw everything else away. Now in 1984, lo and behold, there's an Attorney General's Opinion that says, `With the showing of good cause, an assessment may be changed, but the Department of Revenue must show the reasons why they didn't originally put it in an earlier assessment.' Now I'm out in the garbage can and I'm trying to find those records. And then I get a letter in 19880 - well, then I see, Standard says the Department of Revenue says in the Standard Case that we have no position - now I'm looking for all the darn records. And then I get a letter from the Department of Revenue that says, `We want you and others to file friends of the court briefs.' And that letter, by the way, went to 30 or more companies. Remember the first thing I did in my hypothetical - I threw out the records, because I had an indication that the Department of Revenue knew what the rule was. I didn't even agree with that rule, that said three years from the date of the assessment, because I read the law and it said, `three years from the date the return was filed.' That's the difference. Now you go a year back and it's okay, as far as I'm concerned, to differentiate between, for example, changing the tax rate in 1978 from whatever it was then to something higher. We all agree (indiscernible). Change in administrative procedures surrounding a law back to the first of the year, maybe back to the year before, it's not going to be too big of a problem. But when you go back 18 years, I have difficulty differentiating between the heart of the law and the rules around the law. Boom - they are the same, because you're going back so far. Each affects the other and they're indistinguishable. That's my position." CHAIRMAN VEZEY: "Representative John Davies." Number 491 REPRESENTATIVE DAVIES: "Thank you. On that point, it seems to me that in every one of these cases, the state has filed an assessment within the three year period. Isn't that correct?" MR. SULLIVAN: "Yes." REPRESENTATIVE DAVIES: "And in the case that you're talking about, of say three years and one day after that assessment was filed, you throw away your records. But at that point in time, aren't you still in dispute with the state." MR. SULLIVAN: "On an identified portfolio of issues. Those included in the assessment that I received." Number 500 REPRESENTATIVE DAVIES: "But I mean the - you're still in dispute on those back taxes." MR. SULLIVAN: "On the issues in the assessment that I have received. That is correct." REPRESENTATIVE DAVIES: "I guess that I'm having trouble understanding why if there is still a dispute going on, why you would throw any records away." MR. SULLIVAN: "Because I've narrowed down the area of dispute between the state or federal government or whatever, and myself. I know what records I have to keep because I have been told what issues exist when they gave me the assessment. By giving me the assessment, they also told me what issues didn't exist. And those are the ones that weren't in the assessment. But, lo and behold 10 years later, the issues that didn't exist, pop up in an assessment, which I say is untimely." Number 511 REPRESENTATIVE DAVIES: "I guess if the IRS sent me an audit of my 1985 tax records, I wouldn't throw anything away that said 1985 on it." MR. SULLIVAN: "If they didn't say they were going to audit your 85, the IRS sent you a notice saying, `In your 1985 return, we want you to provide additional information with respect to interest deductions. You provide information. And then you get an assessment, and then the federal statute runs, and you throw out all of your documentation on charitable contributions, because you know the issue you have with the IRS is on interest expense deductions. And now, five years later, they come back and issue you another assessment and ask about your charitable contributions, and you say `Wait a minute, I threw all my records out.' That's what we're talking about. Known and unknown." Number 523 REPRESENTATIVE DAVIES: "How long does Exxon usually keep these kind of records around? Is there a general rule of thumb or is it just whatever?" Number 527 MR. SULLIVAN: "There is a records retention and review procedures, and I'm using a hypothetical here in terms of just trying to show how 18 years retroactive is impacted by many, many things. It's impacted by records, it's impacted by corporate memory, I mean, people who were there when the transactions - even sometimes, you can find the people and they go `Ya, I remember that.' If I had an assessment in three years, they'd say `I remember that!'" REPRESENTATIVE DAVIES: "But there isn't any general policy about how long you keep stuff, is there? It just depends on what kind of a document it is." MR. SULLIVAN: "Don't throw things out before the statute of limitations runs." REPRESENTATIVE DAVIES: "Or agreement (indiscernible.)" MR. SULLIVAN: "Probably you don't throw things out before a statute of limitations that has been looked at by a court runs." CHAIRMAN VEZEY: "Mr. Sullivan, on that point, I mean, would you just kind of - could you give us an idea of the volume of records that Exxon Corporation stores or how many square feet of warehouse that you store your records in." MR. SULLIVAN: "I wouldn't have the foggiest idea." CHAIRMAN VEZEY: "We're talking entire warehouse fulls." MR. SULLIVAN: "A lot, and that's about as close as I could come." CHAIRMAN VEZEY: "I'm sorry, Representative Davidson, I believe was (indiscernible)." Number 542 REPRESENTATIVE DAVIDSON: "Well, thank you, Mr. Chairman. Mr. Sullivan, you've given us a very tightly crafted statement here, it seems, but and it was a little too fast for a slow person like me, but it seems, you have indicated that - let me pass for a moment, Mr. Chairman. Well, let me ask you this. Given the limitations factor, is it not in your interest to grant all of the requests by the state to extend your dispute?" Number 554 MR. SULLIVAN: "Mr. Chairman, I indicated earlier that on every occasion that Exxon has been requested by the state to grant an extension, we have done so. Now let me mention there's one where it didn't work. Year-end 1993, the Department of Revenue - it was about mid-December, the statute of limitations for the production tax years 87, 88 and 89 were going to expire at year-end 93, and I got a call, it was in December, and was advised by the state - or Exxon got a call, I don't think I got it directly - that they needed a little more time to properly complete the transportation portion of the assessment. And they asked if Exxon would extend the statute of limitations another time; we had already extended it once or twice before. And when the fellow in my department who got the call asked me I said, `Well, the problem that the division has is with respect to the transportation portion of the assessment and I will agree to give them an extension limited to the transportation portion of the assessment, that I'm going to receive.' Now they said that's where their problem was, I do want to speed up the process, they told me everything else was ready, I said, `Then I'll give you a limited extension for the area that you tell me you need it for.' They said, `No' and issued the assessment on December 31. I guess that's the only time I've played hardball with them, which was simply saying, `I'll extend for the reason you told me you need the extension.' Every other time, it's just been a blanket extension." REPRESENTATIVE DAVIDSON: "Mr. Chairman, I have just one other question, if I may. You've characterized this piece of legislation as something that you just cannot live with. But it is my understanding that it was your company that was involved in crafting negotiated law to go forward with this legislation." MR. SULLIVAN: "That is not so. I believe I came up here a week ago Wednesday, when I was advised that there was going to be a meeting between industry and Department of Revenue and Department of Law to work on a potential bill on some of these issues that are outside of Section 1. And I came here to do that, and the landscape quickly changed. I saw these bills, and I've been consistent in my opposition to this since then." REPRESENTATIVE DAVIDSON: "So if this bill goes forward, did I understand you correctly to say that, you still have to go forward with the case before the Supreme Court, right?" MR. SULLIVAN: "No, if this bill is passed, what the legislature has done is pulled the rug out from any opportunity for me to have my day in court. Section 16 in this bill says that it is declaratory of existing law as originally enacted and Section 17 says that it applies to an action or appeal pending before a court on the effective date. The import of those two sections if this bill passes, is to take away my right - my day in court - to defend the Superior Court decision that was rendered in my favor. Because the law that is before the court is the three-year statute and this changes that statute. So I have nothing to argue, because the legislature will have taken away what I am in the Supreme Court attempting to finalize. Something that we have been consistent in our interpretation of the statute from the very first assessment that came three years after a return was filed. And we've been consistent in that position for over 10 years and we are now six months - well, we're five days from an oral argument and probably four to eight months from a decision. This legislative body may take the opportunity for a final resolution of that question away. That's what happens when you pass this bill." CHAIRMAN VEZEY: "Further questions from the committee? Representative Hudson." REPRESENTATIVE HUDSON: "One more. Mr. Sullivan, if the court case that's in process right now, proceeded as scheduled and the lower court's position is upheld, does the state risk the loss of all assessments made within the three year limit or are only the increased assessments that were introduced after the three year limit at risk?" MR. SULLIVAN: "I can only speak to Exxon's case and I will remind you that on average, the state has had five or six years for each tax period, to audit Exxon because we have entered into a voluntary written agreement with the state to extend the statute. I assure you, any assessment that was issued during the first three years or any extension to the three years that Exxon has received, is not at risk at all. Those are valid assessments. I also am telling you that in Exxon's opinion, the Superior Court decision in the Tesoro case - in the Tesoro case, on the six-year collection statute is the law and says that the $2 billion that the attorney general told you is quote `at risk under the assessment statute' is not at risk. Because there is a court decision that says the attorney general is correct. If it's taxpayer to taxpayer on what the valid assessments are, I've got years worth of valid assessment (indiscernible) eight years after I filed the return and that's because I agreed with the Department of Revenue to extend." REPRESENTATIVE HUDSON: "Without figures, Mr. Sullivan, what percentage of the total difference between the state's claim and the company's view is protected within the three years or the agreed upon extensions. What percentage is outside of that? Just a percentage, roughly speaking." Number 642 MR. SULLIVAN: "You're talking Exxon, specific?" REPRESENTATIVE HUDSON: "Yes, sir." MR. SULLIVAN: "I'm not going to be specific simply because of the audience, but I will tell you that as a percentage of the total assessment, it's not (inaudible)." REPRESENTATIVE HUDSON: "But the total, the percentage that is within the fair game..." MR. SULLIVAN: "Oh, the fair game portion. I'm sorry (indiscernible.) The percentage of timely assessments is very large." REPRESENTATIVE HUDSON: "So then, at risk is the smaller of the percentage." MR. SULLIVAN: "That's right. I'm sorry, I confused (indiscernible.)" CHAIRMAN VEZEY: "Further questions from the committee? Seeing none, we'll stand adjourned until 9:00 a.m. tomorrow morning."