HOUSE BILL NO. 399 "An Act disallowing a federal tax credit as a credit against the corporate net income tax; repealing a provision allowing the exclusion of certain royalties accrued or received from foreign corporations for purposes of the corporate net income tax; repealing the reduced rate for the alternative tax on capital gains for corporations; repealing an exemption from filing a return under the corporate net income tax for a corporation engaged in a contract under the Alaska Stranded Gas Development Act; and providing for an effective date." 3:18:43 PM Co-Chair Foster invited his staff to the table to begin his presentation. BRODIE ANDERSON, STAFF, REPRESENTATIVE NEAL FOSTER, explained that the opening remarks would be similar to a piece of legislation that was heard in House Finance in the previous week. Mr. Anderson read from a prepared statement: HB 399 is a result of work done over the last few years with various legislators to address foregone revenue and to provide the state with the ability to potentially capture new revenue. Starting in 2014, the legislation was passed that required both the Department of Revenue (DOR) and Legislative Finance to create a report on indirect expenditures in the amount of foregone revenue not captured by the state. The first indirect expenditure report was submitted in 2015. In that report, it identified a list of indirect expenditures within DOR that should be terminated. Last year during the FY 18 budget process, House Finance Subcommittee for the Department of Revenue reviewed those indirect expenditures and recommended the House Finance Committee offer legislation that eliminates these indirect expenditures. HB 399 repeals certain credits and exemptions from the recommendations offered both in the indirect expenditure and the subcommittee. The indirect expenditures repealed in HB 399 were selected for the following reasons: The indirect expenditures did not meet legislative intent, had limited benefit or wasn't used, or the purpose of conformity has change since the credit, or exemptions were created. House Finance Committee, House Bill 399 repeals the following indirect expenditures: • Federal Tax Credits - Currently tax payers can claim 18 percent of all federal credits against their corporate income tax regardless of where the credits were earned. The Department of Revenue provided an example of a housing credit that would be eligible to be earned in New York to be claimed against Alaska's tax liability for that corporation here. • Foreign Royalty Exclusions - Currently, tax payers can hold 80 percent of their foreign royalty payments against their corporate tax liability. • Reduced Rate for Capital Gains - Under Alaska statutes, Alaska corporate tax payers have a reduced rate of 4.5 percent on their capital gains profits. With this repeal capital gains would be treated like all other profits. In 1986, the federal government removed their recognition of a reduced rate for capital gains and then more recently, through the Trump Administration tax reform, they went ahead and cleaned up the language repealing the complete capital gains section within the federal URC. • Credit associated with the Stranded Gas Act - This credit was never utilized to encourage development under the Stranded Gas Act. The combined total of potential new revenue is estimated to be $6.9 million according to the fiscal note in front of the committee. 3:23:43 PM Mr. Anderson read the sectional analysis: Section 1 Statute: AS 43.20.021 (a) Change: Amends current section Purpose or Effect: Conforming language, removes the list of federal credits as eligible items against Alaska corporate income tax liability. Indirect Expenditure Item: Federal Credits Section 2 Statute: AS 43.20.145 (c) Change: Amends current section Purpose or Effect: Conforming language for "Affiliated Groups", removing the reference to the subsection on foreign royalty payments as eligible Alaska corporate income tax liability. Indirect Expenditure Item: Foreign Royalty Exemption Section 3 Statute: AS 43.20.145 (d) Change: Amends current section Purpose or Effect: Conforming language for "Affiliated Groups", removing the reference to subsection on foreign royalty payments as eligible Alaska corporate Income tax liability. Indirect Expenditure Item: Foreign Royalty Exemption Section 4 Statute: Repealer Section Change: Repeals statutes Purpose or Effect: AS 43.20.021 (c) Repeals the reduced rate for capital gains income. Indirect Expenditure Item: Capital Gains AS 43.20.21 (d) Repeals the eligibility of federal credits for Alaska corporate income tax liability. Indirect Expenditure Item: Federal Credits AS 43.20.036 (a) - Repeals the eligibility of federal foreign tax credit for Alaska corporate income tax liability. Indirect Expenditure Item: Federal Credits AS. 43.20.036 (b) Repeals the eligibility of federal investment credit for Alaska corporate income tax liability. Indirect Expenditure Item: Federal Credits AS 43.20.042 Repeals the eligibility of federal special industrial incentive investment credit for Alaska corporate income tax liability. Indirect Expenditure Item: Stranded Gas Act Exclusion AS 43.20.144 (g) Repeals the exemption for Alaska Corporate tax liability for entities participating in contracts related to the Stranded Gas Act. Indirect Expenditure Item: Foreign Royalty Exclusion AS 43.20.145 (b)(3) Repeals the foreign royalty exclusion. Indirect Expenditure Item: Stranded Gas Act Exclusion AS 43.20.145 (g) Repeals the Stranded Gas Act exclusion. Indirect Expenditure Item: Section 5 Statute: Uncodified Law Purpose or Effect: Applicability Sections 1, 2, 3, and portions of Section 4 as stated are subject to the effective date. Section 6 Statute: Uncodified Law Change: Adds new section Purpose or Effect: Transition: Regulations Effective Date is January 1, 2019 Co-Chair Foster invited Mr. Spanos to the table for questions. Representative Wilson asked if the Capital gains being discussed had to do with Alaskan projects. BRANDON S. SPANOS, DEPUTY DIRECTOR, TAX DIVISION, DEPARTMENT OF REVENUE, clarified that the capital gains rate would apply to any capital gain under the federal code. He added that when the language was originally drafted there was a capital gains rate in the federal code. The federal tax reform of 2017 removed it. It was the Department of Revenue's position was that the bill was a clean-up bill. Because the capital gains rate no longer existed at the federal level, it no longer existed at the state level. The state statute pointed to the statute that was now gone. It was for any long-term capital gain a corporation had. Representative Kawasaki asked if it was possible to get an idea of how many tax payers there were in each of the different groups. He suspected the division would not be able to release names because of confidential tax payer information. Mr. Anderson responded in the affirmative. He referred the committee to a letter in the back up materials from the DOR. He relayed that for the reduced tax rate on capital gains in 2015, the state had 195 recipients equaling about $3.3 million of impacted revenue. Representative Kawasaki found the handout with the information. 3:27:14 PM Co-Chair Foster OPENED public testimony. KARA MORIARTY, PRESIDENT, CEO, ALASKA OIL AND GAS ASSOCIATION (AOGA), read from a prepared statement: Co-Chair Foster, Co-Chair Seaton, Members of the Committee: For the record, my name is Kara Moriarty and I'm the President/CEO of the Alaska Oil and Gas Association, commonly known as "AOGA." AOGA is a professional trade association for the oil and gas industry and I thank you for the opportunity to discuss the reasons of our opposition to House Bill 399. Although I am here on behalf of a diverse group of companies, my testimony today represents the thoughts and sentiments of each member, which was approved by unanimous consent. As I mentioned, I did email the committee more detailed comments for the record, but in the interest of time I wanted to summarize our position and concerns with this bill. This bill makes several changes to how tax payers compute Alaska corporate income tax. One of the major changes is in Section 1 which is categorically repealing a long list of federal tax credits to keep them from being used and determining Alaska tax. In the larger document I included the full list of these credits in the written testimony. A number of these federal tax credits do seem unlikely ever to be used by a company doing business in Alaska. They could stop being adopted by reference for purpose of Alaska's income tax without impacting any tax payers. Yet, except for the historically based credits, like those for Hurricanes Katrina, Rita, and Wilma, which were very time specific because they all occurred in 2005, why should and why would Alaska preemptively disallow credits for activities simply because those activities don't occur here yet (almost similar to the conversation you were having on the previous bill about sporting tournaments). So why not leave the door open to credits for bringing new activities to Alaska. If there proves to be a problem with the federal credit for Alaskan purposes, then it could be dealt with at the specific time. It seems far more appropriate and prudent to my members to consider the merits of these credits individually since a good number of them do seem to reflect sound tax policy for Alaska's purposes. A couple of examples: Why would you want to exclude the credit under Internal Revenue Code, Section 45(a), for employing Alaska Natives to be disallowed. We think it's good policy for the state to encourage the hiring of Alaska Natives? Similarly, why should the credit under Internal Revenue Code, Section 45(p), be disallowed for Alaskan employers who make up the wage difference for employees on active duty in military service? Certainly, I used to be very involved with the employer support of the Guard and Reserve. We know we have a lot of people in Alaska who serve in the National Guard and similar services. Why should Alaskan small employers providing health insurance for their employees not get a tax credit for those costs under Internal Revenue Code, Section 45(r). Again, the majority of businesses in Alaska are small. Coming to our own industry, why should the enhanced oil recovery, or the EOR credit under Internal Revenue Code, Section 43(a) be disallowed for our corporate income tax under Alaska Statute 43.20. Surely getting more oil out of Alaska's aging fields is a good thing. It's essential for our future, for the industry, and both for the state. Specifically, on the EOR credit, it is different than most of the credits in our current tax system and it's different in two important ways. First, the credits that have been most talked about recently in Alaska's tax code were primarily credits against the production tax. While HB 399 deals generically with federal tax credits that Alaska adopted many years ago for the corporate income tax under AS 43.20. 3:32:13 PM Ms. Moriarty continued reading from a statement: Second, and more fundamentally, oil companies' taxable income is based on their worldwide net income and part of that net income is apportioned to the Alaskan part of the business on the basis of the percentages of their worldwide production, worldwide sales, and worldwide property at original cost that are in Alaska. This means an oil company could actually be losing money in its Alaska business but still have sufficient profits elsewhere to have a positive net income overall of which a part would be apportioned to the Alaska business on the basis of these percentages and taxes. All of this brings us to a second major point overall with this bill. Just last year HB 111 created the legislature's oil and gad fiscal system working group, a bicameral, bipartisan working group to analyze the state's oil and gas fiscal regime. The working group to-date, has only met twice since HB 111 was passed last session and both meetings were more organizational in nature and they have not yet considered major policy issues, much less ever discussed how to change the present fiscal regime. We would encourage you to think about putting this bill aside and allowing the legislative working group to do its work including considering changes to the corporate income tax. On the remaining sections of the bill there is a serious constitutional issue with the language of Alaska Statute 43.20.145 that HB 399 does not yet address, which is the definition of "affiliated group." Again, the written testimony goes into much more detail on this point. But, if HB 399 is going to be amending this section of statute AS 43.20.145 we think that it should replace the obsolete text in that paragraph based on the 50 ownership or more which dates back to 1978 and replace it with the unitary business concept that the United States Supreme Court has extensively developed after Alaska adopted that 50 percent ownership percentage. We think if you are going to be making changes, it would be prudent to make a similar amendment to AS 43.20.144(h)(ii) for oil companies. 3:34:50 PM Section 3 doesn't necessarily pertain to us but we just wanted to highlight that it would repeal the reference to royalties from the existing phrase of dividends and royalties taxable to a corporation. These royalties, again, are not royalties in the oil and gas sense that we're all very familiar with, but our royalties used for using intellectual property or something that has been invented and patented, which is very commonplace. Again, it did not have an impact to our members but just thought we would highlight it. Section 4 repeals eight existing sections. The rest of the written comments goes into much detail. I would just close, Mr. Chairman by saying we currently oppose the bill for those various reasons. It is more complex than it seems because it is repealing several sections of federal tax code or our ability to use credits from the federal tax code. We would just encourage to utilize the working group for that purpose. Representative Kawasaki mentioned that in Ms. Moriarty's testimony she had mentioned the Internal Revenue Code (IRC) 45(a) for employing Alaska Natives and IRC 45(p) which talked about active duty military service and another regarding providing insurance. He asked if corporations did not currently take advantage of the specific credits she noted. Ms. Moriarty answered that they believed corporations were taking advantage of the credits. Her understanding was that HB 399 would repeal the ability for corporations to do so. She reiterated that the legislature might want to take a pause to really evaluate the laundry list of tax credits that were under consideration to be repealed to make sure they were understanding the full impact. Representative Kawasaki asked if there were companies that could voluntarily provide information to confirm that they took advantage of the IRC 459(a) for instance, or the IRC 45(p) for active duty military. Could a company voluntarily provide the information. He would like to hear from companies that took advantage of the credit. Ms. Moriarty replied that if a company wanted to voluntarily disclose any portion of what they paid in federal or state taxes, they were entitled to do so. She could follow up with member organizations to find out if there was anyone wanting to provide specific examples. She also suggested reaching out to other Alaska Native corporations and their subsidiaries, the Alaska Chamber of Commerce, Resource Development Council, and other business organizations. She reemphasized that the tax committee was filled with brilliant minds who loved to get into the details. As they were getting into the details little red flags went off prompting the question about whether the sections should be repealed. 3:38:25 PM Representative Wilson asked about the foreign royalty portion of the bill. She wondered about the impact to the oil industry. Ms. Moriarty deferred to DOR. Co-Chair Seaton asked if she was saying that the statute was repealing the federal tax credit. Companies could still take advantage of those federal tax credits on their federal returns. They would just not be able to deduct them against their state corporate income tax. He wondered if he was correct. Ms. Moriarty answered in the affirmative. The state legislature did not have the ability to repeal federal tax code. However, the legislature had the ability to disallow companies from using an apportionment against the Alaska Corporate income tax (companies could not take the full federal tax credit anyway). However, it was an example of an incentive the state could offer to make Alaska look more attractive than other states in the nation. Co-Chair Foster CLOSED public testimony. He provided the committee email address for additional written testimony submissions. Representative Wilson referred to the fiscal note, OMB 2476, by DOR on page 2. It showed the change in revenue and had it split out. She asked about the federal credits of $1.8 million and the reduced rate on capital gains. She wondered if they were no longer available through the federal government. Mr. Spanos responded that the changes on page 2 for federal credits of $1.8 million and foreign royalties of $1.7 million in revenue impact would only apply if the bill were to pass. The Department of Revenue had generated the fiscal note prior to discovering that the reduced rate for capital gains was affected by the federal tax reform. The Department of Law noted that the capital gains rate was eliminated in the federal code and no longer available to an Alaskan corporation. He confirmed that the $3.4 million was gone, but the $1.8 million and $1.7 million would be revenue added to the general fund if the bill were to pass. Representative Wilson asked for clarification regarding a foreign royalty. Mr. Spanos replied that a foreign royalty was only available for a water's edge corporation, a non-oil and gas company. Oil and gas companies filed under the worldwide apportionment which included their income from everywhere. He had used an example in a previous hearing about total income being the pie. For oil and gas companies that pie was their worldwide income. Whereas, for all other non-oil and gas companies the pie was called "Water's edge" or "US" income. 3:42:49 PM Representative Wilson asked if the federal credit applied to all industries. Mr. Spanos replied that the federal credit would apply to both oil and gas and non-oil and gas. Mr. Anderson added that Alaska was currently the only state that copied all federal credits. He suggested that many states either piggy-backed on a federal tax credit or would have language stipulating that federal tax credits applied only to the expenses that occurred in the state. If a corporation used a federal tax credit in the state, they would potentially be eligible for the federal tax credit at 18 percent. He referred to IRC 45(a), the Indian Employment credit. Any multi-state corporation hiring federally recognized Indian employees would be able to hold 18 percent of that credit against their Alaska tax liability. Many states applied it to what was incurred in-state. He encouraged Mr. Spanos to expand on his comments. Mr. Spanos noted that the federal credits included what was available on the federal tax return which was unusual in that most states would want to incentivize something in their own state. Alaska's statute would allow the credit for an expense anywhere. He thought it was important to note that if it was the intent of the legislature to allow a credit to incentivize something in Alaska, it would be an Alaska specific credit rather than a federal credit. Representative Wilson asked if the bill would be removing all of it. However, it was possible to insert language that would tie a federal credit to Alaska. Mr. Anderson confirmed she was correct. It would be a policy decision by the legislature. Representative Guttenberg asked Mr. Spanos to describe the foreign royalties credit being repealed. Mr. Spanos explained that what was being repealed was for a water's edge company (non-oil and gas company) to be allowed an 80 percent exclusion of foreign royalties. For example, if Company A held a patent and had a foreign affiliate Company B using the patent, Company B would pay Company A royalties for the use of that patent. Company A would be able to exclude 80 percent of those royalties. 3:47:02 PM Mr. Anderson used Microsoft as an example regarding their cloud option. The company had been paying a royalty to Ireland to run the Cloud. If Microsoft had a corporate income tax in Alaska, they would be able to apply 80 percent of the royalty payment amount against Alaska's corporate tax liability. Representative Pruitt suggested that the state might be putting itself at a disadvantage by repealing the credit. It might limit the appeal to a future large investor such as Microsoft or Google. Mr. Spanos could not speak to any specific company or the representative's example. However, in general, if the intellectual property was foreign owned and an Alaskan business was receiving a royalty from that foreign business, it would be unusual for a state to allow an exemption of that income from a foreign payor. Co-Chair Foster indicated that amendments were due by 5:00 P.M. on Wednesday, April 11, 2018. HB 399 was HEARD and HELD in committee for further consideration. Co-Chair Foster announced that the committee would be taking a 10-minute break until 4:00 P.M. 3:50:16 PM AT EASE 4:01:50 PM RECONVENED