HOUSE BILL NO. 119 "An Act relating to the dividends from the Alaska Industrial Development and Export Authority; relating to the meaning of 'mark-to-market fair value,' 'net income,' 'project or development,' and 'unrestricted net income' for purposes of the Alaska Industrial Development and Export Authority; and providing for an effective date." 1:13:38 PM GENE THERRIAULT, DEPUTY DIRECTOR, STATEWIDE ENERGY POLICY DEVELOPMENT, ALASKA ENERGY AUTHORITY, DEPARTMENT OF COMMERCE, COMMUNITY AND ECONOMIC DEVELOPMENT, explained that some committee members who had been on the committee in 2016 may recognize the legislation, given it had passed the House Finance Committee with 10 "do pass" signatures and had passed the House floor with 36 "yes" votes (other members had been excused or absent). He shared that the bill had not cleared the final hurdle in the Senate Rules Committee. The legislation before the committee was identical to the previously considered legislation. He referred to page 2, lines 2 and 3 of the bill and explained that when the Alaska Industrial Development and Export Authority (AIDEA) dividend had been established, the legislature had specified it wanted the dividend to be set on the net income in AIDEA's audited financial statement. The legislature had also realized that some things needed to be excluded from the number (line 3 of the bill). The existing statutory language made it clear that although it was necessary to follow all the accounting rules in order for AIDEA to receive its audited financial statement, the legislature got to specify which number it wanted AIDEA to use in the dividend calculation. Unfortunately, since the dividend had been established, some new accounting rules had kicked in that were bringing unnecessary gyrations to the dividend. He explained that AIDEA would like to back those out and base the dividend on true net income. 1:16:09 PM Mr. Therriault provided a PowerPoint presentation titled "Alaska's Development Finance Authority: HB 119 - Proposed Language Changes to Modernize AIDEA's Dividend Statute" (copy on file) beginning with slide 3. He explained the bill aimed to fix two problems. The first related to mark to market changes. There were numerous accounting rules that required following "real transactions," issues that generate revenue or real expense that impact that revenue. Another accounting rule related to estimates and allocations. For example, an asset depreciated over time and its economic value eroded. The third accounting rule pertained to mark to market adjustments for assets that had fluctuation in their valuation. The mark to market valuations brought the largest amount of volatility to the AIDEA dividend calculation. Mr. Therriault turned to slide 4 and addressed current statutory language reading that AIDEA shall adopt a policy for payment of a dividend, which was supposed to be set on net income. Net income meant the change in net position in the agency's audited financial statements on an annual basis. Mr. Therriault turned to slide 5 and addressed the mark to market valuation issue that needed correction. He provided a scenario where an asset's valuation fluctuated because of market changes. He asked members to imagine they owned the asset where a snapshot of the asset was taken and then to pretend they sold the asset at a gain or loss at that amount. Yet, in reality the asset had not been sold. He explained it was the type of fluctuation AIDEA was experiencing. 1:18:02 PM Mr. Therriault moved to slides 7 and 8 showing an Internal Revenue Service (IRS) 1040 tax form. He detailed that for an individual the tax form would show income, perhaps a dividend from a stock portfolio, income from a rental property, and other. The example on slide 8 showed total income of $109,000. He elaborated that income tax would be based on the real $109,000 the individual had made as income. However, slide 10 showed how the individual's tax form would be impacted if the individual had to apply the Governmental Accounting Standards Board (GASB) rules including GASB 31 that had been in place for a number of years and other more recent rules. Line 11 pertained to GASB 31 - the booking of an unrealized gain or loss on marketable securities. He expounded that GASB 31 had been in place for the longest. Mr. Therriault explained that AIDEA held its cash reserves in marketable securities (e.g. T-bills and other). When the stock market was booming, the market for T-bills was suppressed. There had been a booming stock market in the past couple years; therefore, AIDEA's cash reserves held in T-bills were not worth as much. He noted that the T-bills had not been sold and AIDEA had not suffered a loss. The example showed that if the market was doing poorly and the market for marketable securities was booming, AIDEA may have a paper gain from GASB 31 and even though the asset had not been sold, AIDEA would have to pretend like the cash had been realized. He explained that it meant taxes would have to be paid on money that had not really been made. Mr. Therriault pointed to line 16a on slide 10 pertaining to a value adjustment from a 401k account invested in stocks. He asked members to consider a situation where an individual had to take a picture of the valuation on the last calendar day of the year and pay taxes on gains that had not been realized. He explained that it was the type of thing GASB 68 was suggesting AIDEA had to do. He relayed that AIDEA had to follow all the rules to receive its audited financial statement. Additionally, AIDEA had to follow GASB 72 and 75 that had kicked in or would kick in soon. He returned to the personal tax example and explained that previously the individual had $109,000 in income to pay taxes on, but if they had to follow all the same GASB rules and the economy was booming, it would increase the individual's income up artificially to $169,000 and they would have to pay taxes on money they did not receive. 1:21:32 PM Mr. Therriault continued to slide 11 and explained that HB 119 would mean AIDEA would follow all the GASB rules in order to get its audited financial statements, but it would enable the agency to back out the paper adjustments and use its true cash earnings in the dividend calculation. It would mean the agency would be basing 25 to 50 percent of its true cash with the state treasury on a yearly basis instead of an artificially adjusted number. Mr. Therriault advanced to a table on slide 12 showing AIDEA's adjusted true net income since it began paying a dividend [in 1991]. He pointed out that cash available to pay a dividend fluctuated depending on the level of activity AIDEA had. He pointed to a gold line on a table on slide 13 showing that GASB 31 artificially spiked or suppressed net income year-to-year, which brought volatility to the AIDEA dividend calculation. He discussed that three more GASB rules either had kicked in or would kick in soon. The agency feared that if the rules were all driven by the same dynamics in the economy, they would start stacking up, meaning the swings would become more pronounced. He continued it may be that from time to time they offset each other - one may be artificially positive and one may be artificially negative, but depending on what was driving things (e.g. evaluation of real estate, appreciation of stocks, and marketable securities) if they were all in the same direction they could bring some substantial swings to the AIDEA dividend calculation. 1:23:53 PM Mr. Therriault addressed the second problem the bill would address related to the dividend penalty, which happened infrequently (slide 15). He referenced existing language specifying that AIDEA was supposed to exclude certain things. He explained that when the dividend had first been created, AIDEA informed members of the legislature that if it was supposed to pay 25 to 50 percent of its yearly net income back to the state as a dividend on a yearly basis and if the legislature gave an appropriation to work on a specific project, the money was brought onto the AIDEA books by showing an increase in the income. He continued that if the language had not been adjusted at the time and the legislature gave AIDEA $1,000 for a specific project, at the end of the year AIDEA would have to write the legislature a check back for half of the money. The legislature at the time had determined the situation should be avoided. The legislature had specified if AIDEA received money for a specific project from the state General Fund by appropriation or a federal source, the agency was directed to disregard the money as positive debt to net income when making its dividend calculation. Mr. Therriault explained a scenario the legislature had not anticipated. He provided a hypothetical scenario where the legislature gave AIDEA $1 million to explore a project including geotechnical and economic work, and a permitting process. He elaborated that AIDEA turned some of the dollars into work product. He continued that if the project did not move forward, AIDEA would have to write the project off its books. In order to write the project off, AIDEA took the expenditures as a deduction to net income. Previously, the legislature specified that if AIDEA received money from an outside source, the agency was to disregard it on the upside. Under the proposed legislation if AIDEA ever had to write money off because a project was not going forward, they did not want to artificially suppress the dividend in the year the write-off was taken. He stated that the write-offs happened infrequently, but when they did, they artificially pulled the dividend down. Mr. Therriault elaborated that the previous year when the legislation had been proposed, AIDEA had advised the legislature that because of a booming stock market, it appeared there would be a paper loss in marketable securities. He explained that the AIDEA dividend had been suppressed by about $6.5 million in 2017 because AIDEA did not have the ability to make mark to market adjustments. The agency believed it should be sharing with the state treasury out of its true cash on hand; AIDEA wanted to be able to back out the paper adjustments and it would follow all the rules to get its appropriately audited financial statement, but it wanted to remove the unnecessary volatility out of the dividend calculation. 1:27:25 PM Co-Chair Foster referred to the example showing an individual's 1040 individual income tax. He wondered why GASB treated companies like AIDEA differently. Mr. Therriault responded that GASB rules applied to all corporations. After going through the financial meltdown Congress and the governing board for accountants wanted to make sure that if someone was going to invest in a corporation, they did not want the corporation to be able to hide liabilities or assets. He expounded that AIDEA would continue to disclose all the information if the bill passed. He explained the bill recognized that some of the items were merely paper adjustments - an asset had not been sold and AIDEA had not suffered a loss or gain; therefore, AIDEA should not pay the dividend on money it did not earn or suffer a loss on a loss that did not take place. For corporations, particularly corporations where citizens could invest, the accounting boards wanted to ensure substantial transparency in the audited financial statements. 1:29:09 PM JOHN SPRINGSTEEN, ALASKA INDUSTRIAL DEVELOPMENT AND EXPORT AUTHORITY, Department of Commerce, Community and Economic Development (via teleconference), clarified that for publicly traded corporations regulated by the Securities Exchange Commission and other related entities there was an equivalent set of accounting rules set by the Financial Accounting Standards Board. Co-Chair Foster surmised the primary reason for the GASB rules was to increase transparency. He explained typically a person used the 1040 IRS form to pay their taxes. He noted that the example included an unrealized gain of $25,000, but it did not mean the individual had to pay taxes on the amount. He believed the information on the form was not for tax purposes, but merely helping to illustrate the situation AIDEA was facing. He surmised the $25,000 was shown on the slide because AIDEA was trying to increase transparency and let investors know it had unrealized gains and losses. Mr. Therriault responded affirmatively. The example was meant to illustrate that if a person had to include the gain in their tax calculation they would pay the federal government a larger check. Comparatively, when AIDEA had to book the gain it went into the dividend calculation; it did not increase AIDEA's taxes, but it increased the dividend AIDEA paid on money it did not actually make. Co-Chair Foster stated his understanding that the GASB requirement was for auditing and financial purposes, not tax payment purposes. He believed the goal of the bill was to fix the system to ensure an accurate dividend was paid, which was not based on artificial paper. Mr. Therriault agreed and explained the goal was for AIDEA to pay the dividend on its true net income. Co-Chair Foster OPENED and CLOSED public testimony. 1:32:36 PM AT EASE 1:32:56 PM RECONVENED Co-Chair Foster indicated there may be some amendments to the bill. He asked that amendments be submitted by Wednesday, April 18, 2018 at 5:00 p.m. HB 119 was HEARD and HELD in committee for further consideration. 1:33:55 PM AT EASE 1:36:42 PM RECONVENED