HB 217-TAX ON GAS FOR IN STATE MANUFACTURING  1:06:04 PM CO-CHAIR JOHNSON announced that the first order of business is HOUSE BILL NO. 217, "An Act relating to the tax applicable to the production of natural gas used in the state as fuel or feedstock in producing a manufactured end product." 1:06:58 PM REPRESENTATIVE P. WILSON moved to adopt the proposed committee substitute (CS) for HB 217, Version 26-LS0816\R, Bullock, 2/8/10 ("Version R") as the work draft. REPRESENTATIVE KAWASAKI objected and asked what the differences are between Version R and the bill as introduced. REPRESENTATIVE NEUMAN, sponsor of HB 217, replied that the differences are related to questions previously raised by committee members about identifying the tax credits. Department of Revenue staff worked with the bill drafter to address these questions. Because of some credits that are available under the Alaska's Clear and Equitable Share (ACES) law, an either/or clause was added to ensure that the 5 percent credit would act to the best benefit. Thus, one sentence became eight pages long because it must be applied to preceding statutes. REPRESENTATIVE KAWASAKI removed his objection. There being no further objection, Version R was before the committee. 1:08:41 PM REPRESENTATIVE NEUMAN said HB 217 would reduce the production tax for gas that is manufactured within the state of Alaska in an attempt to induce manufacturing in the state to create jobs. It would not affect Cook Inlet gas. He pointed out that manufacturing is a molecular change in the gas or the methane. An example of manufacturing is the Fischer-Tropsch process, which is a catalyzed chemical reaction for making alternative fuels. However, converting gas to liquefied natural gas (LNG) for export is not manufacturing because it is simply a cooling and compressing process. He reiterated that the purpose of HB 217 is to create jobs. 1:10:52 PM REPRESENTATIVE SEATON requested further explanation of the differences between Version R and the original bill. REPRESENTATIVE NEUMAN deferred to Donald Bullock, the bill drafter. 1:11:47 PM DONALD BULLOCK JR., Legislative Counsel, Legislative Legal and Research Services, Legislative Affairs Agency, Alaska State Legislature, pointed out that Section 9 of Version R, beginning on page 9, line 31, is HB 217 prior to this CS, which was a change in the definition of "used in the state". That "used in the state" definition was relevant to what is currently AS 43.55.011(o), which sets a maximum tax rate on gas that is produced and used in the state. In response to [previous committee] discussion, the sponsor asked for a CS that would allow producers to choose whether to apply the cap to gas that is used in the state or to have it taxed at the regular rate that is applicable to other gas no matter where it is used. He said the reason for this is because, as he understands it, AS 43.55.011(m) requires that gas subject to the cap have the credits applied before the cap is applied; thus, the credits that were applied to gas used in the state could not be available against other production. MR. BULLOCK explained that Section 4 of Version R therefore adds a new section to AS 43.55 which would provide for an election that a producer could make to either have the gas that is used in the state taxed as any other gas or have the cap applied. If the producer makes the election provided by Section 4, then it is just like AS 43.55.011(o) - the cap on gas used in the state is the same as the cap on gas that is produced in Cook Inlet. Because this is a new section that provides for the cap, most of the bill just corrects cross references to the section and replaces reference to the cap in AS 43.55.011(o) to the new section which is 43.55.014. So, the change in the CS is rather than having the cap applicable to all gas used in the state, producers have the option to go for the cap that is currently in AS 43.55.011(o) through the enactment of this new section or just have gas used in the state taxed as any other gas that is taxed without regard as to where it is used. 1:14:48 PM REPRESENTATIVE SEATON inquired at what point a company could make this selection. He posed a scenario in which a company that is having a major development takes the tax credits and the tax write-offs against all of its upstream expenses at the high rate and offset that against its oil. Then, once gas starts flowing, the company makes this election and its gas tax is now at a very low rate. In that situation, the state would be spending 60-70 percent of the development cost through tax credits and deferrals and then when production starts the tax would be at 5 percent and the state would never recover its offsets even if there is great gas production. CO-CHAIR NEUMAN responded he believes a lot of that is already done and HB 217 is just adding manufacturing to the end of that. He deferred to Mr. Rogers of the Department of Revenue for further explanation. 1:17:25 PM GARY ROGERS, Oil & Gas Revenue Specialist, Tax Division- Administration, Department of Revenue (DOR), replied that much of the answer to Representative Seaton's question would depend upon each individual producer's circumstances and he therefore does not have an answer at the moment. REPRESENTATIVE NEUMAN said he believes if that election is made, then all the rules applicable to AS 43.55.011(o) apply to the cap on gas used in state. If the election is not made, the gas is taxed at the other tax rate. MR. BULLOCK added that HB 217 allows a taxpayer to opt to use what is currently AS 43.55.011(o) or to not have the gas subject to the limitations, and that limitation comes with requirements of how the credits are applied. 1:19:58 PM CO-CHAIR JOHNSON surmised that Representative Seaton's question is whether a producer has the ability to move back and forth between the tax rates depending on flow - is it an either/or, or is it an and. For example, once an election is made, can the taxpayer go back and pick a better rate based upon its tax credit, or is the taxpayer bound to its original election once gas is flowing. REPRESENTATIVE SEATON agreed that that sums up his question. He cited Point Thomson as being an example because it is a large gas development and right now the State of Alaska is making a major contribution through the 20 percent tax credit. There is also the upstream tax on oil of 25 percent plus progressivity, so at $70 per barrel the state may be putting in 70 percent of the total investment into that field. After gas starts flowing, his question is whether the 5 percent tax rate could then be elected for gas that is used in in-state manufacturing. He said he does not believe that in such a scenario the state would ever recover its investment. So, yes, the question is timing and whether a taxpayer could utilize one rate and then at a later date make the other election. 1:22:00 PM MR. BULLOCK pointed out a disconnect between Sections 4 and 5 in the CS. Under AS 43.55.014(c) in Section 4, the election is made annually at the time the return for the production tax is filed. However, [Section 5] talks about making the estimated payments during the year that would be based on what the projected tax would be if the taxpayer made the election. So, 43.55.014(c) could be amended to say that the taxpayer makes its election at the time the first estimated payment is due for the tax for the year, rather than waiting until the end of the year to claim it. REPRESENTATIVE SEATON said his problem with this is that most of the investment in the exploration and development of the field takes place before gas ever flows. So, if this is an annual election, it would let an oil company write off at maybe 70 percent; thus, the state would be investing in the field at 70 percent of the total expenses. Then, annually, when the gas starts to flow, the company could elect the 5 percent tax rate. This is something that must be guarded against. Though that may be a provision in the fuel and electrical generation portion, and this is adding manufacturing, the manufacturing could utilize significant amounts of gas, much more than fuel usage for residences. If the state does not have an export market, then all of the gas would be this way and the state would be the major investor and would receive very little in taxes. 1:23:59 PM CO-CHAIR JOHNSON asked whether that problem would remain if the manufacturing aspect of this is taken out. MR. BULLOCK answered that the manufacturing expands the definition of gas "used in the state" to manufacturing, which it does not do now. This expands the market for the gas that could be used in the state. That, in turn, expands the amount of gas that would be subject to an election to have the cap applied. However, he pointed out that the credits under the production tax in AS 43.55.023-025 would not be affected by HB 217, and they would still be generated as they always are. So, the effect of the bill is that it expands the volume of gas that could be used in the state by providing more purposes that are allowed to be subject to what is now a cap and, under the bill, would be subject to the election. 1:25:07 PM REPRESENTATIVE SEATON said his point is that the purpose of this bill is to expand the amount of gas that would be selling at a very low tax rate and if the state is giving all of the credits that are available through other provisions and allowing upstream deductions of the 25 percent plus progressivity, then the state will have a lot of money invested and get very little back. While the state would receive revenue from manufacturing, manufacturing will not pay the bills. CO-CHAIR JOHNSON commented that this is a policy call of whether to trade taxes for jobs. 1:26:29 PM REPRESENTATIVE P. WILSON, in regard to page 3, line 26, "make the election at the time the return is due", requested Mr. Bullock to comment on his previous suggestion to make the election earlier than that. MR. BULLOCK explained that ACES changed what was a monthly tax to an annual tax, while at the same time providing for monthly installments. So, AS 43.55.020, which is amended by Section 5 of Version R, provides for the calculation of an installment payment that is roughly equal to one-twelfth of the tax liability that will be due for the year. There was already a provision in AS 43.55.020(a) that applied to gas used in the state and how to determine how that cap affects the installment payment. So, his suggestion was that since the taxpayer makes installment payments during the year as the gas is produced, the taxpayer could make the election at the time an installment payment is made rather than after the end of the year. He pointed out that the producer has to know whether the gas is used in the state or not, but in the case of manufacturing there are not yet any manufacturing facilities in the state. The credits that are accruing are going to be applying to other production until this "used in the state" kicks in, which applies to the question that Representative Seaton had. 1:28:40 PM CO-CHAIR NEUMAN added that HB 217 provides the opportunity for Alaska's gas to be used in different ways for manufacturing. Right now Alaska's gas is used for home heating and electrical generation. The goal is to also use it for manufacturing and create thousands of jobs in the state. An issue was identified by the Department of Revenue (DOR) and an effort has been made to fix that. The fiscal note is zero. Right now no gas is being produced for manufacturing in-state and 5 percent of nothing is zero to the state. Therefore, to him, this incentive is good. His goal is to have a pipeline to Southcentral Alaska to some manufacturing and everything possible must be done to try to establish that. He agreed that revenue to the state is important, but pointed out that by creating more manufacturing, those manufacturers would be paying corporate taxes. Alaska needs to find ways to diversify its economy, he opined. CO-CHAIR JOHNSON interjected that manufacturing could take place anywhere in the state. CO-CHAIR NEUMAN agreed and reiterated that manufacturing means a molecular change and would not include LNG export. 1:31:35 PM REPRESENTATIVE SEATON agreed that the state has been counting on gas as the replacement when oil goes down. However, should HB 217 pass, and the "large" pipeline stays inside the state, and all of the gas is used in-state, then the state would get no revenue off of that gas. He said he is using the term "no revenue" because the tax credits and the upstream amounts would probably fully offset any amount of tax the state receives. When he looks at jobs he is also looking at saying there will not be forward funding of education and there will not be a number of other things because the state's tax base has gone down as a result of the decline in oil and almost no tax on the gas used for manufacturing. The state would then need to substitute another tax regime, such as an income tax, tax on mining, or tax on manufacturing. CO-CHAIR JOHNSON commented that if those other funding sources were out there, such as the manufacturing, that would be a pleasant decision to make. It is a policy call, he reiterated. 1:33:49 PM REPRESENTATIVE SEATON said his problem with HB 217 is whether the incentive is being given to the right people - it is a production tax; it does not go to the manufacturer. If the state wants to have use of gas for manufacturing, a credit would be given to manufacturers that use gas as a feedstock. Then it would be the manufacturer that is being encouraged instead of giving a low tax rate to the producers and hoping that they pass their lower costs on to the manufacturer using that gas. CO-CHAIR JOHNSON offered his understanding of that concern. MR. BULLOCK pointed out that AS 43.55.014 would sunset in 2022, so there would be an end period for the election to apply. As it went forward it could be seen how it works and the statute could be adjusted by the legislature. CO-CHAIR NEUMAN allowed that this is his concern too, but there is also revenue from corporate taxes, royalties, local property taxes, and the purchase of permits and leases from the state. He noted that HB 217 says "used as ... feedstock" for the manufacturing process and this is what the bill started with. 1:35:50 PM REPRESENTATIVE GUTTENBERG commented that at times the state's tax breaks and incentives do not produce what is expected. For example, in the Interior the requirement that logs could be exported until they were milled resulted in the logs being run through the mill to cut off two sides to create slab wood and then the rest of the log was exported to Japan. He offered his concern that a minor part of the gas molecules could be taken off and the rest exported, rather than using most of the gas for in-state feedstock for lots of different products. He inquired whether such an unintended consequence has been looked at. CO-CHAIR NEUMAN responded that he hopes lots of products will be made from the gas. He noted that the Fischer-Tropsch process creates synthetic transportation fuels and a by-product of that process is feedstock for plastics. The goal is to have ethanes for raw plastics, as well as butanes and synthetic propanes. He urged members to talk to him and Mr. Bullock to get their questions answered. CO-CHAIR JOHNSON urged members to speak individually with the sponsor so their questions can then be put on the record in a clear and concise manner at the next hearing of HB 217 and action can be taken on the bill. 1:41:04 PM MR. BULLOCK pointed out that the reason HB 217 has gone from one paragraph to ten pages is because of all of the cross references that have to be changed. He advised that when reading the bill, anything related to such cross references will be seen as (o) in brackets, because this is the subsection of AS 43.55.011 that is being deleted, and before that bracketing will be insertion of the new election section which is bolded and underlined. 1:42:06 PM REPRESENTATIVE P. WILSON asked why the sponsor chose to provide the benefit to the producer rather than the manufacturer. CO-CHAIR NEUMAN replied that the cost of feedstock will be a primary consideration for potential manufacturers because that will eventually be the cost of the finished product. This would get that cost of the feedstock to a rate that is acceptable. He related that the cross references are the result of the Department of Revenue's determination that maybe - in a few circumstances - there could be a disincentive to the cost of gas for electrical generation and home heating use. If that happened, it could cause Alaskans to have to pay more for home heating and electrical generation. Therefore, he agreed to this suggestion in an attempt to reduce the cost for those customers, which was the intent of expanding the Cook Inlet rate of 17.5 cents to the rest of the state. CO-CHAIR JOHNSON held over HB 217.