HB 235-DECOUPLING FROM FED TAX DEDUCTION 8:42:36 AM CHAIR WEYHRAUCH announced that the first order of business would be HOUSE BILL NO. 235 "An Act excepting from the Alaska Net Income Tax Act the federal deduction regarding income attributable to certain domestic production activities; and providing for an effective date." [Before the committee, was CSHB 235, Version 24-GH1137\F, Kurtz, 4/7/05.] 8:44:19 AM TOM WILLIAMS, Chair of Tax Committee, Alaska Oil and Gas Association (AOGA), informed the committee that he is also Alaska tax counsel for BP Exploration (Alaska) Inc. He recalled that at the last hearing there were a number of questions that [AOGA] didn't have a chance to answer, which he would like to address today. He then turned to the U.S. Supreme court case, Kraft General Foods, Inc. v. Iowa Department of Revenue and Finance, which was mentioned at the prior hearing. He said that the case is not applicable to Alaska because Iowa adopted parts of the federal system for the treatment of foreign and domestic dividends for tax purposes. Iowa chose the parts that would help the state and decoupled from what it saw as having a negative revenue impact. As a result, Iowa established a system that only taxed foreign earnings paid as dividends from foreign subsidiaries; domestic earnings whether from foreign or domestic subsidiaries weren't taxed. The aforementioned is what the U.S. Supreme Court said constituted the discrimination against foreign commerce. 8:45:57 AM CHAIR WEYHRAUCH asked, for clarification purposes, if the aforementioned case was because Iowa was "tinkering" with the federal code. MR. WILLIAMS replied that Iowa was tinkering with the federal code in the sense that it decided which portions to use for "Iowa purposes." Iowa adopted particular federal code income sections, but didn't adopt the tax credit provision. Mr. Williams opined that there is no state action to be done, the federal law went into effect January 1, 2005. "There is nothing that happened other than January 1st arrived," he said. There is no state action to say Alaska is discriminating. More importantly, if Alaska were to follow the status quo, it would adopt the entire federal code with regard to the qualified production activity income (QPAI). Mr. Williams emphasized that the federal code has already been adopted in its entirety. He added that in the Iowa case, foreign commerce was involved. Foreign commerce includes an extra dimension in that there are issues that can impact the nation. Therefore, from the federal constitutional perspective it's important not to let states interfere with foreign policy decisions because it could have devastating implications abroad and domestically. In regards to why one would object to legislation that would return the state to where it would be had Congress not acted, Congress did act and Alaska adopted it. MR. WILLIAMS then highlighted that earlier in 2005, the Department of Revenue (DOR) made an administrative tax change to the [economic limit factor (ELF)] that resulted in $150 million [loss] annually. Therefore, he characterized an additional $30 million as "piling on," especially in a time of surplus. He acknowledged that the state never has enough money to cover every agenda. He stated this legislation is unnecessary and could have unintended consequences similar to those [discovered with the ELF tax change], including the deferment of projects. Mr. Williams pointed out that $50 oil is $50 oil no matter the location, [a difference] is that Alaska has higher costs than anywhere else. Therefore, Alaska must recognize its strengths, one of which is a "stable and predictable tax regime." 8:53:11 AM REPRESENTATIVE SEATON asked, for clarification purposes, if Mr. Williams's testimony was implicating that Alaska needs to couple with the federal tax code because decoupling would be detrimental to Alaska. MR. WILLIAMS said there are many strengths with staying coupled with the Alaska system, such as ease of administration for the DOR. Similarly, the industry's perspective is Alaska should follow the federal definition of taxable income because it doesn't require additional modifications of tax calculation purposes in Alaska. He added that coupling is efficient for taxpayers and industry. He noted that not every thing the federal government does is a tax break for the oil and gas industry. 8:55:51 AM REPRESENTATIVE SEATON opined the legislature either automatically couples which offers security or decouples when it's appropriate, and "one or the other needs to float." MR. WILLIAMS said the legislature makes that decision about whether to decouple from a specific provision. He alluded to the idea that tax laws have become increasingly complicated and therefore allowing the federal government to do the "heavy lifting and the enforcement tax laws" is wise. 8:58:01 AM MR. WILLIAMS, in response to Chair Weyhrauch, said Congress doesn't have the power to tell states how to define income. 8:59:34 AM CHUCK HARLAMERT, Juneau Section Chief, Tax Division, Department of Revenue, referred to the Kraft decision and the implication that because Alaska took no action the discrimination was somehow permissible. However, [a provision] is or is not permissible per the constitution. Mr. Harlamert recalled testimony from the prior hearing that implied that because Alaska treats credits a bit differently, Alaska has the ability to engage in this sort of discriminatory treatment of income. However, constitutional issues are a prerogative of the courts which have dealt with income and credit issues on a separate basis. Therefore, he opined that income issues are fairly "settled." He highlighted that if a state treats economic activity outside of the state or the country differently than inside and it's less favorable, than it's impermissible discrimination. In contrast, virtually every state with an income tax has credits and those credits are restricted to activity within the state. The aforementioned doesn't "square" with the aforementioned discussion regarding income because it favors in-state activity. Alaska allows credits wherever earned in the U.S. and apportions those credits to the state. Until four months ago there was no court definition that using tax credits for investment in the state violated the Commerce Clause. From a historical perspective, before and after the Kraft case DOR had regular and ongoing disputes with taxpayers regarding whether the state could incorporate the federal government's discrimination and apply it. Virtually all the taxpayers filed on the basis that the state couldn't discriminate, the state argued, and generally lost. Therefore, the department acquiesced in its regulations in 1998 such that the calculations of foreign and domestic activities outside the state were equalized to calculations of income inside the state, which has benefited every major taxpayer as well as the state because it's generated a predictable tax scheme. 9:04:53 AM STEVEN B. PORTER, Deputy Commissioner, Department of Revenue, commented that each state has to determine whether the federal government's decisions are appropriate for the state. He related his belief that maintaining the "status quo" is appropriate and there is no need to provide the industry with an additional incentive considering the current economic environment. And maintaining the status quo does not threaten to raise the industries taxes, he added. With regard to the argument that by changing the tax status it increases the risk to the state environment, he suggested asking the [oil and gas companies] which authorization for expenditure (AFE) isn't going forward due to this small increment. Although the industry may argue that this legislation will produce an increased risk for investment, Alaska is one of the safest places when one considers the risks worldwide. 9:08:01 AM REPRESENTATIVE SEATON asked how this legislation would effect the fishery corporations, specifically could there be a situation such that fishery companies could pay no corporate tax because of the [QPAI] generated outside of the state. MR. HARLAMERT replied, "No, to have any benefit from this proposal or from the federal law as applied in Alaska, you would have to owe tax, ... the deduction is limited to the percentage rate times the lesser of your QPAI, or your qualified income, or your taxable income. So unless you have taxable income ... the deduction won't do you any benefit." REPRESENTATIVE SEATON asked if the QPAI generated outside the state would impact the corporate income tax of those corporations paying tax within the state. MR. HARLAMERT replied, "The [QPAI] could reduce their tax before credits at a maximum at 9 percent, and so they would be paying 91 percent of what they would have paid without the bill anyway. If you look at tax after credits that [amount] can increase because its 9 percent of the tax." 9:10:51 AM CHAIR WEYHRAUCH turned to Mr. Porter's query regarding the risk environment. He related his belief that AOGA's testimony has said the cumulative effect of the legislature acting on the administrative proposal to effect the QPAI coupled with the previous administrative decision to effect ELF, produces a potential long-term risk environment. MR. PORTER relayed that Governor Murkowski has been clear in his statements regarding the [oil] industry. Governor Murkowski expects the state to receive its "fair share" of the revenue while supporting new development. He added that the state has "been open to, and encourages the industry" to come to the division with its economics. The industry is encouraged to bring its AFEs to the division detailing how the incremental tax on that field effects the economics of that project. CHAIR WEYHRAUCH, upon determining no one else wished to testify, closed public testimony. 9:14:27 AM REPRESENTATIVE SEATON [restating his motion from the prior hearing] moved to adopt CSHB 235, Version 24-GH1137\F, Kurtz, 4/7/05, as the working document. There being no objection, Version F was before the committee. REPRESENTATIVE SEATON moved to report CSHB 235, Version 24- GH1137\F, Kurtz, 4/7/05, out of committee with individual recommendations and the accompanying fiscal notes. There being no objection, CSHB 235(W&M) was reported from the House Special Committee on Ways and Means.