SB 86-INTEREST ON DELINQUENT TAXES  CHAIR CON BUNDE called the Senate Labor and Commerce Standing Committee meeting to order at 1:35 p.m. and announced SB 86 to be up for consideration. Present were Senators Seekins, French, Stevens; Senator Davis was excused. SENATOR WILKEN, sponsor, related to the committee that: SB 86 was brought to him by a constituent and is an act relating to the interest on delinquent taxes. When a business in Alaska submits a tax report to the Department of Revenue, the department reviews the report to insure its accuracy. When an error is found in a report resulting in an under payment or an over payment in the taxes, an interest of 11% is attached by statute. This interest rate is set in statute, AS 43.22.05, which mandates the interest on the delinquent taxes to be 5 percentage points above the District 12 Discount Rate or 11%, whichever is greater. SB 86 proposes to eliminate the reference to 11% interest and retain the 12th District Discount Rate, plus 5% as the formula for calculating interest on delinquent taxes. This will establish a fair and reasonable method of calculating interest by allowing it to float with the market. We believe it is inappropriate to charge Alaskans 11% on delinquent taxes, especially since many delinquencies result from honest mistakes, as you will hear today. Another disturbing practice is that the department often doesn't find the discrepancy in a tax report for two or three years. Unfortunately, for the business owner, the 11% interest accrues from the date the tax report was filed, not the date the discrepancy was discovered. According to the Department of Revenue, the fiscal impact to the state as a result of this legislation will be marginal. The state will receive a fair and reasonable interest from the delinquent taxpayers and will also pay a fair and reasonable interest on refunds to tax payers. CHAIR BUNDE asked what were the typical interest rates throughout the nation when the 11% was first set. MR. DARWIN PETERSON, Staff to Senator Wilken, replied that the interest rate was higher than that. The interest rate in statute was simple 8% until the legislation was enacted that changed it to 5% above the 12th District Discount Rate or 11%, whichever is greater. CHAIR BUNDE asked what the discount rate was then. MR. PETERSON replied in 1980 the discount rate was 12% in the 12th District. SENATOR STEVENS asked how this legislation would change the date of filing for the charges starting to accrue if a mistake had been made. MR. PETERSON replied that all this bill does is change the interest rate. The fact that it takes the department years to discover a mistake begs the question that could be answered under separate legislation at the end of the budget process. He understands that statute requires the department to discover a mistake within three years. Since that is what is in statute, the department often waits and reviews tax reports when it gets close to the statutory deadline. It was 20 months before they realized there was an honest mistake in Mr. Walker's tax reports. At that time the 11% interest rate had accrued for the entire 20 months. SENATOR STEVENS continued saying that if it's a floating rate, it could be greater or lesser than when the mistake was actually filed. This would base it on when it was discovered. SENATOR SEEKINS said this would also have an effect on the interest the state pays for overpayments of taxes and asked where that would tie in statutes. MR. PETERSON said that the state is also liable for the 11% if there is an overpayment of taxes. SENATOR SEEKINS asked if they had considered putting a cap on the rate. MR. PETERSON said that is a possibility. MR. DAN DICKENSON, Director, Tax Division, Department of Revenue, said he wanted to give them a little history of this section of the law. Up until 1980, if the taxpayer underpaid his taxes, interest was calculated at 12% simple interest when a company finally paid the amount due. As Governor Hickel characterized this situation in his March 1991 letter of transmittal for the bill that resulted in the current law, he said the state ends up loaning billions of dollars to its tax payers at very low interest rates. As everyone knows, a huge backlog built up of oil and gas taxes over the state. I was able to locate an accounts receivable payment from March 1991 that shows $3.6 billion dollars in outstanding taxes. As you can imagine, over $3 billion of that was in oil and gas back taxes. The legislature and administration made a good decision in 1991; they changed the law. They made three cases. First of all interest was moved from a simple to more standard commercial practice of compounding interest. The change to compound interest made a dramatic difference in the interest owed on long delayed cases. Second, interest was defined as the federal reserve inter-bank rate plus 5% or - and this third point is the interesting point - a minimum of 11%. This change was designed to get the attention of companies that had been underpaying their taxes and it did. At the same time, in 1991, a change was made in Title 38 putting oil and gas royalties on the same higher intra bank rate or 11% compounded. Over the next five years, $3.5 in back taxes and royalties flowed into the CBRF, the constitutional budget reserve fund and a whole different attitude became apparent. Clearly, there was more than just interest rate changes at work in this situation, but it is also clear that the interest rate change played a significant role. Now, in 2003, our accounts receivable in the tax division is $71 million or about 2% of what it was in 1991. So now it's time for another good decision, to bring the interest rates more in line with market rates. I don't think this will bring about a return to backlog. Since this change sticks with compound rates, tax payer delay will rapidly become more and more expensive to the tax payer. This bill does not change the interest rate on tax due oil and gas royalties. This legislation simply eliminates the 11% minimum rate on taxes and allows the rate to float at 5% above the federal reserve's intra-bank rate. And just as the new rate structure applies to back taxes owed the state, it would also apply to certain tax refunds paid by the state, thereby saving us some money. The administration supports this bill and urges you to do the same. CHAIR BUNDE asked him to comment on language stating that the clock starts ticking at the time the taxes are filed rather than when the error is found. MR. DICKENSON, in response, asked the committee to "put on the glasses" of a large corporation who is paying hundreds of millions of dollars in taxes to the state. There are frequently conceptual problems about how things get characterized in both royalty or the tax situation. These are sophisticated tax requirements and sophisticated royalty payers. In those situations, we don't want to have the state essentially lending money to the companies; in other words, have the companies underpay. We'll be in a dispute with them for a year or two, three, four, these can go on, and, then when it's finally agreed, then the interest clock starts to run. The notion should be that when a tax amount is agreed upon, we go back and look when that was due and we make sure that the company doesn't gain any advantage from not having paid when it was due. That's a very different perspective than the small business owner who perhaps made an inadvertent error and is faced with the same situation. CHAIR BUNDE asked what would preclude the interest clock from starting to tick the moment you found an error rather than waiting until after everything was litigated. MR. DICKENSON replied that nothing would preclude it and that would set a small advantage for the companies for not paying their taxes. What it would really do is totally change the way the division was organized and approaches problems. Right now when we, and I'll just use Exxon, because everyone understands that they're a tax payer here and they're the world's largest industrial organization. When we audit them, we don't want to be going in every month and - the pay production tax as a monthly tax - and try to catch the errors so that we start the interest clock running. We wait until we have a two-year cycle and go in, step back, look at it closely, sometimes subsequent events have occurred that are important, sometimes we need to hire experts that understand some aspects of the business. We are certainly organized around a principle that if a company has underpaid, we can be thorough and careful and make sure that we get the right amount and that we're not penalized for taking the time to do it correctly. If we were to change the statute, we would have to think about our emphasis and think about how dealt with the timeliness of findings and pointing out these kinds of errors... SENATOR FRENCH asked where the statute says the refund interest rate is set the same as the delinquent tax. MR. DICKENSON replied AS 43.05.280 - Interest on overpayments (a) - Interest shall be allowed and paid on an overpayment of tax under this title at the rate and the manner provided in AS 43.05.225, section 1. SENATOR FRENCH said the fiscal note spoke about the potential difference of close to $1 million per year in the amount going to the constitutional budget reserve and asked him to comment on that. MR. DICKENSON replied that it's hard to estimate because the number of payments is fairly small and the volatility is fairly high. Interest is about one third of the dollars going into the CBRF and that could change because the division is getting more and more caught up, currently auditing 2000 and 2001 for the major companies and 2002 for some of the smaller ones. They also need to look at what future interest rates are going to look like. Most folks think we're at an historic low and it's not safe to use the 7.25%, which is what the interest rate is today. Using assumptions, they came up with a ballpark figure of $1 billion. In the income tax arena, we based our analysis on what the IRS does. They are much further behind than we are. So, let's say we got notice of an adjustment [indisc.] to 1993 and made a tax adjustment and the taxpayer paid us more tax based on that. From 1993 until the effective date of this law, you'd use the 11% and then for the number of months after that, you would drop down and use the 7.25%. So, for the first couple of years, you see almost no drop in the CBRF, but then as you go out several years, that's where you see the drop in [indisc.] and perhaps even go over it. SENATOR FRENCH asked how he picked the fed plus 5% figure. MR. DICKENSON replied that he wasn't directly involved with that legislation, but they take what someone characterized as a risk free rate and added 5%. Credit card rates are much higher than that. CHAIR BUNDE asked if they wanted to keep enough penalty "to keep a careful pencil." MR. DICKENSON replied that is exactly right. He added that the Supreme Court has ruled that interest has no punitive aspects to it; it is merely the time value of money. MR. WAYNE WALKER, President, A&W Wholesale, thanked Senator Wilken and Mr. Peterson for working on this issue and thanked the Department of Revenue for trying to help him. He explained that since 1970 he has been the sole respondent in filing the tax returns for his company on cigarettes and they have as clean a business as anybody. A precedent was set by the Department of Revenue that within a few weeks after receiving their filing, the department would send a letter on whether it was overstated or understated and penalties and interest and by the time of their next month's filing, they were expected to pay whatever they owed including penalties and interest. That went on from 1970 at least through 1995 and maybe further. The report in question was sitting somewhere for 20 months before they received a report from the Department of Revenue. If they had received a report from them sooner, the fine would have been paid immediately. MR. WALKER said the first letter he received was for what was owed on the cigarettes, which was almost $16,000. Five days later, they got another letter adding $3,000 worth of interest. The reason they were upset is because they couldn't understand why 20 months passed when there was 25 years worth of precedent of a couple of weeks. He said also it came at a bad time for his company as they had discontinued selling cigarettes almost two years ago, which means they didn't have the cash flow they used to have. CHAIR BUNDE thanked him for his testimony. There were no further testifiers and he announced that he would hold the bill for further work.