HOUSE SPECIAL COMMITTEE ON OIL AND GAS February 8, 2000 10:08 a.m. MEMBERS PRESENT Representative Jim Whitaker, Chairman Representative Fred Dyson Representative Gail Phillips Representative Joe Green Representative John Harris Representative Brian Porter Representative Allen Kemplen Representative Tom Brice Representative Hal Smalley MEMBERS ABSENT All members present COMMITTEE CALENDAR IRS Ruling on Alaska Gasline Port Authority PREVIOUS ACTION No previous action to record WITNESS REGISTER WILLIAM M. WALKER, General Counsel Alaska Gasline Port Authority Walker, Walker, Wendlandt and Osowski 550 West Seventh Avenue, Suite 1850 Anchorage, Alaska 99501 POSITION STATEMENT: Provided information on IRS ruling. TRAVIS C. GIBBS, Attorney O'Melveny and Myers LLP 400 South Hope Street Los Angeles, California 90071-2899 POSITION STATEMENT: Provided information on IRS ruling. ACTION NARRATIVE TAPE 00-10, SIDE A Number 0001 CHAIRMAN JIM WHITAKER called the House Special Committee on Oil and Gas meeting to order at 10:08 a.m. Members present at the call to order were Representatives Whitaker, Green, Harris, Porter, Kemplen, Brice and Smalley. Representatives Dyson and Phillips arrived as the meeting was in progress. CHAIRMAN WHITAKER announced that the purpose of the meeting was to clear the air and remove any questions about the effect and validity of a recent ruling from the Internal Revenue Service (IRS) in response to a request from the Alaska Gasline Port Authority. He introduced William Walker who would testify by teleconference from Anchorage. Number 0115 WILLIAM M. WALKER, General Counsel, Alaska Gasline Port Authority, Walker, Walker, Wendlandt and Osowski, explained that the port authority in April 1999 had asked the law firm of O'Melveny and Myers to assist in obtaining a ruling from the IRS regarding whether port authority income would be exempt from federal income tax. That request was submitted to the IRS in November 1999. On January 28, 2000, the port authority received word that the IRS had granted the port authority's request for tax exemption. Mr. Walker then introduced Travis Gibbs as the person who had prepared and submitted the application. Mr. Gibbs participated by teleconference from Los Angeles. Number 0216 TRAVIS C. GIBBS, Attorney, O'Melveny and Myers LLP (Los Angeles), explained that the port authority's request was based on a long- held position of both the IRS and the courts that political subdivisions are not subject to federal tax. As far as the IRS is concerned, that position is based on either a constitutional or an implied statutory tax immunity. From the courts' perspective, that position is based on a Supreme Court decision that a political subdivision is not subject to tax unless Congress specifically directs otherwise. Mr. Gibbs said the only congressional exception of which he was aware applies specifically to state universities, making them subject to taxes comparable to those paid by private nonprofit universities. MR. GIBBS said the port authority's request focused solely on whether or not the port authority is a political subdivision. The IRS concluded that based on the definition of political subdivision contained in IRS regulations, the port authority is, indeed, a political subdivision. Mr. Gibbs said the effect of that ruling is that the port authority is not subject to filing income tax returns or paying federal taxes. The ruling is in the form of what is called a private letter, which is submitted to the taxpayer or entity that requested the ruling. Under federal law, the ruling is applicable only to the entity that requested it. That entity can rely on that ruling. Number 0768 CHAIRMAN WHITAKER read what the port authority had sent to the IRS requesting a ruling that, "The authority is a political subdivision of the state whose income is exempt from federal tax." MR. GIBBS said that was the only question asked. CHAIRMAN WHITAKER wanted to know if the ruling specifically stated that port authority income would be exempt from federal income tax. MR. GIBBS said that was correct. In response to a request to quote the answer received, he stated: "Based solely on the representations made and the definition of the term political subdivision in Section 1.103-1B [of the federal income tax code], we conclude that the authority is a political subdivision." Mr. Gibbs said that means the port authority would pay no income tax. Number 0908 REPRESENTATIVE BRICE asked if the ruling applied to taxes other than income tax. MR. GIBBS said the port authority would be exempt from all federal taxes, but that the ruling does not apply to any taxes that might be imposed at the state or local level within Alaska. REPRESENTATIVE GREEN wondered if this response would hold or if the IRS might reconsider it. MR. GIBBS characterized the response as typical of the language used when the IRS rules that a case meets all criteria. He said that as long as the factual representations made regarding the port authority are true, the IRS would not revisit the ruling. REPRESENTATIVE GREEN asked if the IRS might go back and change what constitutes a political subdivision. MR. GIBBS replied that he was very comfortable, based on his knowledge of the rulings process, that the IRS will not go back and revisit or try to change the result. He said the conclusion is consistent with literally hundreds of other rulings. The port authority was advised to get the ruling because some features in its case were unique and because there is so much at stake. This ruling is definitive and binding on both the IRS and the port authority. REPRESENTATIVE HARRIS understood that the port authority's income is to be used for governmental services, with a good portion of it going to the state and the rest to municipalities. MR. GIBBS said that is correct. Net revenues will be distributed among municipalities according to a formula set out in the port authority ordinances. The money is to be used by the state and municipalities for general governmental purposes. REPRESENTATIVE HARRIS speculated that the IRS might have ruled differently if revenue had not been earmarked for basic governmental service. MR. GIBBS said one of the legal standards for a political subdivision is that it be controlled by state and local governments, and that it otherwise have a public purpose. He said the port authority attorneys spent a great deal of time establishing the public purpose of the authority, and had the revenues gone to something other than general governmental activities, that would have put more pressure on the question of whether the port authority serves a public purpose. Number 1345 REPRESENTATIVE SMALLEY wanted to know if the state's Department of Revenue had been involved in determining the percentages that go to the communities and to the state MR. WALKER said the statute that provides for the creation of port authorities does not require that funds go anywhere except to the port authority. This port authority voluntarily established a sharing arrangement whereby 60 percent would go to the state and 30 percent to the communities, with 10 percent retained by the port authority. CHAIRMAN WHITAKER asked if the authority had discussed the allocation with the Department of Revenue and/or other state officials. MR. WALKER said they did, and that they kept those officials apprised that the goal of the port authority project was to benefit all of Alaska. CHAIRMAN WHITAKER asked Mr. Walker about the impact of the ruling on the project's bottom line. MR. WALKER said estimates place the impact somewhere between $2.3 and 3 billion. He explained that the ruling frees money that would normally be used to pay federal taxes, so that money can be used elsewhere in the project, thereby making the project more viable. It raises the rate of return from eight to 12 percent. CHAIRMAN WHITAKER asked what the ruling means to the port authority in terms of dollars per year. MR. WALKER said he would need to calculate that, taking the annual net revenues of the project and assuming that without the ruling, about 35 percent of the total would go to federal taxes each year. CHAIRMAN WHITAKER said his best estimate was an annual effect on the bottom line of $250 million to three-fourths of a billion dollars a year. He added that those are huge numbers. MR. GIBBS responded that, in his experience, the financial market takes a ruling like this at face value. CHAIRMAN WHITAKER wondered why the IRS ruling does not specifically state that port authority earnings would not be subject to income tax. MR. GIBBS said based on recent discussions he has had with the IRS, the agency did not want to go beyond a decision based strictly on the regulations. Despite reluctance to include the specific words related to tax exemption, those who made the ruling have indicated that they understood its effect would be to exclude the port authority from any kind of federal taxes. Mr. Gibbs indicated he had directed attention to other rulings that include specific reference to income tax exemption, words that the port authority would like see included in this ruling. He said that IRS rulings focus on procedural and technical limitations, and the branch with which he was dealing was of the impression that procedurally they should not go further. He expressed hope that the IRS officials involved will agree that there is no procedural reason why they should not fully spell out the ruling's effect on taxes. MR. GIBBS, at Chairman Whitaker's request, repeated the question asked of the IRS and the IRS conclusion that the port authority is a political subdivision. CHAIRMAN WHITAKER asked if the topic of tax-exempt revenue bonds would be a second issue. MR. GIBBS replied that the port authority plans to submit a specific request for a ruling regarding tax exempt bonds when related plans are more fully fleshed out. He added that the ruling that the port authority is a governmental subdivision is a good start in achieving financing for the project, but that there are other rules and requirements that will have be addressed before there can be an answer to the question regarding bonds. Mr. Gibbs clarified for Chairman Whitaker that the port authority's request had nothing to do with tax exempt bonds, but related only to income. REPRESENTATIVE SMALLEY asked if project plans were predicated on a specific market window. MR. WALKER said the project is geared toward the 2005 market window. REPRESENTATIVE SMALLEY followed by asking if the potential revenues of $450 million to $3/4 billion are predicated on an initial seven tons per year or on an expanded 14-20 tons per year. MR. WALKER replied that those estimates were based on 15 million tons per year. REPRESENTATIVE DYSON inquired if a 12 percent discount rate is standard for calculating present worth. MR. WALKER said he did not know, but would find out from the port authority's financial advisers. Chairman Whitaker recalled that the percentage could be arbitrarily fixed, and Mr. Walker confirmed that was the case. REPRESENTATIVE DYSON wondered if 12 percent would be an acceptable rate of return to investors in the project. Number 2017 MR. WALKER stated that on behalf of the port authority, he cannot over-emphasize the importance of the IRS ruling. The port authority concept is what makes this project work, and the ruling is a monumental step that has created tremendous momentum for the port authority. CHAIRMAN WHITAKER asked Mr. Walker if the port authority had discussed with producers or with the state the effect this definitive ruling has on a potential gas project. MR. WALKER said the port authority had met previously with producers and with the state Administration. The port authority will give all of them a copy of the ruling and discuss its impact again now that the decision has been made. In response to a request by Chairman Whitaker, Mr. Walker agreed to keep the committee apprised of progress and the receptiveness of those parties. In response to a question from Representative Green, Mr. Walker said the concept of a port authority being tax-exempt is not unique, but there had not been a previous inquiry in which the facts were identical to this one. MR. GIBBS concurred. CHAIRMAN WHITAKER adjourned the House Special Committee on Oil and Gas at 11:47 a.m. NOTE: The meeting was recorded and handwritten log notes were taken. A copy of the tape and log notes may be obtained by contacting the House Records Office at 129 6th Street, Suite 229, Juneau, Alaska 99801-2197, (907) 465-2214, and after adjournment of the second session of the Twenty-first Alaska State Legislature this information may be obtained by contacting the Legislative Reference Library at 129 6th Street, Suite 102, Juneau, Alaska 99801, (907) 465-3808.