HOUSE SPECIAL COMMITTEE ON OIL AND GAS February 22, 2000 10:10 a.m. MEMBERS PRESENT Representative Jim Whitaker, Chairman Representative Fred Dyson Representative Gail Phillips Representative Joe Green Representative John Harris Representative Brian Porter Representative Tom Brice Representative Hal Smalley MEMBERS ABSENT Representative Allen Kemplen COMMITTEE CALENDAR HOUSE BILL NO. 307 "An Act establishing an oil and gas corporate income tax and making conforming amendments; and amending the tax on corporations levied under the Alaska Net Income Tax Act to eliminate the state corporate income tax on taxable income of less than $10,000; and providing for an effective date." - HEARD AND HELD PREVIOUS ACTION BILL: HB 307 SHORT TITLE: OIL AND GAS CORPORATE TAX ACCOUNTING Jrn-Date Jrn-Page Action 1/21/00 1972 (H) READ THE FIRST TIME - REFERRALS 1/21/00 1973 (H) O&G, L&C, FIN 1/21/00 1973 (H) REFERRED TO O&G 2/16/00 2225 (H) COSPONSOR(S): AUSTERMAN 2/17/00 (H) O&G AT 10:00 AM CAPITOL 17 2/17/00 (H) Heard & Held 2/17/00 (H) MINUTE(O&G) 2/22/00 (H) O&G AT 10:00 AM CAPITOL 17 WITNESS REGISTER REPRESENTATIVE ERIC CROFT Alaska State Legislature Capitol Building, Room 400 Juneau, Alaska 99801 POSITION STATEMENT: Sponsor of HB 307. JUDY BRADY, Executive Director Alaska Oil and Gas Association 121 West Fireweed Lane Anchorage, Alaska POSITION STATEMENT: Testified in opposition to HB 307. TOM WILLIAMS, Alaska Tax Counsel BP/AMOCO P.O. Box 196612 Anchorage, ALASKA 99519-6612 POSITION STATEMENT: Testified on HB 307. DEBORAH VOGT 715 Fifth Street Douglas, Alaska 99824 POSITION STATEMENT: Testified on HB 307. DAN E. DICKINSON, Director Oil and Gas Audit Division Department of Revenue 550 West Seventh Avenue, Suite 570 Anchorage, Alaska 99501-3557 POSITION STATEMENT: Testified on HB 307. STEVE MAHONEY, Associate General Tax Officer ARCO P.O. Box 100360 Anchorage, Alaska 99510-0360 POSITION STATEMENT: Testified on HB 307. ACTION NARRATIVE TAPE 00-14, SIDE A Number 0005 CHAIRMAN JIM WHITAKER called the House Special Committee on Oil and Gas meeting to order at 10:10 a.m. Members present at the call to order were Representatives Whitaker, Dyson, Phillips, Green, Harris, Porter, Brice and Smalley. CHAIRMAN WHITAKER noted that in response to a request from Representative Phillips, there was a memo in committee members' packets regarding the natural gas requirements of Fort Greely, Fort Wainwright, and Eielson Air Force Base. HB 307-OIL AND GAS CORPORATE TAX ACCOUNTING Number 0094 CHAIRMAN WHITAKER introduced the first order of business, HOUSE BILL NO. 307, "An Act establishing an oil and gas corporate income tax and making conforming amendments; and amending the tax on corporations levied under the Alaska Net Income Tax Act to eliminate the state corporate income tax on taxable income of less than $10,000; and providing for an effective date." REPRESENTATIVE ERIC CROFT, Alaska State Legislature, sponsor of HB 307, who was ill and unable to attend, confirmed that he was on teleconference. Number 0180 JUDY BRADY, Executive Director, Alaska Oil and Gas Association (AOGA), said AOGA is an industry trade association whose 17 members represent the majority of the petroleum industry in Alaska. Ms. Brady presented AOGA's comments on HB 307, which proposes to re-enact Alaska's former separate-accounting tax. She shared four reasons why AOGA's opposes HB 307: 1) the present apportionment-based tax does not provide a special tax break for the oil industry; 2) this is not a good time for Alaska to be destabilizing the fiscal rules of the game for doing business in Alaska; 3) HB 307 would tend to have a greater impact per barrel for new fields than for old ones at today's prices, which makes it harder for new fields to clear the economic hurdle to be competitive investments; and 4) income tax is not the whole story. MS. BRADY said the oil companies pay taxes on their Alaskan income at the same rate as do all other companies. She explained that misunderstanding arises from the calculation of how much of the business conducted in more than one state should be attributed to the Alaskan portion of the business. States can choose between two methods of calculating a company's taxable income: separate accounting or apportionment. MS. BRADY explained that separate accounting looks at the business activities occurring in Alaska and tries to figure out how much that company would have made without the out-of-state portions of the business. By contrast, apportionment looks at the profit of the entire business and tries to figure out how much of the profit-making capacity of that business is represented by its in-state activities. All multi-state business that pay income tax in Alaska compute their Alaskan income using the apportionment approach. MS. BRADY testified that critics of apportionment say that if an oil company finds a way to save a million dollars in its Alaskan operations, the state will not see the full million dollars in the income the company reports on its Alaskan tax return. She said that criticism ignores the fact that if an oil company finds a way to save a million dollars in Asia or the North Sea, Alaska benefits by receiving the same percentage of that company's total income. MS. BRADY then asserted that destabilizing taxes would discourage investment in Alaska. She said it would not be wise tax policy for Alaska to change to an accounting method that would, in effect, target new oil fields. MS. BRADY suggested that the actual amount of taxes Alaska has collected from the oil companies since 1981 may not be all that different from what it would have been under the former, separate-accounting formula. She said only the state's's Department of Revenue has complete information to provide the real numbers to compare. In conclusion, she urged the legislature not to enact House Bill 307. CHAIRMAN WHITAKER said he would assure that copies of Ms. Brady's prepared remarks were distributed to committee members. Number 0958 REPRESENTATIVE DYSON referred to a previous discussion with Ms. Brady, and asked if it was her position that when the state changed the accounting method from separate accounting to apportionment in 1981, there had been a conscious decision on the part of the legislature to raise production taxes to offset the loss of revenue from income taxes. MS. BRADY said yes, but she asked that the committee continue that discussion with Tom Williams, who had been with the Department of Revenue at that time. Number 1041 TOM WILLIAMS, Alaska Tax Counsel, BP/AMOCO, explained that in 1981, he was Commissioner of Revenue for Governor Jay Hammond and was actively involved with the legislature and tax legislation. He said that in answer to Representative Dyson's question, yes, it was a conscious decision. MR. WILLIAMS recalled that in 1980, in the course of litigation challenging the constitutionality of separate accounting, the United States Supreme Court stated that the two accounting methods were "theoretically incommensurable," and it sounded to those working for the state at that time as if the court would be ruling against separate accounting, as apportionment had previously been upheld. The state had collected $2 billion [from the oil companies] as the litigation moved forward. With that amount accruing interest, the refund that the state potentially owed to the oil companies threatened to be greater than the entire revenues of the state for a year. That was simply too great a gamble with the public money. MR. WILLIAMS continued, saying there were two approaches taken in 1981. One was to try to settle the litigation altogether. (The settlement approach did not work.) The other was to create a safety net for the separate accounting tax by creating a backstop tax against which the separate accounting payments would be made. If separate accounting were to be struck down, the backstop tax would then become fully due, in effect switching the money from one revenue source to another. MR. WILLIAMS recalled that at that time [1981], the legislative leadership in both bodies as well as the governor came out with a statement saying that Alaska was then getting a little more than 31 percent of the oil wealth, and that as long as the percentage stayed above 30 percent, the state would be getting a fair share. MR. WILLIAMS explained that the state then went to modified apportionment, which was expected to produce more revenue than regular apportionment. However, the amount of revenue generated still was going to be so far below that from separate accounting that it would not keep revenue to the state above the 30 percent threshold. So the production tax was increased. The base rate of the production tax was raised from 12.25 percent to 15 percent, and for large fields like Prudhoe Bay, there was a change made in the Economic Limit Factor (ELF). That combination of raising the base rate and applying the full base rate to fields like Prudhoe Bay was enough to keep the combined production tax and income tax revenues above the 30 percent threshold that everyone had agreed on as the minimum level for the state's share. MR. WILLIAMS confirmed that the modification had succeeded in keeping the revenues above 30 percent. However, "It did cost the state money. But enough out of the billions being projected that the legislature could swallow it, though not necessarily happily in some cases." It turned out that the actual loss was a little higher than Mr. Williams had figured. The Department of Revenue in 1986 did a review to see how things had actually turned out, and it was about twice the size of what he had said. "But still, overall, we protected the revenue." Number 1414 REPRESENTATIVE DYSON thanked Mr. Williams for a very helpful answer and asked a second question: If this bill goes forward, is there a way it could be structured so that the new companies coming into Alaska are not penalized? MR. WILLIAMS said it would be very difficult when the tax is being measured in the way that House Bill 307 proposes to measure production income. There are major expenses up front, and the profit per barrel is going to be greatest in the flush period when field begins producing. Economics eventually start to erode and eventually they become marginal, and when a company reaches break-even, it is done. That is inherent in the nature of the business. He said he didn't "see a fix within [HB] 307." REPRESENTATIVE DYSON wondered if it would be impractical to say that the new companies coming in to Alaska could go under the apportionment accounting for three to ten years or until their production got to a certain number of barrels and give them some kind of a phase in, a honeymoon period. MR. WILLIAMS said one certainly could do something like that, and in a direct sense, that would deal with the problem expressed. But he cautioned that transitioning into and out of separate accounting is a difficult thing to do. REPRESENTATIVE DYSON asked what the state is receiving now in relation to the 30 percent threshold. MR. WILLIAMS said he did not know about the other oil companies, but he believed that the state still is getting 30 percent from British Petroleum. He said the Department of Revenue is obviously the place to get the full answer. REPRESENTATIVE GREEN asked who else was scheduled to testify so he could direct questions to the appropriate person. Chairman Whitaker said he thought Dan Dickinson would be the only other witness. Deborah Vogt said she would like to testify, and Chairman Whitaker promised that she would be given that opportunity. Number 1697 REPRESENTATIVE SMALLEY asked Mr. Williams if a set of figures provided to the committee were accurate. [That information had come from House Bill 307 sponsors and showed oil company income tax payments to the state from 1982 to 1997, comparing the actual amount paid under the current approach with what would have been paid under separate accounting.] Mr. Williams said he did not know enough about the other companies to know if the figures were accurate or not. He said he would accept them as being accurate. MS. BRADY cautioned that in looking at those figures, one should be aware that they do not show the other half of the equation, the income from increased production taxes that she had described. She added that separate accounting is demoralizing, [it] "drags on a company to a have a method that is in such dispute that you are constantly fighting over it." REPRESENTATIVE PORTER said those figures do not take into account the amount of money that was received by the state as a result of the increase in production tax, is that correct? MR. WILLIAMS said it was. REPRESENTATIVE PORTER then asked if the sheet of figures could be characterized as "not exactly a fair statement." MR. WILLIAMS characterized it as an incomplete statement. Number 1862 CHAIRMAN WHITAKER asked for clarification about exactly which approach the state uses today, saying he understood that it is modified apportionment. MR. WILLIAMS said that is correct, that for the oil industry, the state uses a modified apportionment approach. He went on to explain that the standard apportionment approach uses three factors: property, payroll, and sales, and looks at how much of those is in-state, then takes the average of the three percentages and that is the percentage of a company's income deemed to have arisen from in-state activities. The modified apportionment approach uses the same property factor, but in place of payroll it substitutes production, how much of a company's oil and gas production worldwide was produced in Alaska. The second modification used on the apportionment side is in the sales factor. It not only looks at retail sales, but also at pipeline tariffs which are paid by the producing company. There are also some technical tweaks to the base, "the total pie, figuring the size of that pie, but in terms of how you calculate the slice, the apportionment, those are the changes." Number 1932 DEBORAH VOGT of Douglas, Alaska, began her testimony by clarifying that she had retired from state government [as Deputy Commissioner, Department of Revenue] last June, and was testifying from her historic memory of the subjects, not as a representative of the Administration. She said she had no dispute with what the other witnesses had told the committee about the two methods - separate accounting and apportionment - "neither one of which purports to be completely accurate." She compared the two by giving the analogy of dividing a restaurant bill according to who ate what (separate accounting) or equally among the diners (formula apportionment). MS. VOGT said that in a large sense, it does not make any difference which way it is done, so long as the profitability is more or less uniform, so long as everybody ate the same things or so long as all the factions of the business are more or less equally profitable. That was one of the things the legislature had in mind in 1978 when it went to separate accounting for the oil industry, she recalled. The legislature recognized that there would be phenomenal profits from the oil production on the North Slope and that the three-factor formula, as originally designed, was not going to accurately represent that income. MS. VOGT pointed out that regarding the sales factor, normally it is sales to a final, ultimate third party that counts, not the transfer between branches of the business. Since none of the oil companies' final sales took place in Alaska, the sales factor was going to be zero for oil and gas produced in Alaska. Number 2060 MS. VOGT addressed the property factor. She said that when the state supreme court decided that separate accounting was constitutional, the court pointed out that Prudhoe Bay was reflected on the company's books at approximately 1 percent of its value. The reason for that was that the oil and gas itself, the oil in the ground - which is generally the greatest asset an oil company owns - is not reflected on the company's books. If a company had an oil well for which it had paid $15 million, and that was a dry well, the well would be reflected on the company's books at $15 million. If that same $15 million well sat on top of several billion barrels of oil, it still would be reflected on the books at $15 million. She added, "Discovery is not an accounting event." She said that was one of the main flaws with the property factor, and that is still a flaw because Alaska still uses the property factor to account for oil and gas. MS. VOGT said the payroll factor has been abandoned because oil production is not a labor-intensive activity; additionally, a number of Unites States tax laws encourage oil companies to do business through subcontractors. The oil industry uses many subcontractors on the North Slope. In another industry, those people might show up in that company's payroll factor, and that was one of the reasons the legislature went to separate accounting. Number 2134 MS. VOGT described the three-factor formula as it would apply to a retail company doing business in several states. All three factors would increase in response to greater profitability in one particular state, and so the factors would be responsive to the different levels of profitability within the company. What the legislature found in 1981 was that those three factors do not really move when oil becomes more profitable. The system is simply not responsive to the changes of profitability within the business. So Alaska went to separate accounting in 1978. MS. VOGT recalled the separate accounting litigation that she handled for the state at the Alaska Supreme Court and United States Supreme Court levels. One thing she disputed in the testimony she had heard that morning concerned the duration of the "cloud of uncertainty" over the separate accounting method. She said the cloud did not linger after 1986, since the Alaska Supreme Court had decided in 1984 and the U.S. Supreme Court had decided in 1986 that the separate accounting method is constitutional. MS. VOGT said she certainly agreed with Tom Williams that there [previously] had been a substantial cloud. In 1978, there were [U.S. Supreme Court rulings in] two oil company cases that gave one pause in terms of keeping the separate accounting law on the books. Tom Williams had referred to the fact that the severance tax was changed in 1981, affecting the ELF; part of the thinking [then] was that by the time the ELF "kicked in again" in 1986, the litigation would be resolved and it would be time for the legislature to look again at income tax with regard to the oil industry. Number 2262 MS. VOGT offered her main point: corporate income tax in relation to the oil industry has not been reviewed thoroughly since 1978. Separate accounting was repealed in 1981 under the threat of litigation, but not because of any great philosophical determination by the legislature that modified apportionment would be better. She said she believes it is time for the legislature to look carefully at the income tax as it relates to the oil companies. She mentioned an item in a recent issue of the Juneau Empire that said taxes collected under the modified apportionment formula would go down if the merger of BP/ AMOCO with ARCO goes through. She said she did not know if that is a fact, but that it is something the legislature should look into. MS. VOGT also disputed the assertion made that morning that modified apportionment is better for encouraging new business. Separate accounting is not going to tax any business until that business actually is making money in Alaska. An oil company is active in the state for a long time before that company starts making any money. Modified apportionment is going to start taxing a business the minute it sets foot in the state. Because apportionment will bring some of the company's worldwide income into the state for taxation even though the company may be losing money in Alaska, Ms. Vogt believes apportionment is really anti- competitive for new businesses coming into the state. Number 2348 MS. VOGT said another assertion had been made that morning that the oil industry does not get any tax breaks compared to other industries. She pointed out that the oil industry is the only industry that Alaska taxes on worldwide apportionment. In 1991, the state retreated from worldwide [apportionment] for all other businesses except oil, and went to what is known as "water's edge." Ms. Vogt recalled that Alaska was one of the last states to use the worldwide unitary approach, which was something that the United States' foreign trading partners did not like at all, having individual states looking into the books of foreign subsidiaries. All of the states retreated to water's edge, although California still allows the worldwide unitary approach as an option. When Alaska went to water's edge, it was, she recalled, at the oil companies' request that they were left on worldwide while everyone else went to water's edge. Ms. Vogt returned to the restaurant analogy, pointing out that if Alaskan activities are extremely profitable, it is better for the oil industry to have that profit diluted as much as possible; the worldwide approach, therefore, is better than water's edge. In her opinion, that is an advantage the oil industry has over other businesses in Alaska. MS. VOGT said it would be interesting to hear from the Department of Revenue how the 30 percent factor has looked over time. It was her understanding that the state has not received anything like the 30 percent that was set as a hurdle in 1981. Whether folks agree that is an appropriate level or not, "that is something else." TAPE 00-14, SIDE B MS. VOGT concluded by saying that she thought it was worthwhile for the legislature to look carefully at corporate income taxes as they apply to the oil industry. Number 2460 REPRESENTATIVE PORTER asked Ms. Vogt if she remembered whether other oil-producing states use separate accounting. MS. VOGT said it is her understanding that they still do. Certainly they did at the time of the litigation. Texas does not have an income tax. California uses apportionment [as an option], but some of the other states including Oklahoma, Mississippi, and others used separate accounting, and she believes they still do. REPRESENTATIVE GREEN referred to the declining value of an aging oil field as the value drops toward the economic limit, as is happening to the big fields in Alaska. He asked Ms. Vogt if she thought that separate accounting might work to the state's detriment now or in the future. MS. VOGT said he was absolutely correct [in assuming that eventually it would reach a point at which] production becomes less profitable. It is possible that separate accounting and apportionment will cross, and it gets down to one's philosophy. She said she did not think the oil companies in Alaska had reached that point, and she did not think they would do so for some time; however, Dan Dickinson was on the line, and he would be the better person to answer that question. She asked the committee to think philosophically about what is appropriate. Is it appropriate to be taxing a field that isn't producing any income as if it were producing income? She said that is one of the advantages of separate accounting: it is only going to tax the fields that are profitable when they are profitable. Number 2378 REPRESENTATIVE GREEN mentioned a pie chart [in members' packets] that showed a breakdown of taxation. He wondered if that proportion seemed reasonable to Ms. Vogt, if - as Mr. Williams had said - other taxes have provided a fairly big fill-in of the difference between the two types of income tax. MS. VOGT said she had not studied the pie chart, but it certainly was true that "severance tax went off" when separate accounting was repealed. She did not think that the other taxes fully recovered the revenue that was lost due to the repeal of separate accounting. In her view, however, that is not really the question. The questions are: What should be done from this day forward? What is the appropriate level of taxation? How should the tax structure look? And what is the best tax to have to encourage diversification, to encourage new industries on the North Slope? REPRESENTATIVE GREEN said he certainly concurred with that, and knew from having worked with Ms. Vogt a few years ago that she is a very fair person. Whether right or wrong in the past, he added, "let's go forward." He then asked if it is going to be better from the state's standpoint to adopt, at this point, one or the other, or a modified form, or some other form of taxation. His concern, he said, was whether Alaska would be able to attract the kinds of investments needed to explore and find new [oil- producing] areas if Alaska does not establish a stable tax rate and say "that's it." "When you come to Alaska you've got bad climate," he commented. You've got long distances, you've got all these other things, but at least you've got a stable tax base." MS. VOGT said she believes separate accounting can be designed as Alaska had it from 1978-81, so that it is more encouraging to new development than is modified apportionment. Modified apportionment will attribute some taxable value to the state, whether the company is making any money or not. If the company is making money on a worldwide basis, that company will have income attributed to the state due to the fact that the company bought a lease, invested, drilled a well or pursued any activity like that. Separate accounting certainly can be designed to take into account those expensive initial expenditures of a company coming into the state. In a sense it already does, but through depreciation, amortization and rules within separate accounting, the state certainly can allow a company to completely recover its expenditure before any tax is levied, if that is what the legislature wants to do. MS. VOGT said that as far as tax stability is concerned, she had been involved in corporate income taxes and other taxes with the state for more than 20 years, and she does not believe that the industry has ever said that this is a good time to look at changing the tax structure - except in 1981, when it was a good time to repeal separate accounting. Number 2160 REPRESENTATIVE PORTER said he was a bit confused; he was under the impression that the committee had heard previous testimony that leasehold property was not considered property under the apportionment method. Ms. Vogt said she thinks that it is. If one drills a well, that is certainly property. She does not think buying a lease is property under modified apportionment. MR. WILLIAMS said leases are in the property factor before there is production from them. It was his recollection that leased property is capitalized at eight times the annual lease rental. For instance if a company had a tract that was bought in the 1969 lease sale for $50 million, it is not reflected as $50 million dollars worth of property in that company's property factor. It would only be eight times the annual rental of a dollar an acre times the number of acres. In relation to total worldwide property in the hundreds of millions, or thousands of millions, something in the hundreds of thousands or tens of thousands is a pretty thin slice, but it is not zero. CHAIRMAN WHITAKER asked Ms. Vogt if she had a copy of her testimony. She said she did not, but offered a copy of her outline, explaining that she had not followed it very closely. REPRESENTATIVE CROFT confirmed that Mr. Dickinson had given a good description of how the value of a leasehold is calculated. Number 2006 DAN E. DICKINSON, Director, Oil and Gas Audit Division, Department of Revenue, said he did not have prepared testimony, but was available to answer questions. CHAIRMAN WHITAKER invited Mr. Dickinson to comment regarding the testimony he had heard. MR. DICKINSON commented on a question Representative Porter had raised. Mr. Dickinson said there are many figures that have been generated by the Oil and Gas Audit Division that deal with separate accounting versus modified apportionment. An important thing suggested by Representative Porter is that the severance tax, or production tax, is deductible for purposes of the income tax. So when one says that here is what the company or the industry would have paid for income tax, it is very important to know whether that includes the changes that were made in 1982 and the changes that were made in 1989 or the production tax, because they, in turn, will affect the income tax. When making comparisons, he cautioned, one needs to make sure that it is an apples-to-apples comparison. CHAIRMAN WHITAKER asked Mr. Dickinson whether he could provide that apples-to-apples comparison historically. MR. DICKINSON said the Oil and Gas Audit Division is putting that together. As Tom Williams said, there was a very thorough analysis done some years ago. Each oil field is a tax partnership and files returns showing the expenses for that field. The division has those numbers through 1997, and just received those for 1998. The division would have to estimate the intervening years. Because there is a two- or three-year lag, estimates have gone out for the intervening years, which is why there are so many numbers out there. Number 1882 CHAIRMAN WHITAKER asked to what year the division has completed the audits and can provide accurate data. MR. DICKINSON said through 1997, and that the division should be able to provide good data through 1998 fairly soon. CHAIRMAN WHITAKER said it would be helpful and appropriate if the division could provide the committee with the data through 1997. He said it probably would not be necessary to wait for the 1998 figures because it should be possible to see the trend at that point [by the end of 1997]. MR. DICKINSON said the division could put that together. However, he cautioned, for the most recent four or five years, the division have to asterisk the actual figures because there are still ongoing disputes with taxpayers. He suggested showing the disputed figures to the taxpayers and letting them comment so that legislators could get a sense of the range between what the state thinks ought to have been and what the taxpayers think should have been. CHAIRMAN WHITAKER said that would be helpful. [MR. DICKINSON and CHAIRMAN WHITAKER discussed when that information would be available to the committee, and settled on a deadline of four to six weeks hence.] REPRESENTATIVE PORTER added that he would like to see what the figures would look like with or without the severance/production tax increase that occurred in 1982. MR. DICKINSON said that would be relatively easy to do, and confirmed that he was going to provide not just a comparison of income under modified apportionment and separate accounting; it would also show the effect of the increased severance/production in 1982 and to the ELF in 1989. Number 1654 REPRESENTATIVE BRICE asked if severance tax is deductible from the income tax. He also asked whether it is a one-to-one deduction. MR. DICKINSON explained that under modified apportionment, the production tax paid in Alaska is deducted when one calculates the worldwide expenses of the corporation. As Alaska's production tax increased, income taxes went down, but it was not by a factor of one to one. REPRESENTATIVE BRICE articulated a quandary. The committee had heard that production tax was increased to offset the loss when the state changed from separate accounting to modified apportionment. But if those taxes are deductible from the corporate income tax, is the state still receiving the true value? Is there a gap there, or is the result revenue-neutral? MR. DICKINSON noted that royalties, oil and gas properties tax, and the production tax all are deductible for purposes of income tax. In fact, he said, if the state take is lumped together, that is the largest single expense leading to the calculation of the income on which the state bases the income tax. One definitely affects the other, and it is logical that if payments to the state are on the order of one third, that could be expected to be reflected in the profitability or the income of (inaud.) Representative Dyson asked Mr. Dickinson of he could give the committee his view of how close the state is to getting the 30 percent profits from the field that was talked about in the late 1970s-early 1980s. MR. DICKINSON said that material is available and the division could certainly put something together for the committee. REPRESENTATIVE DYSON explained that what would be valuable would be to see today's percentage in relation to whatever people were talking about in 1980. MR. DICKINSON said the division can find the 1980 analyses and try to make comparable ones within 4-6 weeks. Number 1315 MR. DICKINSON then pointed out that discussion had centered on modified apportionment as it exists versus separate accounting as proposed in HB 307. The universe isn't necessarily defined with only those two poles. In fact, the state changed modified apportionment, and there is nothing particularly magic about having three factors weighted together. In fact, most states weight the factors separately. In the Lower 48, sales are usually weighted higher than the other factors. If one takes a thorough look at the whole issue, the whole fiscal system and the whole income tax issue, it shouldn't be just in terms of the aforementioned two options, but should look at a number of ways that modified apportionment might be made better. CHAIRMAN WHITAKER observed that Mr. Dickinson had just opened an entirely new can of worms. He asked Mr. Dickinson if he would propose that the Administration make recommendations to do as Mr. Dickinson had just suggested. MR. DICKINSON replied that it was his personal suggestion, but that the Administration has not made a recommendation. Number 1182 REPRESENTATIVE CROFT offered closing comments regarding what had been covered thus far. He noted that an "interesting switch" had occurred when Representative Porter asked Mr. Dickinson about the (unaud.). He said he thought it was appropriate to talk about what the state lost and what it then gained from the increase in the production tax in 1982. But, he continued, there is a tendency to dwell on changes that were made seven years later. He said he does not think it is appropriate to offset everything the state has done since [1982] to try to prove that the state did not lose anything from separate accounting. The numbers available now from Mr. Dickinson show about a $4.6 billion loss and that the changes to the oil production or severance tax brought in about 2.8 [billion dollars], for a net loss to date of about $1.8 billion or a little more. Representative Croft said he would love to see solid numbers. REPRESENTATIVE CROFT recalled that Judy Brady in her testimony had suggested that there may be a problem with separate accounting in that it penalizes the highly profitable stage of an operation, and she called that the early part. He said he is more worried, however, about a theoretical oil and gas company that has service stations and refining but very little production, and that wants to use Alaska for its production. If such a company comes up to Alaska and spends a lot of money to drill and explore, under separate accounting Alaska would not charge [that company] a cent until it started to make money; in contrast, under modified apportionment, Alaska gets a portion of [the company's] Illinois service stations and California refinery, even while [the company] is losing money up here. REPRESENTATIVE CROFT said it seems that modified apportionment discourages exploration because it taxes a company when it is not making any money. Ms. Brady's point was that when a company starts to make a lot of money, in the middle of the drilling of the field, separate accounting demands its 9.4 percent of that; Representative Croft said he thinks that is appropriate. He said he is more worried about that early-early part, when separate accounting asks a relevant question: Are you making any money? REPRESENTATIVE GREEN emphasized that he thinks separate accounting asks the relevant question. Even if the state does have [another big oil strike], it still is asking the wrong question. When a company is not making much money in this state, and when in a few years the state loses some money under separate accounting, he thinks that is fair. Number 0898 REPRESENTATIVE CROFT referred to Deborah Vogt's comment that there never seems to be a good time to change the tax rate. He said he thinks it is part of the legislature's job to take a look at these things periodically. The impact of "don't change the tax rate" seems to him to be a scary idea of abrogating the legislature's ability to look at these things. He said he believes the legislature should periodically review the tax rate to make sure that it is fair, and that the state is getting its fair share. REPRESENTATIVE CROFT then spoke to Representative Porter's question about what system other states use. He said that to the best of his knowledge, Oklahoma and Louisiana use separate accounting, Texas does not have a corporate income tax, and California essentially uses both. More important, the United States government uses separate accounting to figure out how much is owed for United States income taxes. It is basically, in the United States, the preferred method for taxing oil and gas income for the reason that the apportionment factor does not accurately reflect the profit of the oil and gas industry. When one puts together sales, property and payroll, it just does not give an accurate image of what a producing state is making for the company. REPRESENTATIVE DYSON said he was intrigued by Representative Croft's analysis that separate accounting makes it less risky and more attractive for people wanting to explore and develop. He asked to hear the other side's perspective on that. TAPE 00-15, SIDE A MS. BRADY expressed appreciation for the opportunity to present another perspective. STEVE MAHONEY, Associate General Tax Officer, ARCO, said that in practicing tax law for more than 20 years, he has filed tax returns in just about every state in this country, both for oil and gas companies and other companies. He referred to Representative Dyson's question regarding noncompetitiveness. He pointed out that AOGA is made up of 17 very diverse companies. Those members have different operations domestically and foreign, different operations in Alaska and in other states. Most important, some of those within the 17 companies do not have production like some of the larger companies, yet all 17 agree that they would like the current modified apportionment to be retained. AOGA has not asked not to increase taxes, he said. Not one of AOGA members has said that. "What AOGA has said is that this type of income taxation is complicated, convoluted, misunderstood, and creates all sorts of uncertainties for the future," he added. Number 0176 MR. MAHONEY addressed noncompetitiveness. He said if a company does business in two states, and if, say, the activity is 50-50 in two states and the company earns $1, it has $1 of income. Under modified apportionment, presumably, that company would get 50 cents' worth of income in one state and 50 cents' worth of income in the other state; each state taxes based on the rate that they want to apply. If, however, the company is doing all of its business in Washington State and decides to become a producer in Alaska, in the first several years of that activity the company truly does not have any Alaska revenues. It does have activity in the state. Well, if it has activity in the state, the way modified apportionment or apportionment works, activity goes away from the State of Washington. Therefore, the company's tax in the State of Washington goes down, even though it does pay some tax in Alaska. MR. MAHONEY continued with his example. He asked: Does the company's net tax liability go up? Most likely not, he answered, except for the difference in rates [between the two states]. The activity is weighted between the two. So it is not anti- competitive. The company does not pay more taxes than it would have otherwise. In the State of Washington (just as a hypothetical example), the legislature is determined that its best interest is served by having a company that is multi- dimensional, is multi-state, can operate and undertake activities in other states, and is healthy and vibrant; Washington taxes a portion of all of the income of all of the income of that corporation. Washington is willing to let go of a piece of the pie because it knows the pie grows as the company develops in other places, and Washington gets a lesser portion of a bigger pie. Number 0315 REPRESENTATIVE DYSON referred to the more narrow question of a company considering investing, exploring and developing in Alaska, and the fact that under separate accounting, it would incur no tax liability until it started producing. Representative Dyson said he thought Representative Croft was saying that it is "an incentive for new guys to bring their bag of marbles and come and play." He said he appreciated the point that Mr. Mahoney raised, that modified apportionment may decrease an existing tax liability in other places where the company is operating; however, he asked Mr. Mahoney if he could speak to or refute Representative Croft's position that separate accounting appears to be attractive because a company incurs no liabilities until it starts making money. MR. MAHONEY replied that zero is better than some number as far as tax liability is concerned. The question is the overall. Modified apportionment is a very simple calculation. A company takes its federal income tax, makes a few adjustments, then multiplies it by a percentage of activity in the state. Everybody understands it. Separate accounting does not provide that. REPRESENTATIVE PORTER referred to testimony that Oklahoma, Louisiana and California - all producing states - use separate accounting. He asked: If apportionment is much more beneficial to the industry, why do these states not use it? Number 0520 MR. MAHONEY explained that separate accounting is defined in different ways in different states. There are different formulas, different methods, and so on. For example, Louisiana has separate accounting but allows for percentage depletion, which is the largest deduction the oil industry has ever had on an income tax return. That depletion allowance was part of a negotiation between the state and the oil industry as to what would make the industry work in the state, what would promote development, and what would get the state its fair share. Mississippi has separate accounting. For those two state, it works. MR. MAHONEY continued. He said oil and gas are really no different from timber, mining, or any other natural resource industry. All of the other states in the Union that apply income taxes -including Texas, through its franchise tax, which is a franchise tax based on income - have determined that apportionment is the methodology that works best in the long term to get the largest pie and to get the state's piece. The federal government does not use separate accounting. The federal government taxes all of the income in the whole world as if it were U.S. income, and then applies credits for other taxes paid. [HB 307 was held over.] ADJOURNMENT Number 0670 There being no further business before the committee, the House Special Committee on Oil and Gas meeting was adjourned at 11:43 a.m.