Unpacking House Bill 111
Once Gov. Bill Walker signs House Bill 111 into law, cashable tax credits to oil and gas companies working in Alaska will be a thing of the past.
But the bill that became contentious in legislative debates — despite House Democrats, Senate Republicans and Walker agreeing on the major aforementioned policy change — has many other subtle but substantive provisions.
For starters, it does not end all tax credits, or even all of them related to oil and gas projects.
Capital expenditure and exploration credits applicable to work in the “Middle Earth” region of the state, which is pretty much anywhere other than Cook Inlet or the North Slope, continue until they expire on their own.
The same can be said of credits for capital projects at the state’s three oil refineries or for entities looking to build natural gas storage, such as the Interior Gas Utility in the Fairbanks area.
“We’re not changing the refinery credit; we’re not changing the LNG storage credit. We’re not changing a couple of these credits that people don’t think so much about that have these built in sunsets in 2020 or 2021,” Tax Division Director Ken Alper said in an interview.
Companies earning certificates for those credits will just not get cash for them. The Middle Earth capital expenditure credit is applicable to production tax, while the small exploration credit for the region is applicable to corporate income tax, according to Alper.
Interior-area Alaska Native regional corporations Doyon Ltd. and Ahtna Inc. have been the primary Middle Earth explorers, drilling for oil and natural gas to serve as a local heating fuel supply.
Also, Cook Inlet operators can still earn transferrable production tax-applicable certificates that have not yet phased out after the passage of House Bill 247 last year, which eventually ends the credit program in that basin. The state just won’t refund them for work done after July 1.
The Oil and Gas Tax Credit Fund is repealed Jan. 1, 2022, or sooner if the outstanding credit certificates are paid off by the state before then. The Legislature appropriated $57 million to the fund to pay down the state’s outstanding credit liability, which was expected to be nearly $1 billion by the end of the 2018 fiscal year before HB 111 passed. The Department of Revenue estimates repealing the cashable credits will save the state roughly $150 million per year over the long-term.
There are also a few fine points surrounding the application of tax deductions and the “ring fencing” provisions that were sticking points in negotiations between House Democrats and Senate Republicans that seemed to confuse even some legislators involved in the HB 111 negotiations.
Alper suggested the confusion likely stemmed from the multiple versions of the bill that were drafted during negotiations.
The ring fencing provision prevents a company in a loss position from applying its 35 percent annual carry forward loss deduction to its production tax obligation until there is production from the project that caused the loss.
Ring fencing was something the Democrat-led House Majority fought hard for to prevent a company from purchasing a non-producing project and using the deductions tied to it against their existing production taxes. It’s a scenario industry representatives dismissed as theoretical.
However, ring fencing only applies to companies in a loss position; a producer can deduct 35 percent of its expenses from a development project against its current production tax obligation if it is profitable.
The big win for Republicans and the Senate Majority was fending off the production tax increases in the version of HB 111 passed by the House.
Additionally, HB 111 limits on the time a company can hold a deduction at full value, which was a win for Democrats and is intended to spur quicker development and ultimately production from a company looking to recover its expenses through tax deductions.
A company without North Slope production can hold its deduction at full value for up to 10 years, after which the value of the carry forward deduction is reduced by 10 percent per year.
While legislators have implied the annual deduction value reduction is 10 percent of the original amount per year, Alper said he interprets the bill language, which states the value decreases “by one-tenth of the value of the carried-forward annual loss in the preceding year,” to mean the loss deduction would be worth 90 percent of its original value in year 11; 81 percent of its original value in year 12, 73 percent in year 13 and so forth.
It’s a point on which he said he would have to confer with Department of Law officials.
For producing companies in a loss position, the deductions can only be held at full value for seven years before the “downlift” kicks in.
Senate Resources chair Sen. Cathy Giessel, R-Anchorage, said the deduction downlift was one of the last pieces of the bill to be settled.
“It’s a tight timeframe to have your full expenses deductible,” Giessel said.
Alper said the clock starts the first year a company reports an annual loss, not when a lease is acquired, as some indicated initially.
The July 1, 2017, retroactive effective date for the bill passed very late July 15 also caused some heartburn in the state Tax Division, at least when it was initially proposed by Senate leaders in a press conference a couple weeks ago, Alper said.
That’s because while the State of Alaska works on a fiscal year starting each July 1, taxes are collected on the calendar year, and the immediate worry among auditors was that ending the cashable credit certificates July 1 would require two six-month tax returns for 2017.
After a detailed reading of the bill, it was determined that it directs a company’s reported losses be bifurcated, meaning a company that posts losses to generate a $10 million net operating loss credit in 2017 will receive a $5 million cashable certificate for the first half of the year and a $5 million certificate that could be sold to another production taxpayer or held to offset future taxes but not cashed out, according to Alper.
Finally, the credits are settled but oil taxes are not. The bill establishes a legislative oil and gas tax working group that — with the help of the three oil and gas consultants the Legislature now has on retainer — will examine the state’s fiscal regime for the industry and make recommendations in the 2018 regular session.
Elwood Brehmer can be reached at [email protected].