United States: Tax Policy Update 18 Mar 2014

The Camp Counselor: Energy. In this week's Camp Counselor, we take a closer look at how provisions of the House Ways & Means chairman's tax reform discussion draft could impact the energy sector with insights from McGuireWoods's Russ Sullivan and Dan Chung.

If you thought that Chairman Camp would spare the energy sector because one of its champions, Rep. Kevin Brady (R-TX), is second-in-command on the Ways & Means Committee, then you bet on a nearly dry hole. Camp's tax reform drilled the oil and natural gas industry, refineries, coal and renewables with equal force.

Only electric utilities, who never embraced bonus depreciation and full expensing, came out saying "That wasn't so bad." Rep. Brady probably should be credited with saving expensing of intangible drilling costs, and many of the independents who fought for its preservation also escaped the narrowing of master limited partnerships and avoided the 10-percent surtax applicable to passthroughs under Camp's plan.

Energy firms might embrace the reduced top rate for corporate taxpayers, which would be phased down over five years to a flat 25 percent rate after Jan. 1, 2019, and the repeal of the Alternative Minimum Tax, but Camp's plan would also jettison accelerated depreciation -- a significant consideration in major oil and gas investments. The Joint Committee on Taxation has estimated that the repeal would increase revenues by $269.5 billion over the next 10 years -- revenue that would largely flow from higher taxes paid by energy and domestic manufacturing firms. The repeal of accelerated depreciation is the number one largest revenue raiser out of all of Camp's domestic business tax proposals (see "Top Ten" list below).

The energy industry is also wary of Camp's proposal to repeal the Last-In, First-Out (LIFO) accounting method, effective as of Dec. 31, 2014. Under the LIFO method, it is assumed that the last item entered into the inventory is the first item sold. Accordingly, the taxpayer's cost of goods sold is valued at the most recent cost, which generally brings about a lower income tax liability. LIFO repeal ranks fifth on the revenue raisers list, bringing in an additional $79.1 billion over ten years.

Oil and gas companies also fear the repeal of the percentage depletion deduction. Under percentage depletion, the deduction for the recovery of one's capital investment is a fixed percentage of the gross income from the sale of the oil or gas. While the percentage may vary, percentage depletion is generally set at a rate of 15 percent of the gross income based on your average daily production of crude oil or natural gas. Percentage depletion is particularly beneficial because the cumulative depletion deductions may be greater than the capital amount spent by the taxpayer to acquire the property. Camp's tax reform would strike sections 613 and 613A, which address percentage depletion, effective December 31, 2014. The repeal would only produce $5.3 billion in additional revenue over ten years--not enough to put it on the "Top Ten" revenue raisers list.

The oil and gas companies can momentarily breathe a sigh of relief because the intangible drilling cost (IDC) remains intact. These are the costs incurred to develop an oil or gas well that is not a part of the final operating well, such as survey work, ground clearing, drainage, wages, fuel, and repairs. The IDC has been a part of the Tax Code for over one hundred years now. It was initially meant to encourage oil and gas development despite the risk for not being able to produce. However, some argue that with modern technology, these risks have been reduced and IDC is no longer needed to catalyze investment in oil and gas development.

Other provisions specifically target the renewable energy industry, such as the proposal to repeal two key business credits -- the Production Tax Credit (PTC) and the Investment Tax Credit (ITC). Many of the Camp draft's provisions affecting the energy industry are slight variations of those found in former Senate Finance Chairman Max Baucus's energy tax reform discussion draft released in December of last year. 

Baucus similarly proposed repealing the PTC and ITC in his December 2013 discussion draft, but he proposed replacing them with two new energy tax credits aimed at spurring clean energy production. Here, the Camp draft proposes no such substitution.

The PTC generally provides that a taxpayer may claim a credit for the production of electricity from qualified energy resources. The credit is based on 1.5 cents per kilowatt-hour, adjusted for inflation, and available during a 10-year period. Camp's tax reform proposes to phase down this credit by reverting to a 1.5 cent per-kilowatt-hour rate without adjustment for inflation. Thereafter, the entire tax credit would be repealed, effective for electricity and refined coal produced and sold after Jan. 1, 2024.

Under Camp's draft, the ITC credit available under Section 48 of the Tax Code would no longer apply to any energy property placed in service after Dec. 31, 2016. Additionally, the energy credits available under Sections 48A, 48B, and 48C, addressing qualifying advanced coal project credits, qualifying gasification project credit, and qualifying advanced energy project credit would be repealed, effective as of Dec. 31, 2014.

Top Ten Revenue Raisers in the Camp Draft (in billions over 10 years)

1. Accelerated depreciation repeal ($269.5)
2. Amortization of research & experimental expenditures ($192.6)
3. Amortization of certain advertising expenses ($169)
4. Phaseout and repeal of deduction for domestic production ($115.8)
5. Excise tax on large banks ($86.4)
6. LIFO repeal ($79.1)
7. Net operating loss deduction ($70.5)
8. Repeal of like-kind exchanges ($40.9)
9. Computation of life insurance tax reserves ($24.5)
10. Limitation on use of cash method of accounting ($23.6)