Who in the U.S. oil and gas industry can provide a theoretical defense of, say, percentage depletion in terms suitable for television news? Who can explain why a requirement to capitalize geological and geophysical costs hurts producers? Who can describe the perverse economic effects of the alternative minimum tax (AMT)?
Anyone concerned about the industry's tax treatment should be brushing up on accounting concepts that answer questions like these. Congress has created a bogeyman known as corporate welfare. Anything can happen.
WHAT'S WELFARE?
To be sure, corporate welfare exists and ought to be eliminated. Taxpayers spend billions of dollars each year to pamper or protect favored businesses, and Congress should quit making them do so. But terms like "corporate welfare" have a way of embracing too much.
Decades ago, for example, Congress came to view percentage depletion as a gift by taxpayers to oil companies. Now, therefore, it doesn't matter that taxpayers in other extractive industries use the mechanism to recover investments in wasting assets. In the oil and gas industry, only independent producers can use percentage depletion, and AMT and various limits have seriously reduced its value.
Percentage depletion developed as a way to prevent taxation of invested capital. Because it reduced the tax liabilities of profitable companies, however, it became a legislative bogeyman. Similar processes have reduced current-year deductibility of intangible drilling costs (IDCs) and broadened AMT's maw. The pattern is for tax mechanisms created for sound reasons to evolve into dragons that lawmakers slay for votes. The result is a complex mish-mash that hurts U.S. ventures needing to compete for capital with projects treated better elsewhere.
In a statement to a Senate committee earlier this year, Marathon Oil Co. Pres. Victor G. Beghini described how the deductible value of capital costs has eroded for long-lived upstream investments. "Exploration finding costs for successful prospects are presently recovered through depletion over the producing life of the property," he noted. "In that period, only about one half of the original cost is recovered on a net present value basis.
"Recent technological improvements provide improved data upon which development decisions are made. However, the current tax system penalizes the use of enhanced techniques. The U.S. tax system allows an accelerated recovery of IDC. However, companies that are AMT taxpayers are not allowed this treatment; instead, they must recover the cost over a 60 month amortization period. The regular U.S. tax treatment of tangible costs is also worsened by the AMT."
LIMITING DEDUCTIONS
Beghini compared the U.S. and U.K. tax systems by showing how each would affect the value of a single upstream project. On a net present value basis, the project was worth 30% more if carried out in the U.K. by a U.K. company than if it were done in the U.S. by a U.S. company. Why? Because the U.K. doesn't limit deductibility of things like geological and geophysical costs and IDCs, as does the U.S., and because it applies no secondary tier of tax liability such as AMT.
Is that corporate welfare? Far from it. As Beghini says, "The U.K. tax system provides no specific oil and gas incentives but, more importantly, provides no disincentives." Politicians in lather over corporate welfare may have trouble with the distinction. Companies must help them understand that corporate welfare and the absence of disincentives are not the same things.
Copyright 1995 Oil & Gas Journal. All Rights Reserved.