"Avoiding Potential Pitfalls when Automating Sales and Use Tax" by Michael Miller, CPA

"Low Oil and Gas Prices and the Impact on Taxing Jurisdictions" by Daron Fredrickson


Low Oil & Gas Prices and the Impact on Taxing Jurisdictions

Prepared by: Daron Fredrickson, Partner - Merit Advisors, LLC 

 (LOGA Industry Report - Summer 2016)

We in the industry know the impact the current low oil & gas pricing has on our companies. What is typically considered less is the impact to taxing jurisdictions.   While the first thought that may come to your mind is “that is not my concern”, it really is a concern to us all.

States, counties, cities, school districts, and special districts (fire, junior college, etc.) rely heavily on some mix of ad valorem taxes, sales & use taxes, and severance taxes as major source of revenue. All of these tax types are subject, like our companies and clients, to the volatility of the oil and gas market. 

Since late summer 2014, as prices have dropped, the concern from the taxing jurisdictions has risen. For tax year 2015, the jurisdictions received some benefit from several months of higher prices in 2014. Those prices kept the prior year average higher than current pricing.  This difference helped, particularly in states with valuation scenarios solely tied to the prior year.  Also, ongoing projects were being completed, which held the activity in the market higher for some time.

Tax year 2016 will be more difficult for the jurisdictions as neither of the aforementioned scenarios exist any longer.   As the concern grows and available funds drop, the jurisdictions will continue to feel more pressure to protect tax bases.  At the same time, taxpayers will be under pressure to limit tax liability as much as legally and ethically possible.  That conflict will define tax year 2016 for those of us who deal with state and local tax types.

As you think of the indirect taxes or state and local taxes the industry pays, it is important to think of just what each represents.

Severance Tax

Defined - A tax imposed on oil, gas, natural gas liquids extracted (severed) or processed within a State. May also be referred to a Gross Production Tax

Whether the severance tax is based on volume produced or the value of the produced products, significant price fluctuations impact the amount of tax collected. Since rates are set in statute or possibly the state constitution, loss in value or production can’t be offset by a rate increase.

Many times, when the severance tax collections drop, the first place the jurisdictions look to raise more revenue is the lessening or elimination of incentive rates or exemptions. Incentives and exemptions that successfully brought new activity and revenue to the state can suddenly be referred to as corporate welfare and demonized. 

Another phenomenon during low price periods is increased audit activity. Many jurisdictions see audits as a possible revenue generation tool when monthly collections are lower.  While this seems like a good idea on the surface, many audits generate refunds for oil & gas operators.  While that is great for the company, it obviously is not the intent for the jurisdiction.

Sales Tax

Defined - A tax on receipts from sales, usually added to the selling price by the seller Use Tax

Defined - A state tax on goods purchased in another state for use in the taxing state, to make up for (in lieu) local sales tax.

One of the many changes during an extreme downturn in prices for oil & gas is reduced spending. Reduced spending in jurisdictions creates less sales & use tax revenue.  Local jurisdictions typically feel the drop in sales & use tax revenue faster than the state.  The local jurisdictions rely very heavily on sales & use tax as well as ad valorem tax revenue.  They typically do not have nearly as many sources of tax revenue as the state has available.

Like with the severance tax, there tends to be an increase of audit activity when sales tax collections are reduced over time. The risk to the jurisdiction is the same as well.  An audit can result in refunds rather than additional revenue.  Audits for sales & use tax tend to take a long time.  They can carry on for months or years; the immediate relief for the jurisdictions is not there in this case.

Ad Valorem Tax

Defined - Ad Valorem is Latin for “according to value” and is tax imposed on the owner of either real or personal property based on the assessed value of the property

Another significant casualty of a downturn in oil & gas pricing is the fair market value of assets. Since the basis of the ad valorem tax is fair market value, those changes impact the jurisdictions directly through value loss and potential tax rate increases.

It is very important to note that the majority of the ad valorem taxes collected in a county are for local services and schools. Though valuation reductions are necessary by the very nature of the basis in low price environments, many jurisdictions are placed in a difficult position.  They either have to raise rates to offset losses or reduce services.

Tax Rates – While values being adjusted downward should be undisputed in the current pricing environment, increases in tax rates to offset losses can have a damaging impact on tax liability.

There are typically two components to the ad valorem tax rate, Interest & Sinking (I&S) or bonds and Maintenance & Operation (M&O) or typical costs. The I&S rate is tied directly to the tax roll.  The bonds must be serviced, regardless of the rate it takes.  The M&O rate can be handled with budgeting.

Extreme losses in the tax base, especially if there is a large bonded indebtedness, can drive the rate high enough to erode all gains made in value reduction.

This “tax rate creep” was evident in 2015, but as previously stated, 2016 will have another significant drop in fair market value. This additional drop will impact tax rate.

It is a significant concern as the next slide will show for a few jurisdictions in Texas.

"Oklahoma’s Sales Tax Audit Selection Process is Changing" by Michael Miller, CPA

CPA Focus Magazine  - May/June 2015

By Michael Miller, CPA

Merit Advisors, LLC
114 W. Main St.
PO Box 330
Gainesville, TX 76241

Phone: 940.665.6452
Fax: 940.612.3921
Email: info@meritadvisor.com

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