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Energy Law Exchange

September 13, 2017

Tax Reform And Taxing Big Oil

Senator Robert Menendez, with twenty-one of his Democratic colleagues as co-sponsors, has introduced legislation that repeals the energy tax incentives for the country’s five largest oil companies. In a statement, Senator Menendez said, “Our nation’s tax reform debate should be focused on supporting the middle class rather than lining the pockets of oil giants…the last thing we should be doing is giving handouts to highly profitable corporate polluters.”

Menendez has introduced this bill in three prior sessions of Congress. Most observers view the bill as a political and policy statement rather than a bill that can pass the Senate, however, the Close Big Oil Tax Loopholes Act of 2017 does reflect the highly partisan environment on Capitol Hill and the difficulties for achieving comprehensive tax reform.

As early as this fall, the debate over tax reform will intensify. In the name of deficit reduction,  members of the tax writing committees of Congress will be looking for additional revenues to pay for new tax cuts and keep the legislation revenue neutral. It is estimated that the passage of Senator Menendez’s bill will save $22 billion in revenues.

The legislation eliminates tax breaks for five energy companies that have been fundamental to domestic oil and gas production. Below is summary of the major provisions of this legislation.

  • This bill modifies foreign tax credit rules applicable to major integrated oil companies that are dual-capacity taxpayers. S. taxpayers are taxed on their income worldwide, but are entitled to a dollar-for-dollar tax credit for any income taxes paid to a foreign government. The bill removes this provision for the five targeted companies.  This legislation limits the deduction for income attributable to the production of oil, natural gas, or primary products thereof.  In 2004, Congress enacted Section 199, the domestic manufacturing tax deduction. In 2008, Congress froze the Section 199 deduction at 6% for all oil and gas activity. The bill eliminates the Section 199 deduction for five companies. The legislation limits the deduction for intangible drilling and development costs, denying the five major oil companies the option of expensing Intangible Drilling Costs (IDCs) and requiring such costs be capitalized. IDCs are expenditures such as wages, fuel, repairs, hauling, and supplies necessary for the drilling of oil wells. Currently, integrated oil companies can expense 70% of the cost of IDCs. The bill requires the five companies to capitalize all of its IDC costs. The legislation limits the percentage depletion allowance for oil and gas wells.   Firms that extract oil and gas are permitted a deduction to recover their capital investment under one of two methods. Cost depletion allows for the recovery of the actual capital investment-the costs of discovering, purchasing, and developing the well-over the period the well produces income. Under this method, the taxpayer's total deductions cannot exceed its original investment.  Percentage depletion allows the cost recovery to be computed using a percentage of the revenue from the sale of the oil or gas. Under this method, total deductions could (and often do) exceed the taxpayer's capital investment. The bill repeals percentage depletion for the five major companies.
  • This bill limits the deduction for tertiary injectants. Tertiary injectants are used in enhanced oil recovery to drive more oil from an existing well. Currently, oil companies are allowed to deduct the cost of tertiary injectants rather than capitalizing their costs and recovering them over time.  The bill requires the five companies to capitalize the cost of tertiary injectants it uses during the year and recover those costs over time.
  • Finally, the legislation repeals the Outer Continental Shelf deep water and deep gas royalty relief. Targeting the five companies, the bill repeals Sections 344 and 345 of the Energy Policy Act of 2005. Section 344 extended existing deep gas incentives and Section 345 provided additional mandatory royalty relief for certain deep water oil and gas production.

New technologies and energy tax incentives have made America energy independent for the first time in its history, and contributed to the country’s foreign policy leverage and leadership.

Singling out five energy companies is not sound or consistent tax policy, and the negative impact on the energy industry could be significant.