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Vol. 15, No. 36 Week of September 05, 2010
Providing coverage of Alaska and northern Canada's oil and gas industry

No production, no tax

BP argues state claims for back taxes on ‘lost’ Slope oil are unconstitutional

Wesley Loy

From Petroleum News

BP is raising a new legal argument to try to limit the extent of damages the state can collect for the 2006 pipeline spills in Alaska’s giant Prudhoe Bay oil field.

The state wants back taxes on oil production that was “lost” due to the spills and subsequent shut-ins to replace corroded pipelines. The state contends BP was negligent in its pipeline upkeep, forcing the replacements on an emergency basis.

But the state’s demand for back taxes is unconstitutional, BP’s lawyers argue in a motion filed Aug. 17 in Superior Court in Anchorage.

“As a matter of law, the State may not recover these allegedly ‘lost’ tax revenues because, under Article IX of the Alaska Constitution, only the legislature may define and impose a state tax, and the legislature has imposed no obligation to pay taxes on oil that was not produced or income that was not earned,” the BP court papers say.

Billion-dollar battle

On March 2, 2006, a BP worker driving by on a gravel road smelled oil that had leaked from a major pipeline on the western side of the Prudhoe Bay field. The leaked crude, escaping over days through a small hole and obscured under snow, ultimately proved to be the largest oil spill ever on the North Slope at 212,252 gallons.

It wasn’t until some months later, on Aug. 6, 2006, when a similar pipeline sprang a leak on the eastern side of the field, that the true extent of corrosion in Prudhoe’s key oil transit lines became clear. The transit lines feed processed, sales-grade crude into the 800-mile trans-Alaska pipeline.

BP’s local subsidiary, BP Exploration (Alaska) Inc., in November 2007 pleaded guilty to a misdemeanor violation of the federal Clean Water Act and was sentenced to three years on probation and ordered to pay $20 million in penalties.

The plea wrapped up criminal prosecution of the company for both the federal and state governments.

On March 31, 2009, each government filed a civil suit against BP. Both cases are still pending.

The state suit seeks an array of damages including not only back taxes but royalties on an estimated production shortfall of at least 35 million barrels of crude oil and natural gas liquids. The state alleges the shortfall occurred from 2006 through 2008 in the Prudhoe Bay and Milne Point units.

A lawyer for the state has said these damages could amount to $1 billion or more.

But BP is mounting a vigorous defense and has argued that the production wasn’t lost, but merely delayed. To pay back taxes now could result in double taxation later when the oil is ultimately produced, the company’s lawyers argue.

Company lawyers already have had some success in whittling away at the state’s nine-count lawsuit.

On June 11, Superior Court Judge Peter Michalski partially dismissed one count, in which the state sought to pursue the tax and royalty damages as a tort claim. The state asked the judge to reconsider, but he stood by his original ruling.

Now BP’s lawyers are attacking other counts in the lawsuit that seek to recoup what the state describes as lost revenue.

Production, income taxes disputed

In their Aug. 17 motion, BP lawyers ask the judge to dismiss the state’s remaining tax claims. This includes production, or severance, tax as well as corporate income tax.

In short, BP argues that unless oil is actually produced, it can’t be taxed.

To do so would violate the Alaska Constitution, which holds that “only the legislature may define a taxable event and impose a state tax,” the BP court papers say.

The Legislature has not imposed any obligation to pay taxes on oil that was not produced or on income that was not earned, the motion says.

BP’s lawyers argue that “an award of ‘lost’ tax revenues based on unproduced oil or unearned income would amount to a new tax that existing tax law does not impose. No legal precedent supports the State’s claims.”

Unrealized production is not taxable even if negligence was involved, the lawyers argue.

The effort to collect back taxes is as “farfetched,” they contend, as the state suing a citizen whose negligence gets her fired, resulting in her earning less money and paying less income tax than the state had expected to receive from her.

In fact, had BP paid taxes for 2006 through 2008 including the extra sums the state claims as lost, the Alaska tax code would require the state to make a refund, the BP lawyers argue.

Further, they contend the Legislature can’t retroactively impose a tax on the production shortfall, and the state “likewise may not collect the equivalent of such a tax by labeling it ‘damages.’”

The BP lawyers also argue that non-constitutional reasons exist for why the state can’t collect back taxes. Chiefly, they say the contracts between BP and the state — the oil and gas leases and unit agreements — lack any provision requiring payment of production and income taxes.

At press time, the state had not yet answered BP’s motion.

The case is scheduled to go to trial in September 2011.

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