One of the issues that raises concern with a net production tax is litigation — the possibility that disputes between the State of Alaska and oil companies will generate lengthy legal disputes and end in settlements where the state takes cents on the dollar.
Both Alaska’s existing petroleum profits tax, PPT, and Gov. Sarah Palin’s proposed changes to it, Alaska’s Clear and Equitable Share, ACES, are taxes based on the net. PPT, enacted in 2006, replaced a system that based production taxes on gross revenues.
Litigation which began as oil first flowed down the trans-Alaska oil pipeline in 1977 took almost 20 years to settle.
Jon Iversen, director of the Tax Division in the Alaska Department of Revenue, told the Senate Judiciary Committee Nov. 1 that in the late 1970s and early 1980s the state was entering “an entirely new tax and royalty territory,” without “a substantial body of case law and regulations.”
There were issues that had never been dealt with before — and the state, in the royalty litigation, was not acting as sovereign, but as one of the parties to a contract.
Perhaps the most important thing that was lacking was “objective measure of value,” Iversen said.
“… There wasn’t a defined market or price set for … Alaska North Slope oil.”
No established marketIverson said there wasn’t an established market price for ANS crude oil. Auditors had to use an established market price for some other oil as the basis for a price analysis, or work with a market basket of crudes.
Before the mid 1980s, when Platts came out with public data on oil prices, there wasn’t an established pattern for ANS pricing.
And volumes were high: with some 2.2 million barrels, even a 5 cent difference in the value of oil made a tremendous difference. This was, Iversen said, a “huge risk area for the state and a huge risk area for the taxpayers and the royalty payers.”
Dan Dickinson, a consultant to the Legislature on tax issues, and a former Tax Division director, told committee members he was a consultant in the Amerada Hess litigation, “royalty litigation under the net system.”
“For the first 10 or 15 years the big issue was the value of the oil,” Dickinson said. While publicly reported spot prices are the norm now, in the 1980s there were so-called official prices, but they were set in places like Saudi Arabia.
“We didn’t know how much our oil was worth,” Dickinson said.
Then there were price controls followed by phased decontrol, so for a period “every month … part of the barrel had a price control on it and part didn’t; and every month it changed.” It was “a nightmare” to figure out the value of the oil. The range was from $6-$7 for controlled price to de-controlled in the $30 range, he said.
That was followed by the windfall profits tax, with Prudhoe Bay under one regime and Kuparuk under another.
“I guess what I’m trying to say is there was a huge panoply of issues focused around the price,” he said, and a small group of auditors in the Department of Revenue “grappled with that issue — and they grappled with that issue for 15 years.”
And the issue was also being grappled with on the royalty side.
The issues never went to court, they were settled, “because typically both sides had … fairly decent arguments.” Billions were paid to the state, including interest, by the time those cases settled, Dickinson said.
Changes produce legal uncertainty
“Every time you change the tax, you create a level of uncertainty,” Steve Porter, told the committee. Porter, currently a legislative consultant and a former deputy commissioner of the Department of Revenue, said the uncertainty created isn’t fiscal, it’s legal.
“You create legal uncertainty and so you create new interpretations of the law. And … every time you change the tax you’re going to go through that. It’s to be expected because you’re going to have a difference of opinion,” Porter said.
Those differences could be over a small range of things or a large range of things but whether the tax is “gross or net doesn’t matter — there’s going to be uncertainty,” he said.
Certainty will be created over the next four or five years, and five years from now there won’t be so many disputes because “through regulation and through litigation” definitions will be determined.
Information also an issueIversen said that in the 1970s and early 1980s there were a lot of gray areas and the state’s auditors pushed “to the edge of that gray area to benefit the state.”
It was also a time when the state was digging into taxpayer records “when taxpayers weren’t accustomed to that, so there would be some reticence there in terms of actually providing the information” and there were “aggressive cases of blue-sky audits,” and from there, cases grew to have tremendous dollar amounts and lingered for a decade and a half.
Cases where there were strong issues for the state typically settled first, Iversen said. So when you hear rumors of cases with low settlement values, “for instance below 50 percent, that may be just on issues that were weak for the state to start with.”
It’s a different world today, he said, with oil prices publicly available and defined regulations.
“Also I would say we’ve gained some respect: We were pushing back all those years and being aggressive in our audits.”
Iversen said the risk in terms of dollars is substantially less today than it was historically.
“The major issues are defined. We’ve got clarity now on major downstream cost issues; the downstream issues are not going to be as global … or as significant in terms of dollars as these enormous cases that started in the ‘70s and the ‘80s.”
There will be “more discrete cost issues” now. “And so dollar for dollar on the issues it’s going to be a smaller amount,” Iversen said.
Fewer court cases“Now most cases settle in the Department of Revenue unless we’re just wrong — in which case we acknowledge a mistake…,” Iversen said.
“Unless there’s an actual mistake, most cases settle at 80 to 100 percent,” he said, “…a much, much higher settlement number now, than what we had before.”
On the issue of auditing costs for deductibility under the petroleum profits tax, Iversen said “there will be areas of dispute on the upstream cost side.” But the state has a much more established realm of authority, he said, including the Internal Revenue Code standards.
And it’s accounting, he said. “We’re not hitting, necessarily, the vagaries of the market where there’s just simply not an input that we need in order to make the tax calculation.”
As for concerns about court cases, there is now a well established administrative process, Iversen said.
The division does the audit and if the taxpayer doesn’t like it there is an informal conference at Revenue where the taxpayer can submit “all the evidence and information that they want to submit to us”; then the dispute moves out of Revenue to the Office of Administrative Hearings and presentation to an administrative law judge.
From there a dispute would go to court. While that will take time, it won’t require “numerous motions of summary judgment, numerous huge, deep discovery requests in areas that are gray, muddy areas” as cases did after oil production started.
“We’re not going to need to go there in a typical case,” he said.
There will be issues in “areas of some fertile dispute” that will end up in superior court, but they won’t require decades of litigation, Iversen said, because “the standards have changed; the world has changed.”