The oil and gas industry has a significant and far reaching economic impact in Louisiana. According to one 2014 study, the total direct and indirect impact on the state is approximately $73.8 billion. Taxes make up a large part of the industry’s direct economic impact in Louisiana: In 2013, the industry paid nearly $1.5 billion in taxes to the State, about 14.6% of the total taxes, licenses and fees collected that year. A large chunk of the taxes paid by oil and gas companies are severance taxes, which are levied on the production of natural resources taken from private and public land or water bottoms within the territorial boundaries of the state. Natural resources might include, for example timber, minerals like oil and gas, coal, salt, or sulphur. Overall, collections on oil and gas amount to nearly 92% of all severance tax collections in the state.
In the last few months, the Louisiana Department of Revenue (the “Department”) has audited dozens of Louisiana oil producers seeking additional oil severance taxes. As explained below, the Department has issued audit findings which determine that any negative adjustments embedded into the negotiated prices in various oil purchase contracts were not allowable. As a result, the Department is seeking payment of severance taxes on a price which is higher than the one actually paid pursuant to the contracts. This new interpretation has resulted in significant liability for many producers, some in the hundreds of thousands of dollars.
Severance taxes on oil are paid based on the value of the oil at the time and place of severance. La. R.S. 47:633(7)(a). The value of the oil is the higher of: (1) The gross receipts received from the first purchaser, less charges for trucking, barging and pipeline fees, or (2) the posted field price. Id. Since posted field prices are uncommon today (and the industry would assert that the concept no longer exists and should be removed from the law), the amount of severance taxes due to be paid is likely based on option (1) above. If neither the first purchaser nor producer of the oil claims a deduction for trucking, barging or pipeline fees, then the value of the oil for tax purposes is based solely on the gross receipts received from the first purchaser. Normally, the calculation process ends here and the taxpayer submits payment accordingly. The recent audits by the Department, however, indicate a new state of affairs.
The oil purchase agreements recently targeted by the Department include a price formula which begins with a “market center price” (i.e. West Texas Intermediate Crude Cushing OK), and then includes various positive and negative adjustments to that market center price to arrive at the price to be paid for the crude oil. For instance, if the oil is purchased at or near the lease, the particular lease may include a deduction or premium applicable only to that lease. This increase or decrease from the market center price might be based on a variety of factors. In its recent audit reports, the Department has “unbundled” the contractually negotiated prices actually paid, and seeks to assess additional severance taxes based upon a hypothetical amount of additional value which ignores any negative adjustments embedded in the price formula. The Department essentially created its own theoretical prices for the oil, and is attempting to assess an additional severance tax based on that amount.
Consider the following hypothetical:
- Operator X enters into an Oil Purchase Agreement to sell oil from a mineral lease to First Purchaser Y. Under the terms of the Agreement, First Purchaser takes title to the oil at or near the lease. By law, Operator X is the “severer” of oil and is therefore subject to the Louisiana oil severance tax under LA. R.S. 47:633(7); but, First Purchaser Y agrees to withhold the severance taxes from the proceeds due to Operator X and reports and remits these taxes to the Department.
- Pursuant to the Oil Purchase Agreement, Operator X and First Purchaser Y agree to a price formula which begins with a market center price of $65, and then deducts $3 for a final price of $62 per barrel. Accordingly, First Purchaser Y withholds severance taxes based upon the $62 price it paid to Operator X, and reports and remits the same to the Department.
- A year or two after the sale, Operator X receives an audit report from the Department which provides that Operator X owes additional severance taxes for those months it sold oil to First Purchaser Y under the Oil Purchase Agreement. The audit letter from the Department indicates that the value of the oil for severance tax purposes was actually $65 per barrel, and not the $62 negotiated price. Therefore, the Department proposes to assess an additional severance on the extra $3 per barrel, plus interest and penalties.
A taxpayer who has been audited and receives a notice of proposed tax due from the Department must act quickly to protect its procedural rights. For any significant proposed assessment, a taxpayer should always seriously consider how it can protect itself from additional tax liability.
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