Several new laws and proposals are permanently reshaping the playing field for energy-related tax matters. On October 3, 2008, the Energy Improvement and Extension Act was enacted as Division B of the “TARP” legislation (Pub. L. No. 110-343). On February 17, 2009, the President signed the Stimulus Bill (the American Recovery and Reinvestment Tax Act of 2009, Pub. L. No. 111-5). On February 26, 2009, the President presented an overview of his first Budget entitled “A New Era of Responsibility—Renewing America’s Promise,” and on May 7, 2009, he submitted the full Fiscal Year 2010 Budget. While the Stimulus Bill focuses on positive tax incentives for renewable energy sources, the Budget includes a number of revenue-raising proposals, including new or increased taxes targeted to oil and gas, as well as certain energy-related spending proposals (the “Budget proposals”).
The Budget proposals are, of course, subject to change in the ongoing legislative and political process that is expected to continue for several months. But the Budget is moving ahead. Congress passed a 2010 Budget Resolution on April 29, 2009, (Senate Concurrent Resolution 13). The Administration issued its “Greenbook” of tax proposals (entitled “General Explanations of the Administration’s Fiscal year 2010 Revenue Proposals”) on May 11, 2009. The Greenbook offers further details on a number of the Administration’s tax proposals, but includes only one tax proposal in the energy area (a new one, which is discussed below).
INCENTIVES FOR RENEWABLE ENERGY
The following income tax incentives and Federal government spending programs are currently available for renewable energy projects under the Federal Internal Revenue Code (the “Code”) or certain other Federal laws. This summary includes existing programs. States may also provide benefits, and other financial support may be available.
Federal Income Tax Programs
- Renewable electricity production credit. The Code (Section 45) provides an income tax credit for the production of electricity from qualified (renewable) energy resources where the electricity is sold to unrelated persons. Qualified energy resources comprise wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy. The 2009 credit amount is 2.1 cents per kilowatt-hour for electricity produced from wind, closed-loop biomass, geothermal energy, and solar energy, and is 1.1 cent per kilowatt-hour for open-loop biomass, small irrigation power, municipal solid waste, qualified hydropower, and marine and hydrokinetic. For facilities placed in service after August 8, 2005, the credit generally covers the 10-year period commencing the date that the qualified facility is placed into service. The credit is reduced for grants, tax-exempt bonds, subsidized energy financing, and other credits. The amount of the credit is subject to the general limits on the general business credit. There may be further restrictions, limitations, or requirements specific to types of qualified energy resources. The Stimulus Bill extends the placed-in-service date for qualified wind facilities to December 31, 2012, and the placed in service date for most (but not all) of the other qualified facilities to December 31, 2013. However, qualified solar facilities must have been placed in service after October 22, 2004 and before January 1, 2006.
- Energy investment tax credit. (Code Section 48.) For property placed in service after December 31, 2008 and prior to January 1, 2017, a 30-percent investment credit applies to certain solar energy property used to generate electricity, to heat or cool a structure (but not a swimming pool), or to provide solar process heat; to qualified fuel cell power plants; and to small wind property (the Stimulus Bill lifts the $4,000 credit cap on small wind property). A 10% credit applies to property used to produce, distribute, or use energy derived from a geothermal deposit (but not to electrical transmission); to qualified geothermal heat pump property placed in service prior to January 1, 2017; and to combined heat and power property placed in service prior to January 1, 2017. After December 31, 2016, these credits may be reduced or terminated.
Under the energy investment tax credit, the basis of the property must be reduced by 50% of the amount of the credit and no renewable electricity production tax credit may be claimed for such property. This credit is a component of the general business credit and is subject to its limits and rules. The Stimulus Bill lifts a restriction on subsidized financing.
The Stimulus Bill also allows a taxpayer that owns property that would be a qualifying facility for purposes of the renewable electricity production tax credit to irrevocably elect to receive a 30-percent investment tax credit for most types of qualified facilities placed in service during 2009-2013 (through 2012 for wind facilities).
- Grants. Under the Stimulus Bill, the Secretary of Energy is authorized to provide a cash grant to each person who places in service during 2009 or 2010 property that is otherwise eligible for the (a) renewable electricity credit, or (b) energy credit. The grant is in lieu of those two credits, and a taxpayer need not have a tax liability to qualify for a grant. The grant also applies to property placed in service after 2010 but before the credit termination date with respect to such property, but only if the construction of such property began during 2009 or 2010. The amount of the grant is generally 30% of the basis of the property, which must be reduced by 50% of the amount of the grant. The grant is to be paid within 60 days of the later of submission of the application and placing the property in service.
- Bonds. The Stimulus Bill expands the New Clean Renewable Energy Bonds program, a type of qualified tax credit bond, from $800 million to $3.2 billion.
- Domestic manufacturing deduction. A special deduction of 9% (6% in 2009) is available for net income from domestic production of electricity.
- Credit for manufacturing facility. The Secretary of the Treasury, in consultation with the Secretary of Energy, is to set up a program within 180 days of the enactment of the Stimulus Bill, under which up to $2.3 billion in credits are to be awarded on a competitive basis for, among other things, the establishment or equipping of a manufacturing facility that produces property that will be used to produce energy from certain renewable sources. The criteria and time limits for awards are set forth in the statute. The credits are equal to 30% of the basis of the investment in a manufacturing facility, not including real property.
- Credit for certain residential energy efficient property. A 30% credit applies to the purchase of qualified solar electric property, qualified solar water heating property, qualified geothermal heat pump property, qualified small wind energy property, and qualified fuel cell power plants placed in service prior to January 1, 2017.
- Depreciation. Certain energy property, including solar energy property, geothermal energy property, qualified fuel cell property, qualified microturbine property, and certain biomass property is eligible for a five-year statutory recovery period. Qualified cellulosic biofuel plant property placed in service before January 1, 2013 is eligible for an additional first-year depreciation deduction of 50%.
- Credit for alternative fuel vehicle refueling property. A 30% credit is available for the cost of installing qualified clean-fuel vehicle refueling property placed in service before January 1, 2011 (in the case of hydrogen refueling property, before January 1, 2015) that is to be used in the taxpayer’s trade or business or at the taxpayer’s principal residence. A 50% credit applies in 2009 or 2010 for refueling property other than hydrogen refueling property. The credit may not exceed $30,000 (per taxable year, per location) in the case of business property (in 2009 or 2010, $200,000 for hydrogen refueling property and $50,000 for other refueling property), and $1,000 in the case of nonbusiness property (in 2009 or 2010, $2,000 for property other than hydrogen refueling property). Certain restrictions and special rules apply.
- Incentives for alcohol, cellulosic biofuel, biodiesel, renewable diesel, and certain other alternative fuels. Per-gallon incentives are provided in the form of income tax credits, excise tax credits, or payments.
Federal Spending Programs
The Department of Energy (or other departments) may have certain non-tax support programs available, including loan guarantees, funding for research and development and grants, and bonding authority for certain federal agencies to upgrade electrical transmission to facilitate delivery of electricity from renewable sources. For example, on May 27, 2009, President Obama announced the availability of $467 million from the Stimulus Bill to expand and accelerate the development and use of geothermal and solar energy.
OIL AND GAS REVENUE PROVISIONS AND OTHER CARBON DISINCENTIVES
The most significant current energy proposal is not in the form of a tax, but may have the effects of a tax. The Budget proposes a controversial 100% full auction carbon “cap-and-trade” system, beginning in 2012. The Administration’s goal is to reduce greenhouse gas emissions 14% over 2005 levels by 2020, and 83% by 2050. Under a cap-and-trade system, the Government would issue or auction permits that would allow holders to emit certain levels of greenhouse gases. These allowances would then be freely traded on a secondary market. However, the Administration has already backed off its initial proposal for a 100% full auction in the face of much Congressional opposition, and now supports providing some emission allowances for free, at least initially. The Budget proposes using approximately 80% of the revenue to fund a permanent “Making Work Pay” payroll tax credit, while some legislators want a larger proportion to fund low-carbon and other energy initiatives and to reimburse consumers for the resulting increase in energy costs.
Chairman Waxman and Subcommittee Chairman Markey of the House Energy and Commerce Committee introduced and, on June 5th, reported out the American Clean Energy and Security Act (H.R. 2454), which includes a cap-and-trade proposal that initially allocates for free most of the emission allowances. That bill is proceeding through several other House committees, including Ways and Means, and is expected to be passed by the House sometime in 2009. In the Senate, support for this effort and its timing is less clear.
Revenue Provision Recently Enacted
The enacted Energy Improvement and Extension Act includes a provision that combines the categories of foreign oil and gas extraction income (“FOGEI”) and foreign oil related income (“FORI”) into a new category, called combined foreign oil and gas income (“CFOGI”). Under prior law, different limitations applied to the foreign taxes attributable to FOGEI and FORI. Under the new provision, amounts claimed as taxes on CFOGI are creditable in a particular year only to the extent they do not exceed the product of the highest marginal U.S. corporate tax rate and the amount of CFOGI, essentially adopting for CFOGI the limitation methodology and ancillary rules formerly applicable to FOGEI. The provision primarily burdens the foreign operations of U.S.-based major oil companies. The provision is effective for taxable years beginning after December 31, 2008.
Revenue Provisions Proposed
There are several Administration tax proposals that are not discussed in the Budget or the Greenbook, but are simply included as line items in Table S-11 of the Budget (Table S-6 in the February Budget overview document), under the broad heading of “Other revenue changes and loophole closures.” These are described below. Most of these are tax increases on the oil and gas industry.
- “Reinstate Superfund taxes.” The Budget proposes to reinstate the following taxes in 2011 that are directed to the Hazardous Substance Superfund under Code Section 9507. These provisions not been applicable since January 1, 1996, but are still in the Code.
- An “environmental tax” (Code Section 59A) applicable to all corporations, equal to 0.12% of the excess of “modified alternative minimum taxable income” (which is alternative minimum taxable income without regard to net operating loss deductions and the environmental tax) over $2 million;
- A tax (Code Section 4611) of 9.7 cents a barrel on (a) crude oil received at a U.S. refinery, (b) domestic crude oil used in the United States or exported from the United States, and (c) petroleum products entered into the United States for consumption, use, or warehousing; and
- A tax on certain taxable chemicals sold by its manufacturer, producer, or importer, at varying rates (Code Section 4661), as well as an equivalent tax (Code Section 4671) on certain imported substances containing such taxable chemicals.
- “Repeal LIFO.” The Budget proposes to repeal in 2012 the last-in-first-out (“LIFO”) method of inventory accounting for all taxpayers. In times of rising prices, LIFO enables taxpayers to retain lower-cost inventory while expensing the higher-cost inventory as cost of goods sold. This proposal is expected to have a large effect on integrated oil companies.
- “Eliminate oil and gas company preferences.” The Budget includes the following subcategory of revenue raisers, effective in 2011:
- “Levy excise tax on Gulf of Mexico oil and gas (limits excess royalty relief).” The Outer Continental Shelf Deep Water Relief Act (Pub. L. No. 104-58), enacted in 1995, limits certain oil and gas production royalties on lands leased by the Federal Government. The Budget would “limit excess royalty relief” for certain Gulf of Mexico production by imposing an excise tax at a yet unspecified rate.
- “Repeal enhanced oil recovery credit.” The enhanced oil recovery credit (Code Section 43) allows a 15% tax credit for certain intangible drilling and development costs, qualified tertiary injectant expenses, and tangible property costs attributable to a project involving the application of a tertiary recovery method. Because the credit is subject to complete phaseout when the average annual domestic wellhead price per barrel reaches $28 multiplied by an inflation factor, however, the credit has been completely phased out for all taxable years beginning after 2005. The Budget proposes to repeal this credit.
- “Repeal marginal well tax credit.” The American Jobs Creation Act of 2004 (Pub. L. No. 108-357) provides a credit (Code Section 45I) of $3 per barrel of oil and a parallel .50 credit per 1,000 cubic feet of natural gas for production from certain small or economically marginal wells. Like the enhanced oil recovery credit, the marginal well tax credit is subject to phaseout when the market price of oil or gas is too high, but it never actually phased in. The Budget proposes to repeal this credit.
- “Repeal expensing of intangible drilling costs.” The Budget proposes to repeal the expensing of intangible drilling costs. Under Code Section 263(c) and Treasury Regulation §§ 1.263(c)-1 and 1.612-4, a taxpayer has the option to deduct intangible drilling and development costs for oil and gas wells. Such costs include all expenditures for wages, fuel, repairs, hauling supplies, etc. incident to and necessary for the drilling of wells and the preparation of wells for the production of oil and gas. It is not clear, however, whether the repeal is intended to apply to development costs as well as drilling costs. The proposal does not appear to apply in the case of geothermal wells, also currently provided in Section 263(c).
- “Repeal deduction for qualified tertiary injectants.” The Budget proposes to repeal Code Section 193, which permits a deduction for costs incurred for a tertiary injectant (except for natural gas or crude oil that is recoverable) that is injected into an oil or gas reservoir to extract oil too viscous to be extracted by conventional primary and secondary water-flooding techniques.
- “Repeal passive loss exception for working interests in oil and natural gas properties.” In general, under Code Section 469, most taxpayers (except for corporations that are not closely held) are subject to disallowance of their losses and credits from “passive activities,” which are activities in which they do not materially participate. One exception to the definition of a passive activity is any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the liability of the taxpayer with respect to that interest. The Budget proposes to repeal that exception. The proposal presumably is intended to extend to passive activity credits as well as losses, although the proposal does not specify that credits are included.
- “Repeal manufacturing tax deduction for oil and natural gas companies.” Code Section 199 (added by the American Jobs Creation Act of 2004, Pub. L. No. 108-357) originally provided a deduction equal to 9% (3% in 2005 and 2006, and 6% in 2007, 2008, and 2009) of gross receipts from domestic manufacturing and production activities (less allocable costs of goods sold and other allocable expenses). The base includes gross receipts from the sale of oil, gas, or refined products that are extracted or produced within the United States (but not gross receipts from their distribution), gross receipts from drilling an oil or gas well in the United States, and gross receipts from engineering services performed in the United States for real property construction projects (including oil and gas wells) located in the United States. The Energy Improvement and Extension Act amended the provision to reduce the deduction after 2009 by 3% (i.e., essentially to aasix percent 6%) of the income attributable to the production, refining, or processing income from oil, gas, or any primary product thereof. The Budget proposal appears to completely repeal the deduction with respect to the income attributable to the production, refining, or processing income from oil, gas, or any primary product thereof. However, it is not entirely clear from the statute or legislative history whether the haircut in the Energy Improvement and Extension Act or the repeal proposed by the Budget apply to gross receipts from drilling and engineering.
- “Increase geological and geophysical amortization period for independent producers to seven years.” Geological and geophysical costs (“G&G costs”) are those incurred by a taxpayer for the purpose of accumulating data that will serve as the basis for the acquisition and retention of mineral properties by taxpayers exploring for minerals. G&G costs incurred in connection with the exploration or development of oil or gas within the United States are generally amortized ratably over 24 months (under Code Section 167(h)). However, the Tax Increase Prevention and Reconciliation Act of 2005 (Pub. L. No. 109-222) extended the amortization period for G&G costs incurred by major integrated oil companies to five years, and the Energy Independence and Security Act of 2007 (Pub. L. No. 110-140) further extended it to seven years. The Budget proposal extends to seven years the amortization period for G&G costs incurred by independent producers.
- “Repeal percentage depletion for oil and natural gas.” The owner of a mineral resource property is generally permitted a deduction under Code Section 611 for depreciation of that property, known as depletion. The basic method of depletion is cost depletion, which is the recovery of the adjusted cost basis of the property as the resource is extracted or sold. Under percentage depletion, a flat percentage of the gross income from the property is allowed as a depletion deduction. Percentage depletion with respect to oil and gas wells is generally allowed only in very limited circumstances, as follows. Percentage depletion is allowed at a 22% rate for certain regulated natural gas and certain natural gas sold under a fixed contract. Percentage depletion is allowed at a 10% rate for domestic natural gas from geopressurized brine. In general, certain small producers of oil and natural gas and royalty owners are also allowed to use percentage depletion for a limited amount of their U.S. production. However, the small producer exemption does not apply to persons who are (or are related to) certain retailers or refiners. The Budget proposal repeals percentage depletion for all oil and natural gas.
- “Modify the rules for dual capacity taxpayers.” This proposal is not included in the Administration’s February 26th Budget document, but is described in the Greenbook. Under current Treasury Regulations, taxpayers that are subject to a foreign levy and that also receive a specific economic benefit from that foreign country (known as “dual capacity taxpayers”) may not credit the portion of the levy paid for the specific economic benefit. However, if the foreign country does not generally impose an income tax, the portion of the payment of a dual capacity taxpayer that does not exceed the applicable Federal tax rate applied to net income from the foreign country is treated as a creditable income tax. The balance of the payment is not treated as a creditable income tax. Under the proposal, dual capacity taxpayers would not qualify for foreign tax credits with respect to foreign taxes unless the foreign country generally imposes an income tax, and the definition of “generally imposed income tax” would be tightened.
The proposal would also create a brand new foreign tax credit basket for the category of “combined foreign oil and gas income” that was created under the Energy Improvement and Extension Act (described above), thus singling out oil and gas operations among all industries for reversal of the trend of decreasing the number of foreign tax credit baskets.
INTERIOR DEPARTMENT AND ENERGY DEPARTMENT REVENUE-RAISING PROPOSALS
In addition to the new excise tax on production in the Gulf of Mexico (described above), the Budget proposes further revenue raisers related to Federal leases and research and development, beginning in 2010:
- Creation of a “use or lose” policy for oil and gas leases on Federal lands, including charging a new fee on non-producing leases in the Gulf of Mexico;
- Increasing the return from oil and gas production on Federal lands through “administrative actions such as reforming royalties and adjusting rates;”
- Terminating payments to coal-producing States that “no longer need funds to clean up abandoned coal mines;”
- Charging user fees to oil companies for processing oil and gas drilling permits on Federal lands; and
- Repealing the ultra-deepwater oil and gas research and development program.
EXTENSIONS OF EXPIRING PROVISIONS
The Budget also proposes to extend through calendar year 2010 certain tax benefit provisions expiring before December 31, 2010. Some of these are energy related. The Greenbook describes these provisions as “routinely extended” and specifically mentions credits for biodiesel and renewable diesel fuels.
Here is a partial listing of energy-related spending items in the Budget (a full description would be very long):
- Spending (including tax credits) in the Stimulus Bill may be continued or expanded, including programs for weatherizing low-income homes, modernizing federal buildings, building five coal-fired plants with carbon capture and storage technology, modernizing the electrical grid, wide-ranging loan guarantees, and State and local government energy grants;
- Other financial support for alternative energy technologies, from research to commercialization; and
- Interior Department technical and environmental studies in areas of renewable energy, resource assessment, and developmental mitigation.