On the afternoon of December 4, 2013, Ohio Rep. Matt Huffman (R-Lima) introduced a new severance tax proposal in the Ohio House of Representatives, specifically, Ohio House Bill 375 (HB 375). Co-sponsors of the bill include many House Republican leaders, including Speaker of the House William G. Batchelder (R-Medina). The new severance tax proposal: (i) reduces the severance tax rate on persons extracting oil and natural gas by means other than horizontal wells (e.g., traditional vertical drilling); (ii) imposes a tax on the net proceeds of oil and natural gas produced through horizontal wells; (iii) provides a non-refundable credit against the state income tax equal to the amount of the horizontal severance tax paid by the taxpayer (which includes the oil and gas producer with a working interest or landowner with a royalty interest); and (iv) provides an exclusion from the commercial activity tax (CAT) for proceeds of the sale of oil and gas by persons paying the severance tax applicable to the use of horizontal wells. A copy of HB 375 is available here.
The Severance Tax: R.C. 5749.02(B)
1. Vertical Oil and Gas Wells
The current severance tax in Ohio is set forth by R.C. 5749.02(B), is levied at a rate of 10 cents per barrel of oil and 2.5 cents per thousand cubic feet (or 1 MCF) of natural gas. HB 375 sets up a two-tiered structure for the severance tax depending on the type of well producing the hydrocarbons (e.g., vertical vs. horizontal). Specifically, the bill first amends R.C. 5749.02(B)(5) to maintain the existing severance tax rate of 10 cents per barrel of oil, but only for oil produced from a “well that is not a horizontal well,” or a traditional vertical well. In a similar vein, the bill amends R.C. 5749.02(B)(5) to reduce the severance tax for natural gas produced from a traditional vertical well from 2.5 cents per MCF to 1.5 cents per MCF.
2. Horizontal Oil and Gas Wells
Perhaps most importantly, HB 375 proposes new language in R.C. 5749.02(C) to establish a different mechanism for calculating the severance tax upon persons who extract oil and natural gas through the use of a horizontal well on and after April 1, 2014. Prior to the April 1, 2014, date, oil and gas produced through a horizontal well would still be subject to the existing severance tax rates. The proposed severance tax applicable to oil and gas produced from a horizontal well moves from a fixed rate to a variable one based on the net proceeds from the severance of oil and gas. During the initial five (5) years of production, the severance tax equals one percent (1%) of the net proceeds from the severance of oil and natural gas, with an increase to two percent (2%) of the net proceeds in subsequent years. For purposes of this proposal, the term “net proceeds” means “gross receipts from the severance of oil and natural gas less any post-production costs related to the sale of the oil or natural gas,” which include certain “costs related to gathering, processing, transporting, fractionating, and delivery for sale of oil or natural gas, and any adjustment for shrinkage.”
3. Vertical Oil and Gas Wells
Finally, HB 375 imposes a severance tax that equals one percent (1%) of the net proceeds from the severance of oil and natural gas when production falls below an average of 100 MCF per day of natural gas, or 17 barrels of oil, in any calendar quarter.
Chart Summarizing Ohio Severance Tax
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Horizontal Well Fund: New R.C. 5749.02(D)(7)
Under new language in R.C. 5749.02(D)(7), the General Assembly proposes to create a new horizontal well tax fund within the state treasury to house payments of the severance tax. By September 15 of each year: (1) the tax commissioner must calculate the amount that would have been credited to the fund if the severance tax rates existing as of December 31, 2013, still applied; and (2) the director of budget and management must transfer 90 percent of the certified amount to the Ohio Department of Natural Resources’ oil and gas well fund, and 10 percent of the certified amount to the geological mapping fund. Any remaining amount in the horizontal well tax fund is earmarked for the income tax reduction fund to be used to provide temporary income tax rate reductions.
Non-Refundable Income Tax Credit: New R.C. 5747.63
In R.C. 5747.63, the General Assembly proposes new language establishing a nonrefundable income tax credit for taxpayers equal to the amount of the horizontal well severance tax paid for calendar quarters that end during the taxpayer’s taxable year. Unused amounts may be carried forward for up to seven (7) years. In addition, the owner of oil or natural gas in the ground may designate another taxpayer who has a working interest or royalty interest in the minerals, and who is liable for the horizontal well severance tax (e.g., a landowner under an oil and gas lease) to claim the credit. The credit may be claimed by one party or the other, but not by both. Moreover, a taxpayer that is a direct or indirect investor in a pass-through entity that pays the horizontal well severance tax may claim the taxpayer’s distributive or proportionate share of the credit.
Exclusion from Commercial Activity Tax (CAT)
A new exclusion from the definition of gross receipts for purposes of the commercial activity tax is created in R.C. 5751.01(F)(2)(jj). Receipts from the sale of oil or natural gas by a person paying the horizontal well severance tax are proposed to be excluded from the definition of gross receipts. This means that the commercial activity tax would not apply to such gross receipts.