On February 2, Ohio Governor John Kasich released his “Blueprint for a New Ohio, “outlining budgeting goals for the 2016-2017 fiscal years. Continuing a trend from prior budgets, the plan calls for an additional 23 percent reduction in the personal income tax rate and an expansion of the small business deduction to the first $2 million on net business income. These reductions would be paid for in part by increasing the sales tax rate from 5.75 percent to 6.25 percent, increasing the tax on tobacco products by $1, increasing the commercial activity tax from 0.26 percent to 0.32 percent of gross receipts, and revamping Ohio’s severance tax on oil and natural gas. The proposal increases the severance tax rate to 6.5 percent of the value of oil or natural gas sold at the wellhead, or 4.5 percent of the value if sold downstream. This varies significantly from the proposals that were considered during 2014. This bulletin briefly compares the various proposals.
The severance tax is a volume-based tax imposed on oil and natural gas at a rate, including a regulatory fee, of $.20 per barrel and $.03 per mcf, respectively. These rates apply to oil and natural gas produced by both conventional vertical wells and horizontal wells using hydraulic fracking technology.
House Bill 375
An effort to revise Ohio’s severance tax began in early 2014 with House Bill (H.B.) 375. As introduced, the bill sought to shift Ohio’s severance tax from a tax based on volume produced to a tax based on the value of the commodity produced. Oil and natural gas would both have been taxed at a rate of 1 percent of “net proceeds” (a term that was not defined in the proposal) for the first five years of production. They then would both be taxed at a rate of 2 percent of “net proceeds,” with no tax on slow-producing wells.
House Bill 472: Mid-biennium Budget Review
The Kasich administration released its proposal to revise the severance tax as part of its mid-biennium budget review process. Like the current proposal, H.B. 472 sought to make significant cuts in the personal income tax rate. Those cuts would be paid for in part by revamping the severance tax. Under H.B. 472, the severance tax for oil and natural gas produced by vertical wells remained unchanged. However, both oil and natural gas produced by a horizontal well would have been taxed at a rate of 2.75 percent of gross receipts from the first sale of the oil or natural gas. Similar to H.B. 375, the term “gross receipts” was not defined in the legislation. The bill did, however, provide that in the case of sales between related entities, the Tax Commissioner had authority to establish an arm’s-length price for the transaction.
H.B. 472 did provide a cost recovery period for drillers; during the first three years of production, the first $4 million, $3 million, and $1 million, respectively, of gross receipts was excluded from the tax. Thereafter, the tax applied to the all gross receipts.
The bill also called for a hike in the commercial activity tax rate, from 0.26 percent to 0.30 percent.
Sub. H.B. 375
Eventually, the House wrapped the severance tax changes into a substitute version of H.B. 375. Under Sub. H.B. 375, the rate on oil and natural gas produced by vertical wells would be reduced to $.10 per barrel and $.015 per mcf, respectively. The first $10 million of “wellhead gross receipts” of oil and natural gas produced by a horizontal well would not be subject to tax; thereafter, both would be taxed at 2.75 percent of “wellhead gross receipts.” The term “wellhead gross receipts” was defined as the proceeds from the first sale of oil or natural gas, reduced by specified production costs.
In addition, the bill provided a nonrefundable income tax credit for persons holding a royalty interest in a well producing oil or natural gas equal to a portion of the amount of severance tax paid by holders of the royalty interest. The bill also provided a limited exclusion from the commercial activity tax if the taxpayer is subject to income tax on the income from the first sale of the oil or natural gas.
Although no language is yet available, the administration has announced that the severance tax will no longer apply to oil or natural gas produced by vertical wells. In the case of oil or natural gas produced by horizontal wells, the tax will be imposed at a rate of 6.5 percent of gross proceeds if the commodity is sold at the wellhead, or 4.5 percent of proceeds if the commodity is sold downstream, after some processing costs are incurred. The proposal also includes an increase in the commercial activity tax rate, from 0.26 percent to 0.32 percent, of taxable gross receipts. This increase will apply to severers that sell their oil or natural gas in Ohio.
These various proposals are compared in the following chart:
Click here to view the chart.