Two major decisions were made in Colorado state courts in the past 12 months regarding Colorado tax codes that affect many in the oil and gas industry in the state.
The first was made in BP America Co. v. Colorado Dept. of Revenue (Nov. 2013) regarding state severance tax. In this case, the court considered the computation of the taxable value of the oil and gas extracted in Colorado as subjected to state severance tax, reports Hein & Associates. As severance tax is one of the largest single expenses for an oil and gas company, minor modifications to the computation of the value on which the tax is imposed can have substantial impacts to the ultimate tax paid.
In BP, the court focused on whether a company was allowed to deduct from the sale price of oil and gas the “cost of capital” required to transport oil and gas to market. In other words, BP argued it is not just the hard costs incurred and paid to pipeline companies that should be considered as valid deductions, but the calculation of tax should also take into account the cost incurred by companies to borrow funds and tie up capital in the construction of infrastructure necessary to move product to market.
Ultimately, the court believed that these costs were theoretical, and not an “actual” cost incurred by BP. On this basis, the court rendered its verdict and determined the costs should not qualify when considering the computation of severance tax.
The second major court case in Colorado this year regarding taxes was Pioneer Natural Resources USA, Inc. v. Colorado Dept. of Revenue (Aug. 2014). This case focused on the application of sales and use tax to certain assets purchased. While the associated taxes are not nearly as substantial as those impacted by the BP decision, the case did help those in the industry clarify certain issues.
For sales tax purposes, Colorado exempts manufacturers from having to pay sales tax on machinery used in producing goods. Within certain areas of the state, Colorado considers the extraction of natural resources the same as manufacturing and therefore, extends the same sales tax exemption from sales tax to the equipment used in extraction activity.
In the past, the Department of Revenue viewed extraction and processing as part of the manufacturing processes, but the well-head and flowlines that take the production from extraction to processing were considered transportation. This meant that the machinery used for extraction and processing were exempt from sales taxes in certain parts of Colorado, but any machinery used to transport the product was not.
The Pioneer decision reversed the Department’s position and the court stated that the process of manufacturing begins at the extraction point, and does not end until the last process is conducted that modifies the product into the final form, that is ultimately sold to a third party.
This means that Colorado has taken the position that the conveyor belts that move raw materials between different phases in the manufacturing process were in fact all part of one production operation and the full process should qualify for the exemption.
In the video, Hein & Associates’ National Director of State and Local Tax Services Bill Mueldener discusses oil and gas severance taxes and relates how millions in tax savings were achieved by an E&P company.
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