Understanding Texas Natural Gas Severance Tax IncentivesMr. Michael Miller
February 6, 2012 — 2,656 views
Understanding Texas Natural Gas Severance Tax Incentives
Like many other states, Texas imposes a tax on producers/operators and purchasers of crude oil and natural gas. These taxes, while unavoidable, can be minimized by being aware of incentives and exemptions which are available to qualified producers and operators. Each of these programs has specific requirements and special certification by the Texas Railroad Commission (“TRRC”) before they can be applied.
However, for those that do qualify, the savings can be significant and even allow a recovery of previous taxes paid (within certain limitations). The caveat is that most of these programs only give a producer/operator a limited period of time to apply, so timely action is necessary to take advantage of these incentives. Listed below is a brief summary of some of the programs available for natural gas producers/operators:
High Cost Gas Exemption:
Under this incentive (effective September 1, 1991) natural gas can be designated by the TRRC as high cost gas subject to a reduced severance tax rate for a period of time, if the following criteria are met;
1. Any gas well if production is from a completion which is located at 15,000 feet or more.
2. Geo-pressured brine.
3. Occluded natural gas produced from coal seams.
4. Devonian shale; or designated “tight sand” formations, or produced as a result of production enhancement work. For tight sand formation qualification, the application must include the docket number. Depending on which formation is at issue, surveys and maps of the well location may be necessary for certification to be effective.
The incentive has changed since its inception; under the current form, wells spudded after August 31, 1996 receive a reduced tax rate for 10 years, or until the well accumulates tax savings of 50% of the actual drilling and completion costs for the well.
The TRRC certification process must be completed prior to an operator being able to apply to the Comptroller. Operators must obtain a certification letter from the TRRC. After the certification letter is received, operators must then submit a completed application form AP-180 to the Comptroller, along with a copy of the TRRC letter. Wells spudded after September 1, 1995 must include the actual drilling and completion costs. Further, only current costs are allowed on new/reworked wells.
The application form must be filed the later of; the 180th day after production begins, or the 45th day after the approval by the TRRC. If this deadline is not met the well may still be certified, but a 10% penalty is assessed against the benefit that would otherwise be available. If the application is approved the Comptroller will send the taxpayer a letter acknowledging the same. If applicable, the letter will indicate if a 10% penalty applies for certain periods.
As of the September 2003 reporting period, the oil field clean-up regulatory fee is due on approved high cost gas leases where the taxpayer has reported as being liable for the tax for commodities reported as raw gas, lease use, and products. As noted above, for wells spudded after August 31, 1996, a reduced tax rate applies. The reduced tax rate on each well is based on the actual completion and drilling costs for the same. So there is a possibility of a different reduced tax rate for each qualified well. Qualifying wells are not exempt from tax on condensate.
When completing the natural gas tax report for a qualifying well the “exemption type” field must be reported as “05”, “Reduced Tax Rate For Type 05” should be reported, and “Tax due on Type 05” is calculated by multiplying the “Net Taxable Value” times the “Reduced Tax Rate For Type 05.”
Recovery of Prior Taxes Paid
It is possible to recover severance taxes paid prior to the well being approved as “high cost gas” by filing the appropriate amended returns. There are limitations imposed on refund claims as follows; the ordinary 4 year statute of limitations applies. Amended returns for periods due and payable prior to the Comptroller signature date on the application must be filed within 1 year of the signature date indicated on the TRRC application for exempt certification. As noted above, if the application is not received by the deadline, the exemption is reduced by 10% for the report period beginning the 180th day after the first day of production and ending on the date the application is filed with the Comptroller. Finally, a “work over” lease may not be eligible for an existing exemption under the old lease number. Taxpayers should contact the TRRC to determine if the lease qualifies for an existing exemption, otherwise a new application with the TRRC and the Comptroller’s office is likely required.
Flared/Released Gas Exemption
The Texas legislature created an exemption effective September 1, 1997 for the marketing of gas that had been previously flared or released from oil leases. To qualify, an oil lease must have flared/released the gas according to TRRC regulations in the previous year, and a certification letter must be obtained. The exemption is effective for the life of the applicable well. To apply, a taxpayer must submit a completed exemption application form AP-217 along with a copy of the certification letter from the TRRC to the Comptroller of Public Accounts (“Comptroller”). Once the application is approved, the Comptroller will send a letter acknowledging that the well qualifies.
1. Beginning with the September 2003 reporting period, the oil field clean-up regulatory fee is due on approved exempt leases for flared/released gas where the taxpayer has reported as being liable for the tax for commodities reported as raw gas, lease use and products.
2. Qualifying wells are 100% exempt from the natural gas tax.
For qualifying wells on the natural gas tax report the exemption “type” should be reported as “04” and “net taxable value” should be reported as zero.
Recovery of Prior Taxes Paid
To recover taxes previously paid on an exempt well, amended reports must be filed for periods prior to the Comptroller’s approval. Please note that for refund claims, the ordinary 4 year statute of limitations applies.
Reactivated Orphan Well Exemption
The Texas Legislature approved an exemption, effective January 1, 2006 for oil or gas wells that have been approved for the TRRC’s “orphan” well program. The exemption begins on the 1st day of the month following the Comptroller’s approval of the taxpayer’s application, and lasts as long as the approved operator runs the qualifying well. To qualify, taxpayers must obtain a certification letter from the TRRC designating the well in question as a “reactivated orphan well.” Once the certification letter is received, a taxpayer must then submit a completed application form AP-217 along with the letter.
Qualifying wells are exempt from the natural gas tax and the oil field cleanup regulatory fees (please note that qualifying oil wells under this incentive are also exempt from the crude oil tax and the regulatory tax and the oil field cleanup fees). These wells are not exempt from the condensate tax.
On the natural gas tax report the “exemption type” should be reported as “12” and the “net taxable value” should be reported as zero. Further, the “API number” for the approved well must be reported from November 2007 report period. Similar provisions apply to reporting for a crude oil well that qualifies under the exemption, except that the API number should be reported from December 2007 forward.
Recovery of Prior Taxes Paid
Taxpayers can recover taxes previously paid on an exempt well for periods prior to the Comptroller’s approval by filing amended returns. Please note that the normal 4 year statute of limitations applies.
Conclusion and Recommendations
To improve the likelihood of success in the certification process, we recommend the following steps be taken by any taxpayer interested in these incentives:
1. Seek out a representative that is familiar with both the TRRC and the Comptroller’s office. Regardless of your consultant’s role in the application process; verify that you are getting the maximum value.
2. Identify potential qualifying wells by seeking input and guidance from internal technical personnel. Seek confirmation from outside resources that these well qualify prior to making application. This can save you time, money and headaches.
3. Discuss the potential wells at issue with the TRRC and identify current and developing trends and issues with the approval process. Being aware of potential issues that may affect your application can save you time and possibly preserve statute. In particular, discuss with the TRRC the available supporting documentation that they prefer and which you might need. For some of these incentives, maps and surveys may be necessary for the approval process to succeed. Having these documents ready can help expedite certification.
4. Follow up, follow up, follow up! … the TRRC and the Comptroller’s office do occasionally “misplace” application forms and supporting documents. Retain a copy for resubmission and be sure and send documents certified with a return receipt requested so that you can verify that it was submitted timely and avoid losing statute.
As indicated above, obtaining certification and approval for these incentives can provide an operator/producer with substantial savings typically going forward and retroactively. However, the deadlines and statute of limitations imposed (as noted above) are strictly enforced. Taxpayers that fail to apply in a timely fashion or who file incomplete/incorrect reports; may lose out on the opportunity to benefit from these exemptions with little or no recourse.
Mr. Michael Miller
Merit Appraisal and Tax Consulting, L.P.
Michael E. Miller CPA, state and local tax manager at Merit Appraisal and Tax Consulting; is a former sales and use tax auditor for the State of Texas. He also worked in the state and local tax practice for HoganTaylor LLP and KPMG LLP.