Posts

Don’t Miss Out on the Gross Production Tax Rebate for Economically At-Risk Oil and Gas Wells

This article was published in OIPA Wellhead, a publication produced by Oklahoma Independent Petroleum Association and distributed to its membership.

By Elizabeth K. Brown

brown-elizabeth-portrait

Liz Brown is a director at Phillips Murrah, P.C., where she has practiced for most of her legal career. Liz is primarily a tax and transactional lawyer with a special emphasis in the energy industry.

A little used gross production tax rebate may now be available to help cushion the blow of low oil and natural gas prices.  This gross production tax rebate is available to owners of economically at-risk wells.  The rebate was designed to extend production from wells that otherwise would likely be shut in during difficult times in the oil and gas industry (such as these) and has been in the law since 2005.  With the steep drop in oil and natural gas prices in the last two years, many more oil and gas wells now qualify as economically at-risk than ever before.  In fact, the Oklahoma Tax Commission estimates that the claims for the economically at-risk rebate for the 2015 year will total $132.9 million compared to total rebates of just $11 million in 2013 when prices were much higher.

An “economically at-risk oil or gas lease” eligible for the rebate is any oil or gas lease operated at a net loss or at a net profit which is less than the total gross production tax remitted for the lease during the previous calendar year.   See 68 O.S. §1001.3 (a).   A “lease” for this purpose is defined as “a spaced unit, a separately metered formation within the spaced unit, or each tract within a Corporation Commission approved unitization, or a lease which, for tax reporting purposes, has been assigned a production unit number”.   See 68 O.S. §1001.2 (b).

To determine whether a lease is economically at-risk, an operator starts with the gross production from the lease and then subtracts severance taxes, royalty, operating expenses of the lease including workover and recompletion costs for the previous calendar year, and overhead costs up to the maximum overhead percentage allowed by the Council of Petroleum Accountants Societies (COPAS) guidelines.  No deduction is allowed for depreciation, depletion, or intangible drilling costs in determining whether the well is economically at-risk.

Using that methodology, if the lease is operating at a net loss, then it will be economically at-risk and eligible for the rebate.  The amount of the rebate for economically at-risk wells subject to the standard 7-percent rate is 6/7ths of oil and gas production taxes collected, while the amount of the rebate for wells subject to the 4-percent rate is 3/4ths of oil and gas production taxes collected. To simplify, the impact of the rebate reduces the effective gross production tax rate on qualified economically at-risk oil or gas wells to 1 percent.

The operator cannot claim the rebate until after July 1 of the year subsequent to the year of the production.  So, for example, the claim for rebate for 2015 production cannot be made until after July 1, 2016.  The rebate claim must be made within eighteen months after the date the refund is first available or the claim will be barred.  The rebate claim is to be made on Form 329 “Gross Production Application for Certification – Economically At-Risk Oil Lease”.

To complete the Form 329, the operator needs to provide the following:

  • Operator’s FEI/SSN number.
  • Operator’s OCC assigned company number.
  • Operator’s name and mailing address information.
  • Lease name as found on record at the Oklahoma Tax Commission.
  • Lease description.
  • Oklahoma Tax Commission assigned production unit number.
  • Calendar year for request.
  • Total gross revenue earned for the calendar year including both oil and gas production.
  • Lease royalty.
  • Operating expenses for the lease to include expendable workover and recompletion costs for the previous year.
  • Gross production tax deducted by the tax remitter, which shall not include petroleum excise tax or any fee collected for another agency.
  • Actual overhead cost, but do not exceed the maximum overhead percentage allowed by COPAS guidelines.

The Oklahoma Tax Commission has the authority to determine if an oil or gas lease qualifies for certification as an economically at-risk oil or gas lease.  Within sixty (60) days after an application is filed for economically at-risk oil or gas lease status, the Oklahoma Tax Commission shall make its determination and shall issue either an approval letter or a denial letter to the lease operator.  Upon certification by the Oklahoma Tax Commission, a refund of the gross production taxes paid in the previous calendar year for the lease shall be issued to the well operator or its designee after July 1 of the subsequent year.

Although Oklahoma oil and gas producers could use this tax incentive now more than ever, the economically at-risk lease rebate is itself at-risk as the Oklahoma Legislature explores options to reduce Oklahoma’s budget shortfall.  Earlier this year, a bill was introduced to suspend the rebate for economically at-risk wells.  While the bill did not advance, an amendment to the statute suspending, reducing or eliminating the rebate could be proposed at any time prior to the end of the legislative session.  Hopefully, this much needed rebate will be left alone to do what it was designed to do  –  enable producers to maintain production from their wells that are operating at a loss during this period of low prices.

Absent a statutory change this session to the gross production tax rebate for economically at risk leases, operators should be evaluating whether they may be eligible for the rebate and should be ready to submit claims attributable to 2015 production to the Oklahoma Tax Commission on or after July 1, 2016.   Don’t miss out!

Elizabeth K Brown is an attorney and Director of Phillips Murrah P.C, a member of the OIPA board of directors and CEO of The Gloria Corporation, an oil and natural gas exploration and production company.

Surviving an Energy Industry Down-Cycle

This article was published in OIPA Wellhead, a publication produced by Oklahoma Independent Petroleum Association and distributed to its membership.

Resulting financial stress on your business can be survived

By Elizabeth K. Brown

brown-elizabeth-portrait

Liz Brown is a director at Phillips Murrah, P.C., where she has practiced for most of her legal career. Liz is primarily a tax and transactional lawyer with a special emphasis in the energy industry.

As we all know all too well, the profitability of the energy industry is dependent on oil and gas prices, which are often volatile and generally cyclical. Unfortunately, we in the oil and gas business are in the midst of another industry down-cycle.

According to the recent Baker Hughes’ North America Rig Count report, the number of rigs drilling for oil and natural gas has been cut in half since November. The price of oil has been cut by more than half as compared to last year. In response to lower prices, some oil and gas companies have reportedly reduced their capital expenditure budgets, reported substantial losses, and are selling off assets.  Service and drilling companies have announced major layoffs and so far appear to have been the hardest hit.

Under these circumstances, virtually all companies that are engaged in the Oklahoma energy sector, whether they are exploration and production or service companies, are dealing with reduced profitability and some are struggling to meet their financial obligations.

When a company that relies on a robust energy sector starts to feel the pinch of a down-cycle, restructuring debt or seeking relief through a Chapter 11 bankruptcy reorganization may be the way for the business to survive. Either the workout or a bankruptcy allows the business to have some time for the economy or business sector to recover or for the business to work through its financial difficulties.

What to do?

When a company is experiencing financial stress, the best course of action is to accept the reality of the situation and address it quickly. The first step is for the business to develop a budget so that it has a clear understanding of its current monthly revenues and expenses, its projected future revenues and expenses based upon reasonable assumptions, and the current and estimated future value of its assets. Once the business has that information, it can develop a pragmatic approach to dealing with its expenses and liabilities and will then be ready to approach it creditors with a plan for restructuring.

“If a company is having trouble meeting its obligations, creditors want to know why, what is being done to address the situation and, ultimately, what the overall prospects for recovery are for the business, both outside and through bankruptcy.” said Phillips Murrah bankruptcy attorney Stephen W. Elliott.

The Workout: Avoiding Bankruptcy

A workout is an out-of-court process through which the business owner and the creditors of the business try to reach an agreement to modify the terms of their contractual obligations. Workouts typically involve an agreement of the business’ primary lender to waive defaults or forbear on the lender’s rights to collect interest and principal payments on the loan for a period of time to give the business the opportunity to get back on its feet.  The workout terms may include debt forgiveness, changes in loan amortization, reduced interest rates, or deferred principal or interest payments.

The ultimate goal of the workout is to allow the business to continue operating so that (i) the creditors of the business can ultimately be paid more than they would have received if the business was shut down and the assets were sold at liquidation prices; and (ii) the business can recover from its financial difficulties, all without the costs, delays, and potential uncertainties frequently inherent in bankruptcy. If the workout would be as or more beneficial to the business and its primary creditors than a bankruptcy, then bankruptcy can often be avoided.

“In my experience, candid communication is often the key to avoiding bankruptcy and resolving financial issues through a workout,” Elliott continued.

What are Benefits of Bankruptcy?

Bankruptcy provides potential, wide-ranging benefits to the debtor not available through out-of-court workouts. In a Chapter 11, the debtor oftentimes acts as trustee of the business and continues to manage the company as the “debtor in possession.” Chapter 11 affords the business a number of tools to restructure its debt.

One of the best known is the automatic stay which stops collection efforts outside of the bankruptcy court and keeps the business and its assets from being picked apart piecemeal by creditors. Additionally, in bankruptcy, the business may be able to obtain financing on more favorable terms than it could outside of bankruptcy by giving the post-bankruptcy lender priority over other creditors. Also, there is the possibility in bankruptcy for the business to be able to rapidly sell assets free and clear of liens and even over creditors’ objections, which under some circumstances may be the only way for the business to be able to sell its assets for fair market (as opposed to liquidation) value or to obtain funds to continue the operations.

Finally, the bankruptcy process provides the business with the opportunity for the bankruptcy court to bind creditors involuntarily to the reorganization plan of the business.  The reorganization plan may restructure obligations and discharge debts of the business. This ability of the bankruptcy court to bind creditors can be critical if the business owner’s efforts to put a workout together have failed due to some creditors’ refusal to agree to the proposed workout terms or because there are too many creditors for the business to be able reach an agreement with them.

Action Beats Hesitation

The best course of action for the business owner to deal with financial stress on the business is to be proactive, regardless of whether the solution is in the form of a workout or entails a bankruptcy.  Communication among the business and its creditors is very important.  Generally the earlier the lines of communication are opened between the business and its creditors, the better the chances are of a successful resolution.  The failure of the business to communicate with its creditors concerning its financial stress will often result in creditors assuming the worst and taking legal action that the creditor might not have taken if the business owner had simply communicated with them.  Once those collection actions have begun, filing bankruptcy may be the only course of action available to save the business.

A business owner’s denial of the precarious financial situation of the business or inaction can result in a needless loss of business value and can potentially impair the business’ ability to restructure or reorganize and survive the financial crisis. If you find that your business is in a precarious financial situation, taking action now may minimize the problems created by the down-turn.

About the author:

Elizabeth K. Brown is an attorney and director of Phillips Murrah P.C., a member of the OIPA board of directors and CEO of The Gloria Corporation, an oil and natural gas exploration and production company.

 

Brown: Producing for Oklahoma

Guest article originally published in The Journal Record on Oct. 24, 2014.
Click to see Elizabeth K. Brown’s attorney profile


 

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

A vibrant and growing oil and natural gas industry is paying dividends for Oklahoma, the most recent example being the increased payments to the state’s General Revenue Fund from taxes on the oil and natural gas industry.

Gross collections to the General Revenue Fund increased during the third quarter, up by almost 10 percent from the previous year. A significant portion of that increase came from the state’s gross production tax on oil and natural gas production, which saw a 33.4-percent growth compared with the year before.

The General Revenue Fund is the key indicator of state government’s fiscal status and the predominant funding source for the annual state budget. Collections, reported by the Office of Management and Enterprise Services, are revenues that remain for the appropriated state budget after rebates, refunds and mandatory apportionments.

The growth of receipts from the state’s gross production tax is an important benchmark because Oklahoma’s oil and natural gas industry remains a critical component of the fiscal stability for both state and local governments. The Oklahoma Energy Resources Board’s May 2012 Oklahoma’s Oil and Natural Gas Industry Economic Impact and Jobs Report shows the industry, as a whole, accounts for approximately 25 percent of all taxes paid in the state.

The greatest single benefactor of direct apportionments of gross production tax revenues is the state’s education system. Data from the most recent OERB report released in September shows the oil and natural gas industry accounted for more than $325 million to local school districts across the state. Another $150 million was allocated to the Oklahoma Student Aid Revolving Fund, the Higher Education Capital Fund and the Common Education Technology Fund.

To put that in perspective, take the northern Oklahoma community of Alva. In the heart of the Mississippi Lime, the Class 2A school district received $3.7 million in state funding for the 2012-13 school year. Of that, $2.1 million came directly from the oil and natural gas industry.

This state’s oil and natural gas industry is producing for Oklahoma. A growing oil and natural gas industry means increased funding for Oklahoma’s students and ensures future generations can continue producing for Oklahoma.

NewsOK Q&A: Economic downturn can be boon for people planning their estates

From NewsOK / by Don Mecoy
Published: April 15, 2009
Click to see full story – Economic downturn can be boon for people planning their estates

Click to see Elizabeth K. Brown’s attorney profile

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

Q: Can you explain how the current economic turmoil could be a good thing for some people who are planning their estates?

A: Depressed asset values coupled with historically low interest rates have created a window of opportunity to add significant value to family wealth transfer planning. From stock portfolios to real estate to family business interests, no asset has emerged unscathed. While no one jumps for joy over declining assets, there is a silver lining. I’m seeing a nice planning opportunity, especially for clients with family oil and gas businesses, for implementing certain estate planning techniques now, while the value of those assets is so depressed. The impact of rock-bottom IRS interest rates and lower asset values is that clients have the ability to transfer more of their assets to family members and minimize the taxes that can eat away at an estate’s value.

Q: Are there matters on the horizon that could make it important to act quickly?

A: Unfortunately, yes. In January, a bill was introduced to Congress that would eliminate the ability to take certain discounts from the value of family business interests that are transferred to children and other family members. Historically, these valuation discounts have been very important factors in planning to minimize the estate and gift tax consequences of these transfers. If the estate tax law changes as proposed, these important discounting techniques could be eliminated. While we can’t be certain that Congress ultimately will eliminate these discounts, Phillips Murrah is alerting clients to the possibility that this narrow window may soon close, and we are encouraging them to make these transfers immediately, before further action is taken by Congress.

Q: Do you have any other tips that might be valuable for someone who is considering how to distribute an estate?

A: Take the time to plan now for the event of your death or disability; that plan could be the greatest gift you ever make. And two very timely tips, involving specific estate planning techniques, have become my mantra these days: Consider transfers to Grantor Retained Income or Annuity Trusts (GRATs). Consider sales to Intentionally Defective Grantor Trusts (IDGTs). Both techniques require use of the historically low IRS interest rates, maximizing the value that can pass to family members, tax free.

Director elected to Juvenile Diabetes Research Foundation board of directors

Originally published in The Journal Record on Aug. 3, 2006.
Click to see Elizabeth K. Brown’s attorney profile


 

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

Director Elizabeth Brown was elected as one of 15 members to the Central Oklahoma Chapter of Juvenile Diabetes Research Foundation’s board of directors.

Read more about the other members here.

Limited liability companies and family business

Originally published in The Journal Record on Aug. 26, 1999.
Click to see Elizabeth K. Brown’s attorney profile


 

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

Elizabeth K. Brown’s practice is focused at a strategic level on serving her clients as outside counsel where she assists privately held companies in managing the many legal issues that arise in running a business.

Have you noticed that many new businesses are being formed as limited liability companies instead of corporations or partnerships?

Have you wondered what the reason is for the change?

Have you wondered whether you should explore the possibility of using a limited liability company in your family business?

In recent years, the use of the family LLC has become increasingly popular in the business world as the entity of choice, surpassing the corporation and the partnership.

The reasons for its popularity include that it provides asset protection to the owners of the LLC, has income tax advantages over the corporate form of business and is a convenient vehicle for effectuating a succession plan including giving assets to family members.

Until 1992, there was no such thing as a limited liability company in Oklahoma. Other states had experimented with the concept of creating a business entity that combined the best features of a corporation and a partnership.

In 1992, the Oklahoma Legislature decided to create this new type of business entity and enacted a statute governing its existence and characteristics. Since that time, thousands of new Oklahoma LLC’s have been formed.

The reason for the limited liability company boom is the advantages that the LLC provides over both corporations and partnerships.

Like a corporation, the LLC has the corporate characteristic of providing a liability shield to the owners of the business. Generally, as with a corporation, the creditors of a limited liability company cannot reach the assets of its owners.

For example, if the LLC operates a retail business and a customer slips and falls in the store, the customer may be able to recover from the assets of the LLC, but should not be able to recover from the assets of the LLC owners.

Like a partnership, the LLC provides asset protection to the business itself from the claims of a creditor of the owner of the LLC. While a creditor of a shareholder of a corporation can obtain a judgment against the owner and levy on the stock of the corporation, a creditor of an owner of an LLC can only obtain a charging order against the owner’s interest in the LLC. A charging order only entitles the creditor to receive the owner’s share of distributions from the LLC when made and does not entitle the creditor to become an owner of the LLC or to any voting rights in the LLC.

This asset protection aspect can be quite advantageous to the business owner when the business owner has creditor problems of his own.

For example, if the LLC owner has an outstanding judgment against him personally for $25,000, his judgment creditor would not be able to take his ownership interest in the LLC to satisfy the judgment. Instead, all the creditor would be entitled to receive is the distributions that are made from the LLC to the owner.

Since oftentimes no distributions are made to owners of closely held businesses and instead the profits are reinvested in the business, a creditor of an LLC owner may not be able to collect on any part of his judgment against the LLC interest.

Another advantage of the LLC is that it generally is a flow-through entity for income tax purposes since it is taxed as a partnership.

Many family-owned businesses historically have been operated through a C corporation, which is a separate taxable entity. The problem with the C corporation is that dividend distributions are not deductible by the corporation, so there is the possibility the corporate earnings could be taxed twice before they reach the owner’s hands, once at the corporate level and again at the shareholder level when dividends are paid. As a flow-through entity for income tax purposes, the LLC reports its income on a separate income tax return but pays no income tax. Instead, each owner of the LLC reports his or her prorata share of the income from the LLC on their separate individual income tax returns. The result of partnership taxation is that the income from the LLC is only taxed once.

An important concern for a family business owner is planning for the transition in ownership and management of the family business to the younger generation and the effect of estate taxes on the assets of the business owner. LLCs can help out here, too.

The LLC structure can facilitate the shift in control from the business owner to the child or children who have been groomed to take over the family business when the time arises.

Many family businesses face a cash crisis on the death of the survivor of the business owner and spouse as a result of the estate tax imposed.

With proper planning, the combined estate of a husband and wife are exempt from estate tax up to a value of $1.3 million in 1999. For family businesses that have a value in excess of $1.3 million, business owners need to consider other estate planning techniques to reduce the value of their taxable estates.

One such technique is making annual gifts to children of a portion of their ownership interest in the family business. By making gifts of interests in the family limited liability company, the business owner can substantially reduce the size of his estate and still retain control over the family business.

A big concern of many business owners is that they may lose control over their family business if they give away ownership interests in it. Using a family limited liability company for making gifts can alleviate many of those concerns.

One method for retaining control by the family business owner is by having him or her hold the position of manager of the limited liability company. As the manager, the owner of the limited liability company has authority to control the operations of the business. By a contract called the operating agreement, the business owner can be assured that he will remain as manager for as long as he desires.

Another method for the business owner to maintain control over the family business is by giving away ownership interests that do not have voting rights. By retaining his or her voting rights, the business owner can maintain control over the business but still reduce the value of the estate by gifting the non-voting interests.

With LLCs, more value can be transferred to family members at a reduced gift tax cost by making gifts of an ownership interest in a limited liability company as opposed to gifts of individual assets.

This is because a minority interest in a closely held business is typically not worth as much as the prorata part of the value of the underlying assets of the business. For example, if the business itself is worth $100,000 and the business owner gives a child a 10 percent interest in the business, the gift is worth something less than $10,000.

In determining the value of the gift, the test is what a willing buyer would pay a willing seller for the minority interest. It is well recognized that a buyer will not purchase the minority interest in the limited liability company for an amount equal to the prorata part of the underlying assets of the business — $10,000 in this example. The reason a buyer would pay less than $10,000 for the interest in the limited liability company is that there is no ready market for the minority interest in the family business — discount for lack of marketability — and the minority interest owner cannot control the business — discount for minority interest.

A buyer may substantially discount the amount he would pay for the limited liability company interest because of these factors. Assuming a discount of 30 percent, the buyer would be willing to pay only $7,000 for a 10 percent interest in a limited liability company having assets worth $100,000.

These valuation techniques can be utilized with limited liability companies to provide a bigger benefit to the business owner from certain gift tax exclusions available under the tax law.

One such exclusion, the annual exclusion, allows the business owner to annually give up to $10,000 — $20,000 for the business owner and his spouse — to any one or more individuals without any gift tax consequences. If the business owner wan
ts to reduce the value of his estate by making annual exclusion gifts to his children, he could for example give a child a $10,000 interest in the family limited liability company with no gift tax consequences. A $10,000 gift in the family limited liability company may equal a 13 percent interest in the LLC worth $100,000.

By giving away an interest in the family limited liability company, the business owner can transfer assets which in his hands would be worth about $13,000 for a gift tax cost of only $10,000. Over time, the business owner can transfer a substantial amount of the family business to family members at a reduced gift tax cost and still remain in control of the business.

As you can see, utilizing a family limited liability company in the succession and asset protection plan for the family business can result in tremendous advantages to the business owner and family. The key to designing and implementing a plan that fits your family business is working with your lawyer, accountant and financial planner. Your team of advisers can evaluate your personal situation, recommend a plan that is right for you and your family and then see that the legal documents necessary to effectuate the plan are put in place. Limited liability companies may not be right for every family business, but with the advantages they hold, don’t you think it is worth exploring the possibilities?