Summary of Proceedings

Joint Minerals, Business and Economic Development Interim Committee

Oil and Gas Conservation Commission                                                                  May 21-22, 2002

Casper, Wyoming

PRESENT:            Senator Bill Hawks, Cochair

                        Representative Clarene Law, Cochair

                        Senators Decaria, Mockler, Schiffer and Youngbauer

                        Representatives Anderson, Childers, Esquibel, Illoway, Lockhart, Meyer and Miller

                        Legislative Service Office:  Emily Birtell Gardyasz

                        Others: See Appendix A, Committee Sign-In Sheet.

ABSENT:         Rep. Eyre

AGENDA:        See Appendix B

MEETING MATERIALS:            See Appendix C, Dept. of Revenue White Papers

And Summary of Meeting 4/30/02.  Appendix D, Mineral Tax History. Appendix E, Memo to Management Council 5/2/02.    

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Day 1.  Call to order/Roll call.  Cochair Hawks called the meeting to order at 9:00 a.m. and roll call was taken.  See Appendix F, Attendance.

Interim Committee Rules.  Cochair Hawks explained that the rules adopted last interim modified the provision for motions to reconsider.  Cochair Hawks suggested that the Committee amend the interim rules to go back to the standard language for motions to reconsider.  Rep. Childers moved to amend the rules. Rep. Lockhart seconded.  Passed.  See Appendix G, Amended Interim Rules.

Senator Schiffer moved that a majority vote be required by both House and Senate members in order for a bill to be sponsored by the committee.  Seconded.  Motion failed.

Review of the Wyoming tax system.  Earl Atwood, Director and Randy Bolles, Mineral Tax Administrator for the Department of Revenue (Department) provided a review of Wyoming's mineral tax system and how taxpayer returns are processed.  See Appendix H, The Tax Return Process.

Taxpayer compliance.  Mike Geesey, Director of the Department of Audit (Audit) reviewed the latest available assessment and audit figures.  In 2000, $6.5 billion of assessable value was reported. Six percent of the taxpayers own ninety percent of the taxable value.  868 taxpayers reported taxable value in 2000.  Audit conducts 50-70 audits/year. All coal companies are audited every three years.  In audits of the largest twenty companies additional taxable value is found.  These are the multi-integrated companies.

The mineral industry is 97% compliant; i.e. the companies have paid 97% of what they owe pursuant to Department of Revenue statutes and rules.  The remaining three percent is a net number of under and over payments and represents disputes over statutory interpretation.

Audit's budget.  Mr. Geesey explained that the Mineral Tax Audit division has thirty-six employees plus an attorney.  Audit has $2 million/year for mineral tax audit of which $1.2 million is federal money for federal mineral royalty tax audits and the remaining $800,000 comes from the general fund.

Proportionate profits for coal.  The Department provided an overview of proportionate profits.  See Appendix I, Proportionate Calculation for Coal.  Mr. Bolles explained the direct cost ratio, direct mining costs and indirect costs.  Natural gas also uses the proportionate profits method.

Powder River Coal Co. decision.

The State.  Mr. Bolles explained that the issue involves a dispute between the Department and Powder River Coal Company over the classification of lease bonus payments.  The Department claimed the bonus payments were a direct mining cost and Powder River claimed they were royalties or alternatively, indirect costs.  The Wyoming Supreme Court held that bonus payments are not a royalty, but are an indirect cost.  As a royalty the bonus payments would have been completely exempt from taxation; still, the Court's holding that bonus payments are indirect rather than direct costs results in reduced taxable value.  See Appendix C.

Marty Hardsocg of the Attorney General's Office explained the Court's decision to the Committee.  See Appendix J, Powder River Coal Co. v. Wyoming State Bd. Of Equalization.  The Court held that lease bonus payments do not fall within the catch-all phrase for direct mining costs.  The Court labeled direct mining costs as "hard mining costs."  The Court held that lease bonus payments would have to be allocated, so they are an indirect cost. The Department argued that bonus payments are not an indirect cost.

Mr. Hardsocg said that any changes to the direct cost ratio are dramatic.  The Department has direct costs that are allocated. The Court's decision takes out of the direct cost ratio the actual cost of the lease and the value of the coal itself; all that is left is the cost of extraction.

The Court's dicta that certain costs, like engineering and environmental costs, are indirect will potentially be argued by taxpayers.  The Court's decision will apply to five (5) years of returns and anything to be allocated will be a problem.

Severance and ad valorem tax in the amount of $10 million is at issue.

The Department presented alternatives to the Committee.  Mr. Bolles said that "depletion" could be defined.  See Appendix K,  "Depletion" defined.  The depletion definition would probably work for oil and gas.

Industry response.  Marion Loomis of the Wyoming Mining Association distributed handouts presenting the industry viewpoint.  See Appendix L, Coal Lease Bonus Payments and Appendix M, Wyo. Mining Assoc. Presentation.  Mr. Loomis said that the Wyoming Mining Association is opposed to any change in the statutes.  Mr. Loomis introduced Larry Wolfe, Don Coovert and Bill Hartzler.

Mr. Coovert, accountant with RAG American Coal, helped draft the statutory language at issue.  The indirect costs are subject to tax.  Mr. Coovert worked on legislation in 1988, 1989 and 1990. Proportionate profits was conceived by the IRS and Wyoming adopted it.  But instead of total cost, Wyoming uses direct costs.  With proportionate profits, the state avoids losing any cost in valuation.  There is only one allocation method, if not captured by function.  He has always maintained that is what the statute meant.

Mr. Wolfe, who represents three coal companies, including Powder River Coal said that the legislature ought to write clear, concise, non controversial statutes.

Mr. Wolfe said that as a result of the Court's decision, all coal companies might consider bonus and depletion expenses as indirect costs.  The statute has served the coal industry well over the years.  This is the first time costs have been litigated.

In the 1994 Exxon case, the Board of Equalization looked at final reclamation costs; if they cannot be allocated, they are indirect costs.  Indirect costs are taxed, not in the direct cost ratio, but on the basis of the direct cost ratio.  Mr. Wolfe said that coal companies are not going to manipulate costs.  The Powder River case requires the taxpayer to allocate per the direct cost ratio.

Mr. Wolfe explained that the purchase price of coal is included in taxable value; 60-80% of the lease value is included in the taxable value.  Even as an indirect cost, it is subject to tax.

Mr. Hartzler, tax manager for RAG American Holding, Inc., testified that companies track costs by function, i.e. to determine when equipment needs to be replaced.  Mr. Hartzler provided a copy of the Department's Schedule A and a direct cost analysis.  See Appendix N, Annual Gross Products, Schedule A and Direct Cost Analysis.  The "hard mining costs" would not be allocated.

Mr. Loomis pointed out that Wyoming receives a tremendous benefit from bonuses.  See Appendix M, Wyo. Mining Association, Table 1.

Jerry Shatzer, Gillette County Assessor, stated that everyone wants consistency; this can be achieved statutorily.  Mr. Shatzer is concerned for the whole state.  This is not a Campbell County issue.  He is concerned about the loss of revenue to schools.  70% of all mill levies go to the schools.  Campbell County will pay $300,000 in recapture this year.

Sarah Gorin, Equality State Policy Center, is concerned that the state exercise financial stewardship toward coal, a non-renewable resource.  Revenues have lagged coal production.  Ms. Gorin said we should have data to review.  Lease payments will be made, it just depends on whether the state will reap the benefit.  Under proportionate profits, where costs are attributed, whether direct or indirect, makes a difference in the taxable value.  We need clear statutes.  There are revenue impacts.

Wrap up.  Mr. Bolles explained that the bonus as a direct mining cost is included in the numerator and the denominator of the ratio. Taking the bonus out of the ratio reduces tax revenue.  See Appendix C, Dept. of Revenue White Papers.

Cochair Hawks pointed out that cost allocation will affect gas. After discussion, Rep. Lockhart moved to proceed on the Powder River Coal issue.  See Appendix O, Rep. Lockhart's Motion.  Rep. Illoway seconded.  The motion carried.  The intent of the motion is that the Committee will continue to consider the issue.

Senator Youngbauer later moved that the Department and industry work together, consistent with existing law which would include the Powder River case, to develop proposed legislative changes as may be necessary to clarify direct and indirect mining costs and the proper method of cost allocation and present proposals at the next Committee meeting.  Rep. Lockhart seconded.  Motion carried.

Point of valuation.

The State.  See Appendix C, Dept. of Revenue White Papers.  Mr. Bolles explained that the point of valuation is the top of the ramp for surface mines.  The problem is that this point of valuation changes.  This point determines costs in the numerator and denominator of the direct cost ratio.  Aerial maps are used to verify the location.  The point of valuation can become a contentious issue on audit.  The Department needs a consistent point for valuation.  The industry has changed and more companies are using conveyor systems. Mr. Bolles reviewed various alternatives.  Currently the Department is not involved in litigation regarding the point of valuation; the Department has worked with mines.  If the Committee were to choose a factor, the statutes would have to be clear as to how the factor is determined to eliminate the potential for disputes.  Costs do vary significantly from mine to mine.

Industry response.  See Appendix P, Wyo. Mining Association, Point of Valuation.  Mr. Loomis said that the Department and Audit have been able to determine the point of valuation.  He is concerned about moving the point downstream, which creates "winners" and "losers".  Regarding an industry factor, a mine factor would have to be done each year.  Two years ago, language was drafted to establish a pure calculation from the face of the mine to establish point of valuation.

Mr. Coovert said the current system is complex, but it does work well.  Unless the Legislature is going to change valuation, don't fix what is not broken.  Mr. Coovert said it is not impossible to determine the point of valuation, but a formula could use an engineering mechanism to calculate the same result.

Mr. Hartzler testified that the Department and Audit need an engineer on staff to help determine the point of valuation.

Wrap up.  Mr. Bolles relayed that two years ago industry met with then Director Johnnie Burton and himself regarding this formula and the Department asked for information regarding the effect on taxable value.  With the exception of one company, industry didn't respond. Mr. Loomis agreed to work on this matter; he agreed to poll the industry members in the immediate future and have an answer for the Committee this interim.

Rep. Illoway moved to table the point of valuation issue, directing industry and the Department to report back to the Committee this interim.  Rep. Childers seconded.  Motion passed.

The first day came to a close at approximately 4:30 p.m.

Day 2.  Call to Order/Roll Call.  Cochair Law called the meeting to order at 8:00 a.m. and roll call was taken.  See Appendix F.

Valuation Floor for Coal.

The State.  See Appendix C, Dept. of Revenue White Papers.  Mr. Atwood and Mr. Bolles presented the issue for the Committee.  The Department and the Attorney General's Office believe that coal has an inherent value. Regardless of the market value, the state needs a safeguard to ensure that the state receives value for the coal.  The cost build-up approach would establish the floor.  In Hillard v. Big Horn Coal, the court indicated that minerals do have intrinsic value and approved the cost build-up approach.  If the company could not sell the coal to cover costs, it would not mine the coal.  While members of the coal industry do not want coal to be treated as bentonite, coal could have a statutory floor like bentonite, found at W.S. 39-14-403.  Mr. Bolles reviewed the alternatives with the Committee.

The Committee discussed the issue.  Mr. Bolles said that with proportionate profits the state will always receive some tax.  The Department anticipates that the Revenue Committee will discuss a floor for natural gas.  A floor for coal may never become effective, but it is a safeguard.

As a mine gets deeper, a mine is less efficient and becomes a high cost producer.  Mr. Bolles acknowledged that a floor would be a penalty to less efficient producers.

In a comparison of coal and natural gas, Mr. Bolles explained that 74% of the costs incurred in the Powder River Basin for coal related to production and the opposite occurs in natural gas with approximately 25% related to production.

Industry response.  Mr. Loomis distributed a handout on the issue of a valuation floor for coal.  See Appendix Q, Wyo. Mining Association, Valuation Floor for Coal.  Mr. Loomis urged the Committee not to adopt a floor.  The Big Horn Coal case was decided when coal was valued another way.  There is no reason to establish a floor on coal.  If the market permits, companies will produce.  He suggested that coal is akin to residential property, if the value of your house goes down, you pay on a lesser value, lower property taxes.

There are times when companies will have to sell coal for a loss, for a time.  Coal contracts have due diligence requirements.

Mr. Hartzler said that the Coal Equity Act, W.S. 39-14-105 only goes to severance tax; there is no relief from ad valorem taxes.

Mr. Hartzler said coal is worth what the market will pay.  Mr. Loomis said the minerals are not worth more than the price.  Mr. Hartzler said the real issue is what costs do you include, cash costs?

Mr. Hartzler said that because industry does not know what the minimum would be, it cannot support it.  Industry needs more definition.  Mr. Bolles responded that all direct costs of mining would be added up to determine the floor.

Sarah Gorin supports a floor.  The coal is only taxed one time.

Greg Koenig, Black Hills Corporation (Wyodak Mine) opposes a floor. He questioned how the inherent value of the coal changes based on cost structure.  Mr. Koenig said that mineral taxes are different from other taxes.  Coal companies make huge investments without a guarantee to cover expenses.  Stay with fair market value as the basis for taxation.

Senator Hawks moved to table this issue until the Department can give the Committee a reasonable estimate comparing the cost buildup method vs. proportionate profits.  Rep. Illoway seconded the motion.  Passed.

The Committee agreed that there is latitude in the motion to allow any further investigation while the Department works with industry. This matter can come back before the Committee for further discussion.

Intercompany/Affiliate Sales

The State.  See Appendix C, Dept. of Revenue White Papers.  Mr. Bolles explained that for non-arms length sale of coal, the fair market value is determined pursuant to W.S. 39-14-103(b)(viii).  He gave an example of a captive mine with both an arms length contract and a non-arms length contract.  Mr. Bolles asked, should not the value of coal sold under the non-arms length contract be the same as the arms length contract.  He presented the alternatives to the Committee.

Industry response.  See Appendix R, Wyo. Mining Association, Intercompany/Affiliate Sales.  Mr. Loomis explained that the problem with the options is that the Department should not be allowed to pick the highest dollar amount for fair market value. Vince Mockensturm of Kennecott Energy, Brian Durning of Pacific Corp., and Brad Enzi and Greg Koenig of Black Hills Corp. spoke against statute changes.  Mr. Enzi said the Committee should wait to see the result of current litigation with their company.

Later, Mr. Loomis mentioned that the "Coal Daily" comes out daily with prices for Powder River Basin, comparables for coal that the Department might use to establish an arms length sale price.  See Appendix S, Coal Daily.

Wrap up.  Mr. Atwood asked, should the Legislature wait for the Wyoming Supreme Court to tell them what the Legislature meant? There is a clear and immediate need to improve valuation where there is no arms length sale.  The statutory 12 months puts blinders on the Department by restricting the Department's ability to find a comparable.

Mr. Atwood said that the Department would talk with industry and perhaps reach a compromise.  It is not the Department's intent to seek the highest taxable value by choosing the highest option.

Rep. Illoway moved to table the matter and have the Department work with industry; and have the Department provide a summary of the eight cases that have been brought.  Senator Hawks seconded.  The motion carried.  Then the Committee considered having bills drafted, but determined that because the matter was tabled, they could not proceed.

Rep. Esquibel moved to reconsider the vote.  Senator Hawks seconded.  The motion passed.  The Committee voted on the original motion to table.  Failed.

Senator Mockler moved that LSO staff work with the Department of Revenue to draft changes to W.S. 39-14-103(b)(viii) pursuant to the Department's alternative two of Intercompany/Affiliate Sales White Paper:

39-14-103.  Imposition.

(b)  Basis of tax (valuation).  The following shall apply:

(viii)  For coal used without sale, or coal not sold pursuant to a bona fide arms-length agreement, the sales value for the purposes of paragraph (vii) of this subsection shall be the current fair market value of coal which is comparable in the quality, quantity, terms and conditions under which the coal is being used or sold, both in the spot market and through long-term agreements negotiated within the previous twelve (12) months, multiplied by the respective number of tons used or sold for each reporting period;  as determined by:  The arms-length price of comparable coal produced from the same mine and sold or used under comparable terms, or if a comparable coal price is not available from the same mine, the arms-length price of comparable coal produced from other mines in the area and sold or used under comparable terms;

Rep. Esquibel seconded.  See Appendix C, Department of Revenue Intercompany/Affiliate Sales White Paper.

Senator Schiffer moved an amendment to include in the drafted language words to the effect that the valuation is to determine current fair market value at the mine mouth.  The amendment and motion both carried.

Alternative Valuation Method.

The State.  See Appendix C, Dept. of Revenue White Papers.  Mr. Bolles explained that W.S. 39-14-103(b)(x) needs to be changed to allow the Department to choose an alternative method.  The Department can notify the taxpayer and if the taxpayer disagrees, he can appeal.  At least once a year the Department considers a request from a taxpayer for an alternative valuation method.  Mr. Atwood said this issue is about administrative process.  This will expedite matters.  This is to the taxpayers' advantage.

Industry response.  Mr. Loomis explained that under current law, the Department does not have to accept the taxpayers' alternative method.  The taxpayer should have the right to accept or reject the Department's method.  The statute does not need to be changed.

Mr. Koenig pointed out that previously the Department had to petition the Board of Equalization to use an alternative method. Now the taxpayer and the Department talk if there is a dispute, without going through the appeals process.

Senator Schiffer moved to have LSO draft legislation to allow the Department to use an alternative method in accordance with the Department's second alternative on page two of the Alternative Valuation White Paper.  See Appendix C Dept. of Revenue White Papers.  Senator Hawks seconded. Motion carried.

The next meeting.  Interim topics 2 through 6 (See Appendix T Joint Minerals, Business and Economic Development Interim Committee list) will be on the agenda:

Topic 2 Business Council

Topic 3 Board of Prof. Engineer; Board of Geologists

Topic 4 State Mining Council

Topic 5 Banking

Topic 6 UW Public Policy Institute

Additionally, trona valuation will be on the agenda.

The next meeting will be held July 11th and 12th in Laramie.

Adjournment.  The meeting adjourned at approximately 12:30 p.m.

Respectfully submitted,

Senator Bill Hawks                Representative Clarene Law

Cochair                                 Cochair

All appendices referenced are on file at the Legislative Service Office.