IRS Continues Effort to Levy More Taxes on Drilling Industry

Abstract:Last June the Internal Revenue Service (IRS) proposed redefining offroad vehicles to make them subject to federal excise taxes, an exemption the industry has enjoyed for 25 years. The battle is heating up.

Analysis:The revenue collecting arm of the U.S. government will hold hearings in February on a rule-making change that would impose retail excise taxes on nonfarm equipment used in offroad applications such as oil and gas drilling, and the well service/workover industry.

The proposed change involves tweaking the technical definition of a highway vehicle to include heavy equipment normally used offroad. It would mean levying a 12 percent excise tax on the carrier portion of self-propelled drilling or well service rigs when such equipment is purchased new.

Additionally, an annual heavy vehicle use tax would be imposed on equipment already in use.

While there have been few new rigs added to the fleet over the last couple of decades, the industry expects increased demand for oilfield services to spawn a new-build phase within a decade as the nation replaces a drilling and well service fleet that, on average, is 20 years old.

Additionally the IRS would broaden the collection of fuel taxes on this equipment by phasing out tax refunds for non-highway use.

Currently, oil and gas drilling contractors purchase fuel on a fully taxed basis. Using a hub-meter or other recording device, contractors document the amount of highway as opposed to non-highway operation and file for a refund at the end of each quarter based on estimates of how much fuel was consumed onsite. Industry estimates place the fuel tax portion of this proposed change at $3,500 per rig, per year.

The technical change is another in a long line of battles over diesel fuel tax, tires, and a host of other provisions from which the drilling industry has largely been protected. It would alter through administrative fiat a regulatory structure that has been in place for more than 25 years. The excise tax exemption has existed since the highway trust fund originated. Current definitions were formalized in 1977 and rely on a three-part standard for defining nonfarm offroad equipment.

For oil and gas operators, the change represents one more item that increases the contractor's cost of business. It will show up in some form or fashion in day rates, particularly with regard to fuel costs.

The technical rule change will have a fairly broad economic impact if it is enacted. In addition to oil and gas drilling, the tax will affect general construction, particularly with regard to large mobile cranes, concrete pumpers, the timber industry, the groundwater drilling industry, the utility industry, and mining.

While numbers are hard to develop on a definitive basis, the tax would add $17.5 million annually in costs to the oil and gas drilling industry and an estimated quarter billion dollars in additional costs across all other industries.

That last number is significant. Once federal rule-making provisions reach the $100 million level, they are considered a major change and subject to greater scrutiny.

Monies would be added to the federal highway trust and used in road building or other nationwide highway projects. The irony is that few of the vehicles facing this new tax make much use of the highway system. On the drilling industry side, the impact would address trailer-mounted and self-propelled carrier drilling units.

The International Association of Drilling Contractors (IADC) estimates the average on-road travel for these vehicles at 5,000 miles or less annually. Most of the time these vehicles are onsite in remote, offroad environments boring hole to generate the nation's oil and gas.

While agricultural machinery has been exempted from this tax thanks to the farm lobby's political clout, the new rules could be stretched to include some farm machinery.

Though the hour is late, the tax is not a foregone conclusion. Industry trade groups were successful last September in extending the deadline for comment from September to December 4, allowing interested parties time to marshal opposition. As a technical change, the IRS was almost able to implement the proposal without general notice. However an employee in the Small Business Administration spotted the provision and alerted appropriate trade organizations. The proposed rule change subsequently generated hundreds of comments—a response level far higher than normal on issues of this kind.

Efforts to stave off the tax increase are coordinated through a Washington-based Mobile Machinery Coalition. In addition to the IADC and the Association of Energy Service Companies, coalition members include the National Association of Manufacturers, the National Federation of Independent Businesses, and trade associations in road building, the timber industry, and general construction. In all, more than 50 trade organizations are lobbying to derail the new definition.

"The irony is that at a time when the domestic economy is recovering, the IRS is proposing a tax increase on economic sectors like construction and oil and gas that are largely economically sensitive," explained Craig Piercy, director of the Mobile Machinery Coalition. "It's really bad economic policy."

The change would negate to some degree accelerated depreciation provisions that were part of the post September 11 economic stimulus bill.

The Mobile Machinery Coalition has gotten more than 80 congressional representatives to state bipartisan opposition to the proposed rule change. Additionally, both the chairman and ranking member of the Senate Finance Committee have expressed opposition to the change. Senators Max Baucus (D) Montana and Chuck Grassley (R) Iowa have written IRS acting commissioner Bob Wenzel seeking postponement of any decision until after the committee takes up reauthorization of the Highway Trust Fund during the 108th Congress.

Why the change? The IRS won't say, but some speculate it is an ongoing battle because industry has been successful at mustering political opposition to IRS rule-making provisions in this area. Additionally, political pressures to augment highway funding may be a motivator also.

The IRS has scheduled the administrative hearing for late February following the comment period, which closed last week. After a review of testimony and comments, the IRS could decide to go forward with the rules change, postpone the issue, or leave well enough alone. No one will know for a few months yet. Stay tuned.