Colorado Supreme Court decision changes tax burden of oil and gas companies
The Colorado Supreme Court found in favor of BP (ticker: BP) in a case that could have major tax ramifications for the state. The court unanimously sided with the company that the State of Colorado incorrectly disallowed tax deductions related to BP’s cost of capital in the transportation, manufacturing and processing of natural gas, a decision that could mean the state owes other companies hundreds of millions of dollars.
BP argued that it should be able to deduct the cost of building its own midstream assets in Colorado with return on investment in mind, Bill Mueldener, principal and Denver office managing partner for Hein & Associates LLP, explained to Oil & Gas 360®.
“The state has always allowed a deduction for transportation systems, but they said it only covered the cost of building the system and the depreciation on the system. The issue that has never been defined is what method of depreciation do you use? Is it over 10 years? 30 years?
“The BP case, though, was more about the cost of building the pipeline plus some return on investment,” said Mueldener. When a third-party company like Kinder Morgan (ticker: KMI) builds assets to transport gas, they consider the return on their investment in the project. BP (ticker: BP) said they wanted to include that return as part of their cost of capital.
“They felt that would be more representative of what the market would charge to move this gas to market,” said Mueldener. “The costs are more than just building the asset; they include owning and operating it as well.”
Deciding the value of the deduction for other companies may not be so clear-cut
While the 7-0 vote in favor of BP in the case was certainly a victory for the company, it remains unclear to what extent the decision may affect the wider industry. During a call hosted by Baird today, Christina Gomez, partner at Holland & Hart and the one of the plaintiff’s attorney during the case, said the decision may not lead to such a clear-cut outcome for other companies.
While the case was still in trial court, both parties agreed the amount that was owed if cost of capital was allowed, said Gomez, meaning that when the Colorado Supreme Court sided with BP, the amount it would receive was already known. How exactly the value of the tax deduction was decided, and how that might be applied moving forward remains to be seen.
While the parties had agreed beforehand on the value of the deduction “it wasn’t even clear from the case record how that amount had been calculated,” Gomez told Oil & Gas 360® in an email. Gomez said she believed it was calculated using the BBB corporate bond rate, but she was not able to immediately verify that fact.
Regardless of the method used to decide the value of the deduction, the Supreme Court was not deciding if it was appropriate for use in future cases. “It simply held that cost of capital is allowed and, therefore, BP was owed the stipulated amounts,” said Gomez.
“Going forward, I’m not sure how this will get resolved. It could be by the legislature, but more than likely it will either be by regulations issued by the [Department of Revenue] or by the courts when there are disputes over the proper amounts to be deducted.”
Colorado’s legislature may try to pass a law that would disallow this deduction moving forward after unsuccessfully attempting to do so in the final three days of its most recent session last week. Whether or not companies are able to claim this deduction moving forward, more cases could come to the Colorado courts as companies look for clarification on just how much they are owed from past tax years.
