This article was written by Mark Rossetti and Matt Dodge - State and Local Tax
The recent development in the natural gas industry of drilling in Marcellus Shale formations has resulted in growing business opportunities in the Eastern Great Lakes Region. Companies seeking to take advantage of these opportunities should be aware of the state and local tax implications of doing business in these states. Below is a brief overview of state and local tax considerations specific to the natural gas and oil and industry in New York, Ohio, Pennsylvania and West Virginia.
Governor David Paterson had proposed a 3% tax on natural gas severed from the Marcellus or Utica shale formations by means of a horizontal well. The severance tax proposal was not part of the New York budget, which passed in early August. On August 4, 2010, the New York Senate passed a moratorium on hydraulic fracturing (drilling) in the Marcellus and Utica shale formations until May 15, 2011. The moratorium is expected to become law once the New York legislature returns from its summer recess in September.
New York exempts from sales tax, purchases of machinery and equipment used directly and predominantly in mining or extracting activities. The exemption includes pipe, drilling rigs, vehicles and equipment used in the drilling and production up to the point of sale to the first commercial customer. The exemptions apply to the owners of the well in addition to operators and subcontractors.
Unless the operator is working in New York City, local tax issues in New York should not apply. Cities outside of New York City do not impose income taxes, and local sales taxes are collected and administered by the state.
Ohio imposes a severance tax of 10 cents per barrel for oil and 2½ cents per 1,000 cubic feet of natural gas. The contractor is considered the agent of the resource owner, and thus, the liability of the severance tax rests with the owner.
Ohio also imposes a commercial activities tax (CAT), which is levied upon persons who meet certain minimum thresholds. If Ohio-sourced gross receipts are less than $1 million, only the minimum tax of $150 is imposed. Any gross receipts sourced to Ohio greater than $1 million are taxed at a rate of 0.26%.
Ohio exempts from sales tax purchases of machinery, equipment or other personal property used or consumed principally in a mine or in the excavation from the earth of any substance that can be classified geologically as a mineral, or in the production of crude oil and natural gas. The exemption also applies to property used to transport the extracted substance to a plant or factory where it is to be processed by the person conducting the mining operation. Machinery and equipment purchased to repair or maintain other machinery and equipment that is used in mining is also exempt.
Ohio municipalities have a local income tax that is applicable to businesses with net profits earned within the municipality.
As part of Pennsylvania’s recently passed budget, the legislature agreed to pass a natural gas severance tax by October 1, 2010 which will go into effect no later than January 1, 2011. Currently, there are three (3) bills in various house committees of the Pennsylvania legislature, any of which could become law, once lawmakers return from their summer recess in September. (For additional information regarding the proposed bills please see our Insight, “Pennsylvania – Proposed Gas Severance Tax Legislation.”)
Sales and use tax exemptions exist for the purchase and use of property or services directly and predominantly used in mining, drilling or extraction operations. The exemptions range from extracting equipment to certain protective implements, to pollution control devices. The exemption also includes pumps, pipes, valves, fittings, replacement parts and repair services.
Pennsylvania may impose both income and a franchise tax, depending upon the type of entity conducting business. The respective rates may vary, depending upon the type of business. Therefore, consideration should be given to entity structuring or restructuring to minimize Pennsylvania tax obligations.
Some localities in Pennsylvania impose a mercantile and/or business privilege taxes for businesses operating within the borough, municipality or city. When operating in Pennsylvania, it is important to become familiar with tax obligations imposed by local jurisdictions.
West Virginia imposes a severance tax of 5% on oil and natural gas extraction. Exemptions exist for wells with minimal production, and an annual credit is available to certain taxpayers. Other taxes may apply to oil and gas producers and leases of land related to oil and gas production.
West Virginia imposes tax on personal property in the state, and annual returns are required. Additional filings specific to companies engaged in the oil and gas business may be required.
Sales tax exemptions in West Virginia for natural resources producers are based on the direct use concept. Adopted in 1987, the direct use concept allows an exemption for purchases directly used in operations when they are an integral and essential part of the activity. For example, chemicals used in drilling a well are exempt, while chemicals used to clean the administrative offices are taxable. Items directly used in production that qualify for exemption include: drilling rigs, machinery, repair parts to repair and maintain equipment, pollution control equipment, and safety equipment or clothing. The exemption applies to independent contractors engaged in natural resource production for an owner.
Most cities in West Virginia impose a business and occupation tax (B&O) with the rate of tax based upon the type of business activity. For example, in Wheeling the rate is $1.00 per $100 for production of natural resource products and $0.15 per $100 for selling tangible property at wholesale. Rates vary by city. New businesses operating in West Virginia are advised to contact the city where they will be doing business to properly determine their local tax requirements.
Schneider Downs provides accounting, tax, wealth management and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA and Columbus, OH.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.