Chairman STARK. Thank you. I guess we did a similar sort of thing with real estate just recently for debt financed real estate participation.

Can you explain very briefly for me an outline of the route used by some to achieve this without legislative change?

Mr. GRAHAM. There are principally three routes, Mr. Chairman. One is through the creation of the passive interest known as the net operating profits interest.

A second is through the use of the overriding royalty interest, and

The third through the use of offshore trusts which I have to confess I am not totally familiar with.

But these are of questionable validity relative to the Tax Code, and they are nevertheless indirect ways to do in fact what the limited partnership provides which is limited liability, limited participation in the activity and also a right to receive the profits.

Chairman STARK. I presume that the only reason to take a partnership and dissolve it and distribute royalty interests, for example, is that you may have additional drilling opportunities or require additional capital to rework wells in the future and then you have an agreement in most of these participations that people will pony up their share of the capital, so that that would prohibit you from at some point in time just saying, OK, Apache No. 37 is done, we will just distribute royalty interests in this block of land and everybody will be separate owners.

That, I gather, is structurally a problem in the industry in general. Is that right?

Mr. GRAHAM. I think that what happens in those situations, if I understand the chairman correctly, you are asking the question as to when there are additional oil and gas investment opportunities in an existing entity, what is done.

Chairman STARK. I know what is done. That is the only thing that seems to me that would get the colleges in. In other words, if you would have 1 acre and could only drill one well, and you would drill the well and it would never take any additional capital or you would be sure you would never need any more capital than what it would provide, you could distribute the royalty interests. You wouldn't have to do the partnership accounting.

Mr. GRAHAM. That is a mechanism that can be used.

Chairman STARK. Is it practical if you have other wells? I guess my next question is, What happens to a bank that forecloses on a loan and the examiners just let them pony up the money to keep their share of the production in a partnership, or do they have to just wait and let the other partners suffer the penalty for not providing their share of the capital? Anybody know?

Mr. CAIN. You mean in case the bank went bankrupt?

Chairman STARK. As is fairly common, a limited partner of yours, let's say, may very well pledge, borrow from a bank against prospective royalty for oil payments and then let's say, like the bank down south, they borrowed more than the thing was worth.

Now, the bank might elect-they foreclosed on that interest-I guess what I am saying, let's assume it is an ongoing partnership that has drilling prospects in the future, that calls for some major capital to deepen or rework a well.

Does the bank normally put up their share of capital or do they just wait, and most of your agreements say if you don't come up with the additional capital, the other partners-what do banks normally do?

Mr. GRAHAM. What banks normally do? The banks are relatively hesitant to loan against partnership interests in any regard, but those that do, if there is a foreclosure of that interest, the bank's

interest is to receive its cash, and that interest will be put up for sale.

I would point out that in most programs that do involve drilling there are usually adequate capital provisions retained in the capital base of that entity to provide for a reasonable opportunity to develop the opportunities.

Once that capital is then expended, then normally any additional opportunities that appear are usually farmed out or sold to third parties.

A third point would be in those situations many sponsors-and I believe most of the sponsors that are OII members provide a liquidity means whereby they may retender that interest to the sponsor at a published price; that is, published to all the participants, and that sponsor will repurchase that interest for cash.

So those are the ways that they achieve liquidity in the normal instance.

Chairman STARK. OK. Thank you all very much.

The Chair would just state that several members of the Ways and Means Committee have submitted statements-in this case, Mr. Archer on H.R. 4167. Without objection, it will be put in the record.

Without objection, statements of any members will be accepted into the record during the 2-week period that we will leave the record open.

Is Mr. Lopeman here?

Mr. Lopeman, American Independent Refiners Asociation.

In his absence, if we have his statement here, it will appear in the record his testimony on H.R. 4779, which Mr. Thomas testified on earlier this morning.

That concludes the hearing.

The committee stands adjourned subject to the call of the Chair. [Whereupon, at 2:45 p.m., the hearing was adjourned.]

APPENDIX

The text, summary, and written comments received on bills which are the subject of the hearing follows. The bills are arranged in numerical order.

To define the circumstances under which construction workers may deduct travel and transportation expenses in computing their taxable incomes for purposes of the Federal income tax.

IN THE HOUSE OF REPRESENTATIVES

JANUARY 6, 1983

Mr. STARK (for himself and Mr. HANCE) introduced the following bill; which was referred to the Committee on Ways and Means

A BILL

To define the circumstances under which construction workers may deduct travel and transportation expenses in computing their taxable incomes for purposes of the Federal income

1

tax.

Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,

3 SECTION 1. AMENDMENT OF INTERNAL REVENUE CODE OF

4

5

1954.

(a) TRAVEL AND TRANSPORTATION EXPENSES OF

6 CONSTRUCTION WORKERS.-Section 162 of the Internal

7 Revenue Code of 1954 (relating to deductions for ordinary

(239)