Page images
PDF
EPUB

bill to amend the Internal Revenue Code of 1954, to permit individual retirement accounts, qualified retirement trusts, and certain educational organizations to invest in working interests in oil and gas properties without incurring unrelated business taxable income. I would like a copy of my written statement included in the record.

Senator ARMSTRONG. We will be happy to have it.
[The prepared statement of I. Jon Brumley follows:]

STATEMENT OF 1. JON BRUMLEY

SOUTHLAND ROYALTY COMPANY

ON

S. 1549

This written statement is submitted on behalf of Southland

Royalty Company of Fort Worth, Texas in response to Senate Finance Subcommittee on Taxation and Debt Management Chairman Robert Packwood's announcement of hearings on five miscellaneous tax bills including S. 1549, the subject of this statement.

Southland Royalty Company

Southland Royalty Company was founded in 1924. Southland is the 15th largest independent domestic oil and gas producer and it has operations in almost all of the major oil and gas provinces in the United States including Alabama, Arkansas, California, Colorado, Illinois, Kansas, Louisiana, Mississippi, Montana, Nebraska, New Mexico, North Dakota, Ohio, Oklahoma, Texas, Utah and Wyoming. Southland Royalty is a member of the Domestic Petroleum Council ("DPC"). DPC is also opposed to this bill.

General Information

Southland's Position Regarding S. 1549

S. 1549 will amend the Internal Revenue Code of 1954 to provide that income from an investment in an oil and gas "working interest" by certain tax-exempt entities, such as qualified retirement trusts, individual retirement accounts and college endowments, is exempt from federal income tax. Southland is opposed to enactment of S. 1549 for the following reasons:

Competition with Taxpaying Entities

The taxation of unrelated business taxable income ("UBTI") which has been in the Internal Revenue Code since 1950, is based

on the concept that tax-exempt entities are taxable at regular corporate rates on "active" business income which arises from activities which are unrelated to the entities' tax-exempt purposes. The tax on UBTI is imposed on nearly all exempt organizations as its coverage was extended by the Tax Reform Act of 1969.

The primary objective of UBTI is to eliminate unfair competition by placing the unrelated business activities of covered exempt organizations on the same tax basis as the nonexempt business entities with which they compete. The House Ways and Means Committee report on the Revenue Act of 1950 states:

The problem at which the tax on unrelated
business income is directed here is pri-
marily that of unfair competition. The tax-
free status of
organizations enables
them to use their profits tax-free to ex-
pand operations, while their competitors
can expand only with the profits remaining
after taxes. Also, a number of examples
have arisen where these organizations have,
in effect, used their tax exemption to buy
an ordinary business. That is, they have
acquired the business with no investment on
their own part and paid for it in install-
ments out of subsequent earnings a pro-
cedure which usually could not be followed
if the business were taxable.

The Senate Finance Committee commented that one major purpose of UBTI tax is to "make certain that an exempt organization does not commercially exploit its exempt status for the purpose of unfairly competing with taxpaying organizations." (See Rep.

No. 94-938, 94th Cong., 2d Sess. (1976) at 601).

One of the specific problems and concerns Congress sought to address in the taxation of UBTI was the availability of pools or the accumulations of tax-exempt income which confer upon nontaxable entities an "unfair and harmful competitive advantage"

-

over taxable entities. (S. Rep. No. 2375, 81st Cong., 2d Sess. (1950)).

In the case of an oil and gas drilling partnerships, pools of income created in the partnership, which would otherwise need to be withdrawn each year to pay tax on the partners' shares of partnership income, do not need to be distributed because taxexempt entities have no income tax liability. The result of such a tax-free pooling of funds is that the tax-exempt partner in effect controls the underlying partnership business because it controls the capital in the business.

This bill will reverse a basic tax policy against unfair competition by tax-exempt entities which has been consistently applied for more than 30 years. This bill takes the position that investment in oil and gas working interests should be excluded from the UBTI tax because such investments are passive in nature and are not involved in the active conduct of a trade or business. lined above, the investments in oil and gas working interests are not passive because they would be directly in competition with taxable entities.

[ocr errors]

As out

Southland, as well as other independents, depends on taxexempt organizations to provide capital to fund operations but the capital is obtained through the traditionally allowed "passive" investments the purchase of common stocks and bonds. The proponents of this bill erred in comparing oil and gas investments in working interests specifically to stock and bond investments because comparing such investments is like comparing apples and oranges. Similarly, the tax law should recognize the differ

working interests are generally highly speculative and risky. It is not sound tax policy that pension funds and college endowment funds should be invested in an oil and gas working interest where the entire amount of the investment can be lost if ail or gas is not found in quantities which can be produced in a economically feasible manner. Congress should encourage tax-exempt entities to invest in more conservative investments rather than risky and highly speculative investments, such as, direct investments in oil and gas.

The risks of the investment in oil and gas working interests are recognized in other parts of the tax code as there are special tax incentives for taxable investors. These incentives include the write off of intangible drilling costs, percentage depletion and the treatment of drilling funds as partnerships.

Related to the Exempt Purpose

The tax policy for allowing tax exemption is to encourage taxexempt entities to concentrate on their purpose and not on business matters necessary to make a profit. For this reason, tax-exempt entities are prohibited from concentrating their efforts on business unrelated to their purpose for existence. The complexities of an investment in oil and gas working interest require that a taxexempt entity become extensively involved in the oil and gas business just to make the decisions necessary to make prudent investments and to protect their capital. Tax-exempt entities should concentrate their efforts on their exempt purposes rather than the intricacies of the oil and gas business.

« PreviousContinue »