Capital Costs Deductible Under Colorado's Severance Tax Law

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By Tripp Baltz

April 25 — The plain language of Colorado's severance tax law authorizes oil and gas companies to deduct the cost of capital associated with transportation, manufacturing and processing costs.

The cost of capital is deductible under the state's severance tax statute, which levies a tax on income derived from the sale of natural gas extracted from real property in Colorado, the Colorado Supreme Court ruled April 25 in a lawsuit brought by BP America Production Co. against the Colorado Department of Revenue. The ruling defines cost of capital as the amount of money that BP’s predecessors could have earned if they invested in other ventures rather than in building transportation and processing facilities.

The ruling is significant for the oil and gas industry because it means producers can realize a full deduction for the entire cost of a project, including the “time value of money,” and are therefore “more likely” to undertake such projects in Colorado, Christina Gomez, a partner with Holland & Hart LLP who represented BP America, told Bloomberg BNA April 25.

It “encourages operators to invest in infrastructure needed to get oil and gas to the market, as they can deduct for tax purposes not just the development costs outlaid for a project, but also the cost associated with the time value of money,” Gomez said. “We are pleased that the court recognized the cost that oil and gas operators incur when they make huge investments in facilities and aren’t able to recover that cost through depreciation deductions until much later in time.”

‘Clear Interpretation.'

The ruling allows the Colorado Petroleum Association, which filed an amicus brief in the case supporting BP America, to “provide a collective industry view of Colorado's severance tax statute,” CPA President Stan Dempsey told Bloomberg BNA April 25.

“Colorado businesses benefit from clear interpretations of Colorado tax law,” he said.

The Colorado Attorney General's Office, which represented the Department of Revenue, didn't immediately respond to Bloomberg BNA requests for comment.

The ruling overturns a decision by the Colorado Court of Appeals, which had reversed a lower court ruling that BP America was entitled to deduct expenses associated with the cost of capital. In 2005, BP filed amended severance tax returns for tax years 2003 and 2004, seeking to deduct the cost of capital related to its transportation and processing facilities from revenue generated by natural gas sales.

The parties in the case stipulated that if the cost of capital is allowed as a deduction, BP is entitled to refunds of $629,186 and $669,202 plus interest for tax years 2003 and 2004, respectively.

Any Costs

The state high court said the severance tax statute clearly grants a deduction for “any transportation, manufacturing, and processing costs.”

“The statute does not allow taxpayers to deduct some transportation, manufacturing, and processing costs but not others. Rather, it unambiguously allows a deduction for all transportation, manufacturing, and processing costs.”

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