BILL ANALYSIS AND FISCAL IMPACT REPORT	Page 1 of  2

DATE:  February 22, 2001	Submitted by: TAXATION AND REVENUE DEPT.
	T. GLENN ELLINGTON, SECRETARY
BILL NUMBER: HB - 864

SPONSOR: Representative Burpo

BILL SHORT TITLE: Sequestering Certain Tax Payments Until Risk of Litigation Has Ended

DESCRIPTION: This bill generally proposes some changes to the tax administration act to accommodate possible severe swings of revenue resulting from an aggressive Natural Gas tax verification program. See “Background” below. (1) first, the bill authorizes the Department to pay outside counsel on a contingency basis, provided that the amount of contingency is approved and directed by a court or hearing officer; (2) allows all payments on assessments issued against the Emergency School Tax, Conservation Tax, Oil and Gas Production Ad Valorem and Oil and Gas Severance Tax (see TECHNICAL ISSUE #1) be sequestered in the Extraction Taxes suspense fund until risk on litigation has ended. The Secretary is charged with determining a rule under which payments on assessments other than those from the Natural Gas tax verification program will be immediately released to beneficiaries. Identified payments will be held in suspense, perhaps for years, until the litigation has ended.

EFFECTIVE DATE: not stated – 90 days after adjournment (June 17)

FISCAL IMPACT (Thousands of dollars):  		Note: Parenthesis ( ) indicate a revenue loss:
		Recurring or		
Estimated Impact on Revenues	Nonrecurring	Funds 	
	 FY 2002 	Full Year	     Impact     t     	             Affected          .             	
	*	*	Non-recurring	General Fund (school & conservation)	
	*	*	Non-recurring	STBF (O & G severance)	
	*	*	Non-recurring	STBF bond capacity	
	*	*	Non-recurring	Local Governments and School Districts	

Revenue from this extensive audit and litigation effort has not been included in the short term or long term revenue estimates. Thus, any money collected and distributed should be considered as windfall revenue. Even if payments are sequestered for perhaps years, it will be a windfall when transferred. Based on analogy with the oil program, which generated $11 million in cumulative payments, the Natural Gas program could lead to $40 or $50 million in gross assessments and payments, $30 million in net. The general fund share of sequestration is required to fund attorney’s fees, without disrupting flow of other revenue to the general fund and STBF.

ADMINISTRATIVE IMPACT: The purpose of the sequestration is to assist local governments in their prudent spending and budgeting efforts. Only when the money is “real” will the beneficiaries receive it. The purpose of the change in section 1 is that attorneys will be paid for their work on a timely basis, even if the particular litigation is appealed.

TECHNICAL ISSUES:
1.	On page 5, lines 12 and 13, add “Oil and Gas Production Equipment Ad Valorem Tax. The Oil and Gas Severance Tax is assessed together with Emergency School, Conservation and Ad Valorem Production Equipment Tax.
2.	While the four taxes listed above are assessed together, the only one that affects local governments is the Oil and Gas Production Ad Valorem Tax. If the purpose of this bill is to isolate the “roller coaster” effect on revenues transferred to local governments, then only the OGPAD tax need be listed. This would require a change in audit practice to separately assess OGPAD liabilities from the state-level taxes.

OTHER IMPACTS AND ISSUES:
The 1997 legislature authorized the Department to hire private counsel on a contingent fee basis to launch an investigation into the possible underpayment of severance taxes on oil.  The project has been highly successful, bringing in over $11 million to date, with more recovery anticipated.  The 1999 legislature expanded the project to an investigation of natural gas. This proposed legislation will help the Department carry on the project, by solving two problems that were not anticipated at the start of the litigation.

The first problem is providing a mechanism for paying the private counsel in refund cases. When the Department issues an assessment, the taxpayer may choose to file a protest, or pay the assessment and seek a refund. The first cases to be litigated were protest cases, in which the taxpayer filed an administrative protest challenging the assessment. At the conclusion of the litigation, the amount of tax due was set by a judgment or a closing agreement. The hearing officer also entered an order for fees and costs. When the taxpayer paid the judgment, fees and costs were paid and the balance of the recovery was distributed to the recipients of the tax.  We will need a different procedure for refund cases. In a refund case, the taxpayer pays the assessment, and the money is distributed to the various recipients. The taxpayer then has up to three years in which to file a refund claim. If the refund claim is denied, the taxpayer may then protest the denial, or challenge the denial in district court. If the court or hearing officer orders all or part of the payment to be refunded, the Department will pay the refund plus interest at a rate of 15% per year. Future distributions to the recipients of the tax are reduced in order to pay the refund. If the Department is successful in defending all or part of the refund denial, there is no additional money from which to pay attorney's fees. And there is no mechanism to pay fees from any existing funds.

The proposed legislation solves this problem by amending Section 7-1-6.20 NMSA 1978 to allow the Department to hold payments made on assessments issued under the oil and gas taxes in the extraction taxes suspense fund until the Secretary determines that there is no substantial risk of protest or other litigation. The proposed legislation also amends Section 7-1-6 NMSA 19878 to allow the Department to pay attorney's fees and costs on the oil and gas litigation out of the extraction taxes suspense fund. With these two changes, the Department will be able to use outside counsel to litigate the refund claims that are now being filed in the oil valuation project, and the refund claims we anticipate will be filed in the natural gas valuation project.

The proposed legislation solves a second problem that may arise in the course of the oil and natural gas projects. Although these projects are intended to generate additional revenues, the refund process causes great uncertainty for the tax recipients -- the counties, municipalities and school districts. If the oil and gas companies choose to pay the assessments and seek a refund, those entities will receive unexpected windfalls, but will not know whether that windfall will be taken away from them through a refund claim. Many counties are highly dependent on revenues from oil and gas taxes. A series of windfalls and refunds (or threatened refunds) could throw their budgeting into turmoil. Holding the payments in the extraction taxes suspense fund until the conclusion of litigation prevents this uncertainty.