Could an oil and gas taxpayer use Rule 3.553 reserve methods for its full-cost pool, and when could proved producing reserves be used?

Plain-English summary

Rule 3.553's reserve methods could be used only to amortize intangible drilling costs—not an entire full-cost pool.

The taxpayer asked whether the rule could apply to leasehold costs, lease and well equipment, and intangible drilling costs together. The Comptroller said no. Rule 3.551(d)(1)(C) tied the Rule 3.553 methods specifically to intangible drilling-cost amortization.

The response also clarified reserve evidence:

• The ad valorem method required central appraisal district information.
• The registered-engineer method in Rule 3.553(b)(2) could use proved producing reserves if the engineer met the rule's requirements.
• For out-of-state property where local property tax did not use reserves, proved producing reserves could still be used through the registered-engineer method.

The letter explains that the methods were developed to avoid requiring a separate petroleum-engineer estimate for every well after the 1987 GAAP reporting change for larger oil and gas companies.

Currency note: This is a historical taxable-capital accounting ruling. Texas replaced the former franchise tax with the margin tax effective January 1, 2008.

What this means for you

Oil and gas companies reviewing historical reports

Do not extend a specialized reserve-estimation rule to leasehold or equipment costs that the rule did not cover.

Tax professionals

Match the reserve evidence to the selected method. Appraisal-district data and registered-engineer reports were distinct alternatives.

Common questions

Q: Could Rule 3.553 amortize the entire full-cost pool?
A: No.

Q: Could a registered engineer use proved producing reserves?
A: Yes, if the engineer met Rule 3.553(b)(2).

Q: Could that method apply to out-of-state properties?
A: Yes.

Citations and references

• 34 Tex. Admin. Code Sec. 3.553
• 34 Tex. Admin. Code Sec. 3.551(d)(1)(C)
• 34 Tex. Admin. Code Sec. 3.553(b)(2)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9811138L

Original ruling text

November 16, 1998

Dear Ms. **:

Thank you for your recent letter about Franchise Tax Rule 3.553. Before
responding to your questions, I think it would be helpful to provide some
history and background information surrounding the development of Rule 3.553.

In 1987, the Legislature passed SB 1170, which required oil and gas companies
with more than $1 million in surplus to file franchise tax reports using
generally accepted accounting principles. In 1988, industry associations
sought direction from the Comptroller's Office regarding which methods of
estimating oil and gas reserves would be acceptable for use in dealing with
intangible drilling costs under the new accounting requirements. Their concern
was to avoid the high compliance costs they would experience if they had to
have registered petroleum engineers' estimates for every well, as required by
the federal Securities and Exchange Commission.

The reserve estimating policies set out in Rule 3.415 (the predecessor to
current Rule 3.553) were developed after extensive staff study and consultation
with petroleum engineering experts and industry members. In addition, the
Comptroller's Office worked with the Association of Central Appraisal Districts
to establish a procedure (and form) whereby taxpayers could request reserve
estimates from each county's property tax appraisal records. The rule has
remained essentially the same since it was first effective in 1989.

I will respond to your questions in the order in which you presented them.

Query 1. Can the taxpayer use one of the four methods described in Rule 3.553
for amortizing the entire Full Cost Pool, which would include leasehold costs,
lease and well equipment, as well as intangible drilling costs?

Response: No. Rule 3.553 specifies that it applies only to estimating oil and
gas reserves to be used in amortizing intangible drilling costs. In addition,
Rule 3.551(d)(1)(C), provides in pertinent part: "... Acceptable oil and gas
reserve estimating methods to be used in amortizing intangible drilling costs
are listed in Rule 3.553 concerning Methods for Estimating Oil and Gas
Reserves. ... " (Emphasis added.)

Query 2. Please confirm that we can use proved producing reserves to determine
amortization under Rule 3.553. It is our understanding that the property
values for ad valorem purposes are determined using proved producing reserves.

Response: Rule 3.553 sets out four acceptable methods for estimating the
volume of oil and gas reserves to be used in amortizing intangible drilling
costs. The ad valorem method set out in the rule requires the use of central
appraisal district information.

Query 3. Can we use an engineering report received from an outside provider to
determine proved producing reserves, rather than getting a certificate for
every lease from the county assessors' offices?

Response: The method outlined in Rule 3.553(b)(2) permits evaluation of the
reserves by a registered engineer. If a registered engineer meeting the
requirements in the rule wants to estimate the reserves based on proved
producing reserves, that would be permissible.

Query 4. Can we use proved producing reserves for alternative method 2,
engineering reports?

Response: See response to #3.

Query 5. Can we use proved producing reserves for out of state properties if
the other state does not use reserves to calculate property taxes?

Response: Only if you are following the method outlined in Rule 3.553(b)(2).
See response to #3 above.

This response is based on the facts as presented in your letter. If the facts
change or if there are additional relevant facts, the response may change.

If you have any questions about this or any other franchise tax matters, please
write me or call me toll free at 1-800-531-5441, extension 3-3958.

Sincerely,

Teresa Comer
Tax Policy Division