15 AAC 55.195. Return on investment or cost of capital allowance to be used in calculation of reasonable costs of transportation for oil or gas, other than certain vessel transportation costs for oil or gas produced on or after January 1, 2003

(a) For a vessel, LNG transportation facility, or capitalized improvement placed in service before January 1, 1995, by the producer or by a person from whom, directly or through an intermediate transaction of the same nature, the producer later acquired the vessel as part of a larger transfer of both marine and non-marine assets associated with a business merger or acquisition transaction, a reasonable return including depreciation under 15 AAC 55.191(b) (3)(C) and (D) or 15 AAC 55.191(b) (4)(B)(iii) and (iv) is an amount that yields a return on the acquisition cost of the vessel, LNG transportation facility, or capitalized improvement, after federal income tax, of two percent plus the average annual national inflation rate, measured by the compound root of the GNP deflator, during the period between the time the commitment was made to construct or initially acquire the vessel, LNG transportation facility, or capitalized improvement for the purpose of placing it in service and the time when the vessel, LNG transportation facility, or capitalized improvement had been received or delivered and was ready to be placed into service, or if that period fell entirely within a calendar year, during that entire calendar year, except that if the department replaced that rate of return with a different rate of return for a vessel, LNG transportation facility, or capitalized improvement under former 15 AAC 55.190(i), that different rate of return is allowed instead. The allowance for the reasonable return on the acquisition cost is a level annual amount, determined in the year of initial acquisition for the purpose of placement in service, considering the marginal federal corporate income tax rate in effect that year and the contemporaneous and projected federal income tax benefits. If, in subsequent years, the federal tax rate changes, or other events occur that change the available federal income tax benefits, a revised level annual allowance must be calculated to yield the same after-tax return. For purposes of this subsection,

(1) "acquisition cost" means the amount, not to exceed the cost of the vessel, LNG transportation facility, or capitalized improvement when initially acquired for the purpose of placing it in service, capitalized by the item's actual or effective owner under generally accepted accounting principles, including costs of improvements made after the date a vessel or LNG transportation facility was initially placed in service, and reduced by the

(A) cash value of any federal income tax benefits, such as investment tax credit, of acquiring the vessel, LNG transportation facility, or capitalized improvement; and

(B) reasonable salvage value of the vessel, LNG transportation facility, or capitalized improvement;

(2) "after federal income tax" means after applying appropriate adjustments for the federal income tax benefits of owning and operating the vessel, LNG transportation facility, or capitalized improvement; these tax benefits include tax depreciation, foreign tax credits generated by foreign source income derived from the use of the vessel, LNG transportation facility, or capitalized improvement, capital construction fund contributions, and investment tax credits.

(b) For a vessel or LNG transportation facility placed in service on or after January 1, 1995, and before January 1, 2002, or for a capitalized improvement placed in service on or after January 1, 1995, and before January 1, 2002, that extends the life of a vessel or LNG transportation facility, (1) a reasonable return including depreciation under 15 AAC 55.191(b) (3)(C) and (D) or 15 AAC 55.191(b) (4)(B)(iii) and (iv) is $99,000 per year for 24 years for each $1,000,000 of adjusted shipyard cost, for oil or gas produced before January 1, 2002; and (2) a cost of capital allowance will be allowed as provided in (d) or (f) of this section or 15 AAC 55.196, as applicable, for oil or gas produced on or after January 1, 2002. For purposes of this subsection, "adjusted shipyard cost" means the total amount paid to the person building or selling the vessel, LNG transportation facility, or capitalized improvement to the producer, less any investment tax credit taken by the producer, or in the case of an effectively owned vessel or LNG transportation facility, taken by the legal owner of that vessel or facility and passed on in whole or in part to the producer through reduced charter-hire or lease payments, and less any salvage value used by the producer to compute depreciation expense reported to shareholders and owners. If a vessel, LNG transportation facility, or capitalized improvement is acquired through a contract that states the purchase price in terms of a foreign currency, the cost is the equivalent amount in United States dollars as determined by applying the foreign currency exchange rate on the date that the contract is initially signed. If a modification to the purchase price is later made, the foreign currency exchange rate on the date that the modification is signed must be applied to the amount by which the purchase price is changed.

(c) For a capitalized improvement placed in service on or after January 1, 1995 and before January 1, 2002, that does not extend the life of a vessel or LNG transportation facility,

(1) a reasonable return including depreciation under 15 AAC 55.191(b) (3)(C) and (D) or 15 AAC 55.191(b) (4)(B)(iii) and (iv) is $158,000 per year for 10 years for each $1,000,000 of adjusted shipyard cost as defined in (b) of this section, for oil or gas produced before January 1, 2002, and on or after January 1, 2003; and

(2) a cost of capital allowance will be allowed as provided in (d) or (h) of this section, as applicable, for oil or gas produced during calendar year 2002.

(d) For an LNG transportation facility or capitalized improvement to that facility first placed in service by the producer on or after January 1, 1995, a cost of capital allowance that consists of depreciation and a return on acquisition cost will be allowed for oil or gas produced on or after January 1, 2002. The cost of capital allowance under this subsection is also available for a pipeline facility under 15 AAC 55.191(b) (8), or for a capitalized improvement that is made to that facility. However, an improvement to an LNG transportation or pipeline facility that the producer treats as an expense under 26 U.S.C. 179 may not receive a cost of capital allowance under this subsection. The cost of capital allowance under this subsection is an amount to be calculated annually for a calendar year as follows:

(1) the cost of capital allowance is calculated

(A) using the following formula, except as provided in (B) of this paragraph: cost of capital allowance = initial cash flow/(1 - marginal federal tax rate); and

(B) for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002, the cost of capital allowance equals the total after-tax cash flow;

(2) for purposes of the formulas set out in (1) and (8) of this subsection, initial cash flow is calculated using the following formula: initial cash flow = (remaining unrecovered investment - after-tax present value of future tax depreciation benefits)/present value of an ordinary annuity of 1 at the end of n periods, where "n" is years of remaining life at interest rate WACC;

(4) for purposes of the formula set out in (3) of this subsection, finance cost is calculated using the following formula: finance cost = remaining unrecovered investment from the prior year * ((1 + WACC) exp. (portion of year in service * 0.5));

(5) the remaining unrecovered investment from the prior year, for purposes of the formula set out in (4) of this subsection, and for

(A) the first year the facility is in service, is the sum of the unrecovered investments for all years the facility is under construction; and

(B) a facility that is in service on January 1, 2002, is calculated using the method set out in this subsection and as if the facility received the cost of capital allowances provided in this section for the facility's years of service before January 1, 2002;

(6) for purposes of (5)(A) of this subsection, an unrecovered investment for a year the facility is under construction is calculated as if the facility were built over a two-year period before the first month the facility is first placed in service, with equal amounts paid each year; unrecovered investment for a year the facility is under construction is calculated using the following formula: unrecovered investment for a year the facility is under construction = total amount paid to the person building or selling the facility to the producer * 0.5 * portion of the calendar year the facility is under construction * finance factor during construction;

(7) for purposes of the formula set out in (6) of this subsection, the finance factor during construction is calculated as if the facility were built over a two-year period before the first month the facility is first placed in service; the finance factor during construction is calculated using the following formulas:

(A) for the portion of the first calendar year of construction, and except as provided in (B) of this paragraph, the finance factor during construction = ((1 + WACC for the first calendar year of construction) = it exp. (portion of the first calendar year the facility is in service * 0.5)) * (1 + WACC for the second calendar year of construction) * ((1 + WACC for the third calendar year of construction) = it exp. (1 - the portion of the first calendar year the facility is in service));

(B) for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, the finance factor during construction is calculated as if the portion of the first calendar year the facility is in service is zero;

(C) for the second calendar year of construction, the finance factor during construction = ((1 + WACC for the second calendar year of construction) exp. (0.5)) * ((1 + WACC for the third calendar year of construction) exp. (1 - the portion of the first calendar year the facility is in service));

(D) for the portion of the third calendar year of construction, the finance factor during construction = (1 + WACC for the third calendar year of construction) exp. ((1 - the portion of the first calendar year the facility is in service) * 0.5);

(8) for purposes of (1)(B) of this subsection and the formula set out in (3) of this subsection, total after-tax cash flow is calculated using the following formula: total after-tax cash flow = initial cash flow + after-tax cash flow of depreciation benefits for that tax year;

(9) for purposes of the formula set out in (8) of this subsection, after-tax cash flow of depreciation benefits for that tax year

(A) except as provided in (B) of this paragraph, is calculated using the following formula: after-tax cash flow of depreciation benefits for that tax year = total amount paid to the person building or selling the facility to the producer * marginal federal tax rate * federal depreciation factor; and

(B) equals zero, for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(10) for purposes of the formulas set out in (9) and (12) of this subsection, the federal depreciation factor is the percentage of the total amount paid to the person building or selling the facility to the producer that can be depreciated for federal corporate income tax for the tax year;

(11) for purposes of (2) of this subsection, the after-tax present value of future tax depreciation benefits

(A) except as provided in (B) of this paragraph, is the sum of the discounted annual tax depreciation amounts for each remaining year in which the total amount paid to the person building or selling the facility to the producer can be depreciated for federal corporate income tax for the tax year; and

(B) equals zero, for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(12) for purposes of (11) of this subsection, a discounted annual tax depreciation amount is calculated using the following formula: discounted annual tax depreciation amount = federal depreciation factor * total amount paid to the person building or selling the facility to the producer * marginal federal tax rate * discount factor;

(13) for purposes of the formulas set out in (1), (9), and (12) of this subsection, the marginal federal tax rate

(A) except as provided in (B) of this paragraph, is the highest marginal federal corporate income tax rate for the calendar year; if the federal income tax rate changes during the year, the department will apply the new tax rate to that portion for the year that equals the number of days in the year that include and follow the day on which the old tax rate changed, divided by the total number of days in that year; and

(B) equals 35 percent, for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(14) for purposes of the formula set out in (12) of this subsection, the discount factor is calculated using the following formula: discount factor = 1/((1 + WACC) exp. (discount factor exponent));

(15) for purposes of the formula set out in (14) of this subsection, the discount factor exponent is calculated using the following formula: discount factor exponent = (((((1 - portion of year in service) + 1) * 0.5) - 1) + year depreciation benefit is realized);

(16) for purposes of the formula set out in (2) of this subsection, the present value of an ordinary annuity of 1 at the end of n periods, where "n" is years of remaining life at interest rate WACC, is the result generated by the following formula: (((1 - (1/((1+WACC) exp. (years of remaining life))))/WACC)/((1+WACC) exp. (-0.5)))/portion of year in service;

(17) for purposes of the formula set out in (16) of this subsection, years of remaining life must be determined for each

(A) component of the facility that is in service at the start-up of the facility as if that component had a 30-year life, except that for LNG transportation facilities first placed in service on or after January 1, 1995 and before January 1, 2002, years of remaining life must be determined, for each year before January 1, 2002, as if that component had a 24-year life;

(B) capitalized improvement that extends the life of a facility and that is put in service after start-up of the facility as if that capitalized improvement had a 15-year life; and

(C) capitalized improvement that does not extend the life of a facility and that is put in service after start-up of the facility as if that capitalized improvement had a 10-year life;

(18) for purposes of the formulas set out in (2), (3), (4), (7), (14), and (16) of this subsection, WACC or the weighted average cost of capital,

(A) for a calendar year before 1997,

(i) except as provided in (ii) of this subparagraph, is 10 percent; and

(ii) is eight percent, for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002; and

(B) for 1997 or a later calendar year,

(i) except as provided in (ii) of this subparagraph, is the cost of capital, as reasonably determined by the department, for the category of business described for Standard Industrial Classification (SIC) Industry No. 4924, in the Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual, as revised as of 1987; as described in this subparagraph, SIC Industry No. 4924 is adopted by reference; in determining a cost of capital for a calendar year under this sub-subparagraph, the department will presume, in the absence of facts to the contrary, that the cost of capital is accurately represented by the weighted average cost of capital using the capital asset pricing model (CAPM), ordinary least squares (OLS) for the industrial composite for SIC code number 4924, as reported in Ibbotson Associates The Cost of Capital Yearbook published during the previous calendar year, plus, for LNG transportation facilities, 0.2 percent after December 31, 2001; and;

(ii) is eight percent, for an LNG transportation facility first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(19) for purposes of the formula set out in (16) of this subsection, for facilities that come into service midyear, the portion of the year in service for the first and last calendar years the facility is in service is the number of days the facility is in service during the year divided by 365, and 100 percent for all other years.

(e) The following example illustrates (d) of this section:

Taxpayer A places a facility into service in Year One. The total amount paid to the person building or selling the facility is $1,000,000. The facility comes into service 75 percent of the way into Year One; it is in service 25 percent of the year. For the first partial calendar year of construction, the tax rate is 34 percent and the WACC is five percent. For the second full calendar year of construction, the tax rate is 35 percent and the WACC is six percent. For the third partial calendar year of construction, the tax rate is 37 percent and the WACC is eight percent. For the first year of service the tax rate and WACC are the same as for the third year of construction: the tax rate is 37 percent and the WACC is eight percent. The federal depreciation factors are as follows:

Year 1 = 15%

Year 2 = 22%

Year 3 = 21%

Year 4 = 21%

Year 5 = 21%

Because the facility begins service mid-year, the federal depreciation factors are weighted for time in service as follows:

Year 1 = (0.25 * 15%) = 0.0375

Year 2 = (0.75 * 15%) + (0.25 * 22%) = 0.1675

Year 3 = (0.75 * 22%) + (0.25 * 21%) = 0.2175

Year 4 = (0.75 * 21%) + (0.25 * 21%) = 0.2100

Year 5 = (0.75 * 21%) + (0.25 * 21%) = 0.2100

Year 6 = (0.75 * 21%) = 0.1575

Step One: Calculate the finance factor during construction for the three years of construction under (d)(7) of this section:

For the first calendar year of construction the finance factor during construction would be:

(((1 + 0.05) exp. (0.25 * 0.5)) * (1 + 0.06) * ((1 + 0.08) exp. (1 - 0.25)) = 1.129854044

For the second calendar year of construction the finance factor during construction would be:

(((1 + 0.06) exp. (0.5)) * ((1+0.08) exp. (1 - 0.25)) = 1.090738767

For the third calendar year of construction the finance factor during construction would be:

(1 + 0.08) exp. (((1 - 0.25) * 0.5) = 1.029280887

Step Two: Calculate the unrecovered investment for the three years of construction under (d)(6) of this section:

For the first year of construction the unrecovered investment would be:

1,000,000 * 0.5 * 0.25 * 1.129854044 = 141,232

For the second year of construction the unrecovered investment would be:

1,000,000 * 0.5 * 1.00 * 1.090738767 = 545,369

For the third year of construction the unrecovered investment would be:

1,000,000 * 0.5 * 0.75 * 1.029280887 = 385,980

Step Three: Calculate the remaining unrecovered investment from the prior year for Year One under (d)(5) of this section:

141,232 + 545,369 + 385,980 = 1,072,581

Step Four: Calculate the discount factor exponent for Year One under (d)(15) of this section:

(((((1 - 0.25) + 1) * 0.5) - 1) + 1) = 0.875

Step Five: Calculate the discount factor for Year One under (d)(14) of this section:

1 / ((1 + 0.08) exp. (0.875)) = 0.935

Step Six: Calculate the discounted annual tax depreciation amount for Year One under (d)(12) of this section:

0.0375 * 1,000,000 * 0.37 * 0.935 = 12,971

Step Seven: Calculate the after-tax present value of future tax depreciation benefits for Year One under (d)(11) of this section by adding the discounted tax depreciation amounts for the first five complete years:

Year 1 = 0.0375 * 1,000,000 * 0.37 * 0.935 = 12,971

Year 2 = 0.1675 * 1,000,000 * 0.37 * 0.891 = 55,218

Year 3 = 0.2175 * 1,000,000 * 0.37 * 0.825 = 66,390

Year 4 = 0.2100 * 1,000,000 * 0.37 * 0.764 = 59,352

Year 5 = 0.2100 * 1,000,000 * 0.37 * 0.707 = 54,956

Year 6 = 0.1575 * 1,000,000 * 0.37 * 0.655 = 38,164

Total = 287,051.

Table 1 shows the derivation of the after-tax present value of future tax depreciation benefits for Years One - Six.

Step Eight: Calculate the finance cost for Year One under (d)(4) of this section:

1,072,581 * ((1 + 0.08) exp. (0.25 * 0.5)) = 1,082,950

Step Nine: Calculate the present value of an ordinary annuity of 1 for Year One under (d)(16) of this section:

(((1 - (1 / ((1 + 0.08) exp. (30))))/0.08) / ((1 + 0.08) exp. (-0.5)))/0.25 = 46.79773

Step Ten: Calculate the initial cash flow under (d)(2) of this section:

(1,072,581 - 287,051) / 46.79773 = 16,786

Step Eleven: Calculate the cost of capital allowance under (d)(1) of this section:

16,786 / (1 - 0.37) = 26,644

Step Twelve: Calculate the after-tax cash flow of depreciation benefits for Year One under (d)(9) of this section:

1,000,000 * 0.37 * 0.0375 = 13,875

Step Thirteen: Calculate the total after-tax cash flow for Year One under (d)(8) of this section:

16,786 + 13,875 = 30,661

Step Fourteen: Calculate the remaining unrecovered investment at the end of Year One under (d)(3) of this section:

(1,082,950 - 30,661) * ((1 + .08) exp. (0.25 * 0.5)) = 1,062,461

Table 2 shows the capital construction allowances for the remaining years using the tax rates and WACCs given in the example.

TABLE 1: AFTER-TAX PRESENT VALUE

OF FUTURE DEPRECIATION BENEFITS

CLICK TO VIEW TABLE

TABLE 2: COST OF CAPITAL ALLOWANCE FOR LNG AND PIPELINE FACILITIES

(continued)

TABLE 2: COST OF CAPITAL ALLOWANCE FOR LNG AND PIPELINE FACILITIES (cont.)

CLICK TO VIEW TABLE

(f) For a vessel first placed in service on or after January 1, 1995, or for an improvement that extends the life of a vessel and that was first placed in service on or after January 1, 1995, a cost of capital allowance that consists of depreciation and a return on investment will be allowed for oil or gas produced during calendar year 2002, except that a producer may elect to expense the first $1,000,000 in costs incurred with respect to improvements during calendar year 2002. An amount expensed may be either deducted in the month incurred or amortized over all months in calendar year 2002. The cost of capital allowance under this subsection is an amount to be calculated annually for a calendar year as follows:

(1) the cost of capital allowance is calculated

(A) using the following formula, except as provided in (B) of this paragraph: cost of capital allowance = after-tax cash flow / (1 - marginal federal tax rate); and

(B) for a vessel that was first placed in service on or after January 1, 1995 and before January 1, 2002, or for a capitalized improvement that extends the life of a vessel and that was first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002, the cost of capital allowance equals after-tax cash flow;

(2) for purposes of (1) of this subsection, after-tax cash flow is calculated using the following formula: after-tax cash flow = remaining unrecovered investment from the prior year / present value of an ordinary annuity of 1 at the end of the remaining life at interest rate WACC;

(3) for purposes of the formula set out in (2) of this subsection, remaining unrecovered investment is calculated using the following formula: remaining unrecovered investment = ((mid-year unrecovered investment - after-tax cash flow) * ((1 + WACC) exp. (portion of year in service * 0.5 ))) - value of any federal tax credits, deductions, or benefits that are allowable under 26 U.S.C. (Internal Revenue Code), including any tax depreciation deductions and capital construction fund benefit, and that were not included in the calculation made under (6)(A) or (C) of this subsection in the year for which the tax is paid;

(4) for purposes of the formula set out in (2) of this subsection, remaining unrecovered investment for the first year the vessel is in service is the net unrecovered capital investment;

(5) for purposes of the formula set out in (3) of this subsection, mid-year unrecovered investment is calculated using the following formula: mid-year unrecovered investment = remaining unrecovered investment from the prior year * ((1 + WACC) exp. (portion of year in service * 0.5));

(6) for purposes of (4) of this subsection, net unrecovered capital investment is the total amount paid to the person building or selling the vessel to the producer, including any improvements to existing vessels,

(A) minus any investment tax credit taken by the producer under 26 U.S.C. 38 (Internal Revenue Code), or in the case of an effectively owned vessel, as described in 15 AAC 55.191(k) , taken by the legal owner of that vessel or facility and passed on in whole or in part to the producer through reduced charter-hire or lease payments; this subparagraph does not apply to vessels first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(B) minus the after-tax net present value of the salvage value of the vessel in Year 25; this subparagraph does not apply to vessels first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(C) minus the net present value in the first year the vessel is in service of any other federal tax credits, deductions, or benefits allowable under 26 U.S.C. (Internal Revenue Code), including any tax depreciation deductions and capital construction fund benefit, where appropriate; this subparagraph does not apply to vessels first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002; and

(D) plus a return on capital used during construction;

(7) for purposes of (6) of this subsection, a return on capital used during construction is the sum of the yearly construction cost of capital for each year of construction, calculated as if the vessel were built over a two-year period before the first month the vessel is first placed in service, with equal amounts paid each year;

(8) for purposes of the formula set out in (7) of this subsection, yearly construction cost of capital for a year is calculated using the following formula: yearly construction cost of capital = construction unrecovered investment - yearly outlay;

(9) for purposes of the formulas set out in (8) and (10) of this subsection, yearly outlay is calculated as if the vessel were built over a two-year period before the first month the is first placed in service, with equal amounts paid each year; yearly outlay is calculated using the following formulas:

(A) for the portion of the first calendar year of construction, and except as provided in (B) of this paragraph, yearly outlay = portion of the year in service for the first calendar year the vessel is in service * 0.5 * total amount paid to the person building or selling the vessel to the producer;

(B) for a vessel that was first placed in service on or after January 1, 1995 and before January 1, 2002, or for a capitalized improvement that extends the life of a vessel and that was first placed in service on or after January 1, 1995 and before January 1, 2002, the yearly outlay is calculated as if the portion of the first calendar year the vessel is in service were zero;

(C) for the second calendar year of construction, yearly outlay = 0.5 * total amount paid to the person building or selling the vessel to the producer;

(D) for the portion of the third calendar year of construction, yearly outlay = (1 - the portion of the year in service for the first calendar year the vessel is in service) * 0.5 * total amount paid to the person building or selling the vessel to the producer;

(10) for purposes of the formula set out in (8) of this subsection, construction unrecovered investment is calculated using the following formula: construction unrecovered investment = yearly outlay * construction finance factor during construction;

(11) for purposes of the formula set out in (10) of this subsection, the construction finance factor during construction is calculated using the following formulas:

(A) for the portion of the first calendar year of construction, the construction finance factor during construction = ((1 + WACC for the first calendar year of construction) exp. (portion of the first calendar year the vessel is in service * 0.5)) * (1 + WACC for the second calendar year of construction) * ((1 + WACC for the third calendar year of construction) exp. (1 - the portion of the first calendar year the vessel is in service));

(B) for the second calendar year of construction, the construction finance factor during construction = ((1 + WACC for the second calendar year of construction) exp. (0.5)) * ((1 + WACC for the third calendar year of construction) exp. (1 - the portion of the first calendar year the vessel is in service));

(C) for the portion of the third calendar year of construction, the construction finance factor during construction = (1 + WACC for the third calendar year of construction) exp. ((1 - the portion of the first calendar year the vessel is in service) * 0.5);

(12) for purposes of (6) of this subsection, after-tax net present value of the salvage value of the vessel in Year 25 is calculated using the following formula: after-tax net present value of the salvage value of the vessel in Year 25 = 0.04 * total amount paid to the person building or selling the vessel * (1 - marginal federal tax rate for the first year the vessel is in service) * salvage value discount factor;

(13) for purposes of the formula set out in (12) of this subsection, salvage value discount factor is calculated using the following formula: salvage value discount factor = (1 / ((1 + WACC for the first year the vessel is in service) exp. (24.5)));

(14) for purposes of the formula set out in (2) of this subsection, present value of an ordinary annuity of 1 at the end of the remaining life is calculated using the following formula: present value of an ordinary annuity of 1 at the end of the remaining life = (((1 - (1 / ((1 + WACC) exp. (years of remaining life)))) / WACC) / ((1 + WACC) exp. (-0.5))) / portion of year in service;

(15) for purposes of the formula set out in (14) of this subsection, years of remaining life must be determined for a vessel as if the vessel had a 24-year life beginning on the first day of the month that the vessel takes on its first load of oil, and for a capitalized improvement that extends the life of a vessel, as if the capitalized improvement had a 15-year life beginning on the first day of the month that the vessel with the new improvement takes on a load of oil; the life of the vessel or capitalized improvement will not be suspended during periods of lay up or dry dock, while the vessel is not in service, or for any other reason;

(16) for purposes of the formulas set out in (1) and (12) of this subsection, the marginal federal tax rate

(B) equals 35 percent, for a vessel first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(17) for purposes of the formulas set out in (2), (3), (5), (11), (13), and (14) of this subsection, WACC, or the weighted average cost of capital,

(A) except as provided in (B) of this paragraph, is the cost of capital as reasonably determined by the department, for the category of business described for Standard Industrial Classification (SIC) Industry No. 4924, in the Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual, as revised as of 1987; as described in this subparagraph, SIC Industry No. 4924 is adopted by reference; in determining a cost of capital for a calendar year under this paragraph, the department will presume, in the absence of facts to the contrary, that the cost of capital is accurately represented by the weighted average cost of capital using the capital asset pricing model (CAPM), ordinary least squares (OLS) for the industrial composite for SIC code number 4924, as reported in Ibbotson Associates The Cost of Capital Yearbook published during the previous calendar year, plus 0.4 percent; and

(B) is eight percent, for a vessel first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(18) for purposes of the formulas set out in (3), (5), (9), and (14) of this subsection, for vessels that are first placed in service by the producer mid-year, the portion of the year in service for the first and last calendar years the vessel is in service is the number of days the vessel is in service during the year divided by 365, and 100 percent for all other years;

(19) vessels first placed in service by the producer on or after January 1, 1995, that were in service for a different producer or for a different person before that date and subject to (a) of this section, continue to be subject to (a) of this section, and the cost of capital allowance set out in this subsection will not be allowed for those vessels; vessels first placed in service by the producer on or after January 1, 1995, that were in service for a different person before that date and subject to (b) of this section, continue to be subject to (b) of this section through December 31, 2001; after December 31, 2001, the cost of capital allowance set out in this subsection will be allowed for those vessels;

(20) for purposes of (6), (9), and (12) of this subsection, if the total amount paid to the person selling the vessel is not based on an arm's-length, third party transaction, is tied to the receipt of other consideration, or cannot reasonably be established by the taxpayer, the total amount paid to the person selling the vessel is the remaining unrecovered investment of the vessel at the time of the acquisition as determined by the department; in making this determination, the department will consider prices paid for similar vessels and other factors related to the value of the vessel;

(21) for purposes of the formula set out in (14) of this section, for vessels first placed in service by the producer on or after January 1, 1995, that either were in service for a different producer or for a different person before January 1, 1995, or were engaged outside the state in ordinary and necessary operations incurred to transport oil or gas before January 1, 1995, years of remaining life must be determined as if the vessel had a total 24-year life and for a capitalized improvement that extends vessel life as if the capitalized improvement had a total 15-year life; the lives of the vessels or capitalized improvements will be considered to have begun at the first loading of oil and will not be suspended during periods of lay up or dry dock, while the vessel is not in service, or for any reason;

(22) for purposes of (6), (9), and (12) of this subsection, if a vessel is acquired through a contract that states the purchase price in terms of a foreign currency, the cost is the equivalent amount in United States dollars as determined by applying the foreign currency exchange rate on the date that the contract is initially signed; if a modification to the purchase price is later made, the foreign currency exchange rate on the date that the modification is signed must be applied to the amount by which the purchase price is changed.

(g) The following example illustrates (f) of this section:

Taxpayer A first places a vessel in service in Year One. The total amount paid to the person building or selling the vessel is $1,000,000. The vessel comes into service 75 percent of the way into Year One; it is in service 25 percent of the year. For the first partial calendar year of construction, the tax rate is 34 percent and the WACC, including the additional 0.4 percent described in (f)(17)(A) of this section, is nine percent. For the second full calendar year of construction, the tax rate is 35 percent and the WACC is eight percent. For the third partial calendar year of construction, the tax rate is 36 percent and the WACC is seven percent. For the first year of service the tax rate and WACC are the same as for the third year of construction. The net present value of the capital construction fund benefit is $354,034.

This example shows the cost of capital allowance for a vessel carrying oil or commingled oil and NGLs.

Step One: Calculate the yearly outlay for each calendar year of construction under (f)(9)(A), (B), and (C) of this section:

For the portion of the first year calendar year of construction the yearly outlay would be:

0.25 * 0.5 * 1,000,000 = 125,000

For the second calendar year of construction the yearly outlay would be:

0.5 * 1,000,000 = 500,000

For the portion of the third calendar year of construction the yearly outlay would be:

(1 - 0.25) * 0.5 * 1,000,000 = 375,000

Step Two: Calculate the construction finance factor during construction for each calendar year of construction under (f)(11) of this section:

For the portion of the first calendar year of construction the construction finance factor during construction would be:

((1 + 0.09) exp. (0.25 * 0.5)) * (1 + 0.08) * ((1 + 0.07) exp. (1 - 0.25)) = 1.148523540

For the second calendar year of construction the construction finance factor during construction would be:

((1 + 0.08) exp. (0.5)) * ((1 + 0.07) exp. (1 - 0.25)) = 1.093326088

For the portion of the third calendar year of construction the construction finance factor during construction would be:

(1 + 0.07) exp. ((1 - 0.25) * 0.5) = 1.025696602

Step Three: Calculate the construction unrecovered investment for each calendar year of construction under (f)(10) of this section:

For the first calendar year of construction the construction unrecovered investment would be:

125,000 * 1.148523540 = 143,565

For the second calendar year of construction the construction unrecovered investment would be:

500,000 * 1.093326088 = 546,663

For the third calendar year of construction the construction unrecovered investment would be:

375,000 * 1.025696602 = 384,636

Step Four: Calculate the yearly construction cost of capital for each calendar year of construction under (f)(8) of this section:

For the first year of construction the yearly construction cost of capital would be:

143,565 - 125,000 = 18,565

For the second year of construction the yearly construction cost of capital would be:

546,663 - 500,000 = 46,663

For the third year of construction the yearly construction cost of capital would be:

384,636 - 375,000 = 9,636

Step Five: Calculate the return on capital used during construction under (f)(7) of this section:

18,565 + 46,663 + 9,636 = 74,865

Step Six: Calculate the salvage value discount factor under (f)(13) of this section:

(1/ ((1 + 0.07) exp. (24.5))) = 0.191

Step Seven: Calculate the after-tax net present value of the salvage value of the vessel in Year 25 under (f)(12) of this section:

0.04 * 1,000,000 * (1 - 0.36) * 0.191 = 4,879

Step Eight: Calculate the net unrecovered capital investment under (f)(6) of this section:

1,000,000 - 354,034 + 74,865 - 4,879 = 715,952

Step Nine: Calculate the present value of an ordinary annuity of 1 at the end of the remaining life under (f)(14) of this section:

((( 1 - (1 / ((1 + 0.07) exp. (24)))) / 0.07) / ((1 + 0.07) exp. (-0.5 ))) / 0.25 = 47.45589

Step Ten: Calculate the after-tax cash flow under (f)(2) of this section:

715,952 / 47.45589 = 15,087

Step Eleven: Calculate the cost of capital allowance under (f)(1) of this section:

15,087 / (1 - 0.36) = 23,573

Step Twelve: Calculate the mid-year unrecovered investment under (f)(5) of this section:

715,952 * ((1 + 0.07) exp. (0.25 * 0.5)) = 722,033

Step Thirteen: Calculate the remaining unrecovered investment under (f)(3) of this section:

(722,033 - 15,087) * ((1 + 0.07) exp. (0.25 * 0.5)) 712,951

Table 1 shows the cost of capital allowances for the remaining years using the tax rates and WACCs given in the example.

TABLE 1

COST OF CAPITAL ALLOWANCE FOR VESSELS CARRYING OIL OR COMMINGLED OIL AND NGLS

CLICK TO VIEW TABLE

(h) For an improvement to a vessel that does not extend the life of a vessel and that was first placed in service on or after January 1, 1995, a cost of capital allowance that consists of depreciation and a return on investment will be allowed for oil or gas produced during calendar year 2002, except that a producer may elect to expense the first $1,000,000 in costs incurred with respect to improvements during calendar year 2002. An amount expensed may be either deducted in the month incurred or amortized over all months in calendar year 2002. An improvement that the producer treats as an expense under 26 U.S.C. 179 may not receive a cost of capital allowance under this subsection. The cost of capital allowance under this subsection is an amount to be calculated annually for a calendar year as follows:

(1) the cost of capital allowance is calculated using the following formula: cost of capital allowance = initial cash flow / (1 - marginal federal tax rate);

(2) for purposes of the formula set out in (1) of this subsection, initial cash flow is calculated using the following formula: initial cash flow = (remaining unrecovered investment from the prior year - after-tax present value of future tax depreciation benefits) / present value of an ordinary annuity of 1 at the end of n periods, where "n" is years of remaining life at interest rate WACC;

(5) for purposes of the formula set out in (4) of this subsection, remaining unrecovered investment from the prior year for the first year the capitalized improvement to a vessel is in service is the total amount paid to the person building or selling the capitalized improvement to the producer;

(6) for purposes of the formula set out in (3) of this subsection, total after-tax cash flow is calculated using the following formula: total after-tax cash flow = initial cash flow + after-tax cash flow of depreciation benefits for that tax year;

(7) for purposes of the formula set out in (6) of this subsection, after-tax cash flow of depreciation benefits for that tax year is calculated using the following formula: after-tax cash flow of depreciation benefits for that tax year = total amount paid to the person building or selling the capitalized improvement to a vessel to the producer * marginal federal tax rate * federal depreciation factor;

(8) for purposes of the formulas set out in (7) and (11) of this subsection, the federal depreciation factor

(A) except as provided in (B) of this paragraph, is the percentage of the total amount paid to the person building or selling the capitalized improvement by the producer that can be depreciated for federal corporate income tax for the tax year; and

(B) for a capitalized improvement that does not extend the life of a vessel and that was first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002, is the percentage allowed on a five-year schedule as follows:

(i) for year one, 15 percent;

(ii) for year two, 22 percent;

(iii) for year three, 21 percent;

(iv) for year four, 21 percent;

(v) for year five, 21 percent;

(9) for purposes of (2) of this subsection, after-tax present value of future tax depreciation benefits is the sum of the discounted annual tax depreciation amounts for each remaining year in which the total amount paid to the person building or selling the pipeline facility to the producer can be depreciated for federal corporate income tax for the tax year;

(10) for purposes of (9) of this subsection, a discounted annual tax depreciation amount is calculated using the following formula: discounted annual tax depreciation amount = federal depreciation factor * total amount paid to the person building or selling the capitalized improvement to a vessel to the producer * marginal federal tax rate * discount factor;

(11) for purposes of the formulas set out in (1), (7), and (10) of this subsection, marginal federal tax rate

(B) equals 37 percent, for a capitalized improvement that does not extend the life of a vessel and that was first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(12) for purposes of the formula set out in (10) of this subsection, discount factor is calculated using the following formula: discount factor = 1 / ((1 + WACC) exp. (discount factor exponent));

(13) for purposes of the formula set out in (12) of this subsection, the discount factor exponent is calculated using the following formula: discount factor exponent = (((((1 - portion of year in service) + 1) * 0.5) - 1) + year depreciation benefit is realized);

(14) for purposes of the formula set out in (2) of this subsection, the present value of an ordinary annuity of 1 at the end of n periods, where "n" is years of remaining life at interest rate WACC, is calculated using the following formula: present value of an ordinary annuity of 1 at the end of n periods = (((1 - (1/ ((1 + WACC) exp. (years of remaining life)))) / WACC) / ((1 + WACC) exp. (-0.5))) / portion of year in service;

(15) for purposes of the formula set out in (14) of this subsection, years of remaining life must be determined for each capitalized improvement to a vessel as if it had a 10-year life beginning on the first day of the month that the vessel with the new improvement takes on a load of oil; the life of the capitalized improvement will not be suspended during periods of lay up or dry dock, while the vessel is not in service, or for any other reason;

(16) for purposes of the formulas set out in (2), (3), (4), (12), and (14) of this subsection, WACC, or the weighted average cost of capital,

(B) is eight percent, for a capitalized improvement that does not extend the life of a vessel and that was first placed in service on or after January 1, 1995 and before January 1, 2002, for each year before January 1, 2002;

(17) for purposes of the formula set out in (3), (4), (13), and (14) of this subsection, for capitalized improvements to a vessel that come into service mid-year, the portion of the year in service for the first and last calendar years the capitalized improvement to a vessel is in service is the number of days the capitalized improvement to a vessel is in service during the year divided by 365, and 100 percent for all other years;

(18) capitalized improvements to a vessel acquired for service on or after January 1, 1995, that were in service before that date and subject to (a) of this section, continue to be subject to (a) of this section, and the cost of capital allowance set out in this subsection will not be allowed for those capitalized improvements; capitalized improvements to a vessel acquired for service on or after January 1, 1995, that were in service before that date and subject to (b) of this section continue to be subject to (b) of this section through December 31, 2001; after December 31, 2001, the cost of capital allowance set out in this subsection will be allowed for those capitalized improvements;

(19) for purposes of (5), (7), and (10) of this subsection, if the total amount paid to the person selling the capitalized improvement to a vessel is not based on an arm's-length, third party transaction, is tied to the receipt of other consideration, or cannot reasonably be established by the taxpayer, the total amount paid to the person selling the capitalized improvement to a vessel will be determined by the department; in making this determination, the department will consider prices paid for similar improvements and other factors related to the value of the capitalized improvement;

(20) for purposes of (5), (7), and (10) of this subsection, if a capitalized improvement to a vessel is acquired through a contract that states the purchase price in terms of a foreign currency, the cost is the equivalent amount in United States dollars as determined by applying the foreign currency exchange rate on the date that the contract is initially signed; if a modification to the purchase price is later made, the foreign currency exchange rate on the date that the modification is signed must be applied to the amount by which the purchase price is changed.

(i) The following example illustrates (h) of this section:

Taxpayer A places a capitalized improvement to a vessel into service in Year One. The total amount paid to the person building or selling the improvement is $1,000,000. The improvement comes into service 75 percent of the way into Year One; it is in service 25 percent of the year. For the first year of service the tax rate is 37 percent and the WACC, including the additional 0.4 percent described in (h)(16) of this section, is six percent. The federal depreciation factors are as follows:

Year 1 = 15%

Year 2 = 22%

Year 3 = 21%

Year 4 = 21%

Year 5 = 21%

Because the improvement begins service mid-year, the federal depreciation factors are weighted for time in service as follows:

Year 1 = (0.25 * 15%) = 0.0375

Year 2 = (0.75 * 15%) + (0.25 * 22%) = 0.1675

Year 3 = (0.75 * 22%) + (0.25 * 21%) = 0.2175

Year 4 = (0.75 * 21%) + (0.25 * 21%) = 0.2100

Year 5 = (0.75 * 21%) + (0.25 * 21%) = 0.2100

Year 6 = (0.75 * 21%) = 0.1575

This example shows the cost of capital allowance for an improvement to a vessel carrying oil or commingled oil and NGLs.

Step One: Calculate the discount factor exponent for Year One under (h)(13) of this section:

(((((1 - 0.25) + 1) * 0.5) - 1) + 1) = 0.875

Step Two: Calculate the discount factor for Year One under (h)(12) of this section:

1 / ((1 + 0.06) exp. (0.875)) = 0.950

Step Three: Calculate the discounted annual tax depreciation amount for Year One under (h)(10) of this section:

0.0375 * 1,000,000 * 0.37 * 0.950 = 13,185

Step Four: Calculate the after-tax present value of future tax depreciation benefits for Year One under (h)(9) of this section by adding the discounted tax depreciation amounts for the first five complete years:

Year 1 = 0.0375 * 1,000,000 * 0.37 * 0.950 = 13,185

Year 2 = 0.1675 * 1,000,000 * 0.37 * 0.916 = 56,788

Year 3 = 0.2175 * 1,000,000 * 0.37 * 0.864 = 69,566

Year 4 = 0.2100 * 1,000,000 * 0.37 * 0.816 = 63,365

Year 5 = 0.2100 * 1,000,000 * 0.37 * 0.769 = 59,788

Year 6 = 0.1575 * 1,000,000 * 0.37 * 0.726 = 42,296

Total 304,979.

Table 1 shows the derivation of the after-tax present value of future tax depreciation benefits for Years One - Six.

Step Five: Calculate the finance cost for Year One under (h)(4) of this section:

1,000,000 * ((1 + 0.06) exp. (0.25 * 0.5)) = 1,007,310

Step Six: Calculate the present value of an ordinary annuity of 1 for Year One under (h)(14) of this section:

(((1 - (1 / ((1 + 0.06) exp. (10)))) / 0.06) / ((1 + 0.06) exp. (-0.5)))/ 0.25 = 30.31069

Step Seven: Calculate the initial cash flow under (h)(2) of this section:

(1,000,000 - 304,979)/ 30.31069 = 22,930

Step Eight: Calculate the cost of capital allowance under (h)(1) of this section:

22,930 / (1 - 0.37) = 36,397

Step Nine: Calculate the after-tax cash flow of depreciation benefits for Year One under (h)(7) of this section:

1,000,000 * 0.37 * 0.0375 = 13,875

Step Ten: Calculate the total after-tax cash flow for Year One under (h)(6) of this section:

22,930 + 13,875 = 36,805

Step Eleven: Calculate the remaining unrecovered investment at the end of Year One under (h)(3) of this section:

(1,007,310 - 36,805) * ((1 + .06) exp. (0.25 * 0.5)) = 977,600

Table 2 shows the capital construction allowances for the remaining years using the tax rates and WACCs given in the example.

TABLE 1: AFTER-TAX PRESENT VALUE OF FUTURE DEPRECIATION BENEFITS

CLICK TO VIEW TABLE

TABLE 2: COST OF CAPITAL ALLOWANCE FOR IMPROVEMENTS TO VESSELS CARRYING OIL OR COMMINGLED OIL AND NGLS

TABLE 2: COST OF CAPITAL ALLOWANCE FOR IMPROVEMENTS TO VESSELS CARRYING OIL OR COMMINGLED OIL AND NGLS (cont.)

CLICK TO VIEW TABLE

History: Eff. 1/1/2000; Register 152; am 1/1/2002, Register 160; am 1/1/2003, Register 164

Authority: AS 43.05.080

Editor's note: The material adopted by reference in 15 AAC 55.195(d) , (f), and (h) from the Standard Industrial Classification Manual may be viewed at or obtained from the Department of Revenue, Tax Division, 550 W. 7th Avenue, Suite 500, Anchorage, AK 99501. The Cost of Capital Yearbook is published by Ibbotson Associates, 225 North Michigan Avenue, Suite 700, Chicago, Illinois 60601.

Before 1/1/2000, Register 152, the substance of 15 AAC 55.195(a) , (b), and (c) was in 15 AAC 55.191(d) , (f), and (g). The history note for 15 AAC 55.195 does not reflect the earlier history of the provisions currently set out at 15 AAC 55.195(a) , (b), and (c).

The Alaska Administrative Code was automatically converted to HTML from a plain text format. Every effort has been made to ensure its accuracy, but neither Touch N' Go Systems nor the Law Offices of James B. Gottstein can be held responsible for any possible errors. This version of the Alaska Administrative Code is current through June, 2006.

If it is critical that the precise terms of the Alaska Administrative Code be known, it is recommended that more formal sources be consulted. Recent editions of the Alaska Administrative Journal may be obtained from the Alaska Lieutenant Governor's Office on the world wide web. If any errors are found, please e-mail Touch N' Go systems at E-mail. We hope you find this information useful. Copyright 2006. Touch N' Go Systems, Inc. All Rights Reserved.