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Oil and Gas Companies Will be Most Impacted by Inflation Reduction Act, Moody’s Says

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 5 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 5 minute read

Oil and gas companies will have to pay more taxes under the Inflation Reduction Act of 2022, according to accounting analysts at Moody’s Investors Service.

While the law includes provisions aimed a tackling climate change and health care policies, it also increases taxes for large companies.

The Inflation Reduction Act requires companies that have book profits over $1 billion to pay a 15 percent corporate alternative minimum tax—or book minimum tax. And companies that engage in stock buybacks will pay a 1 percent excise tax.

“In our analysis, we found that large oil & gas issuers that pay little income tax also tend to have some of the largest share buy back plans, which will make them the most affected by the new taxes,” Moody’s David Gonzales, vice president-senior accounting analyst, and Alastair Drake, senior vice president-senior accounting analyst, wrote in an August 2022 Sector Comment. Gonzales has also served as a member of the Financial Accounting Standards Board’s Financial Accounting Standards Advisory Council.

They estimate that 9 percent of Moody’s-rated U.S. investment-grade companies are likely to pay higher cash taxes under the new book minimum tax. And this is credit negative for those companies.

Gonzales and Drake did not expect that speculative-grade companies will be significantly affected because they tend to be smaller companies.

Moody’s analysts explained that the new law allows companies to keep benefiting from accelerated tax depreciation. This will help lessen the impact of the alternative minimum tax in the short-term for companies that are in capital intensive industries.

The Tax Cuts and Jobs Act of 2017 allows full expensing of short-lived capital investments—instead of depreciating them over time—for five years. After that, it phases out by 20 percentage points per year.

Thus, more capital-intensive companies are expected to be pulled into the minimum book tax over the next four years, Moody’s said.

“The book minimum tax, which will reduce cash flow for those affected, targets large multinational corporations that would otherwise be paying little to no tax in years of significant financial statement profitability,” Moody’s wrote. “This tax effectively eliminates a substantial portion of the benefits of deferred taxes and net operating losses for companies that have a consistent $1 billion dollars of reported pre-tax income.”

Moody’s analysis shows that four industries—oil and gas; high tech; chemicals, plastic, and rubber; and hotel, gaming, and leisure—will be most affected by minimum book tax.

Among oil and gas companies, there are 19 investment grade-rated companies with $1 billion modified pre-tax income, and 14 companies pay less than 15 percent cash tax rate.

To more easily illustrate accelerated depreciation under current tax laws, the analysts’ note explains that the modified pre-tax income is calculated by taking book pre-tax income and replacing depreciation expense with capital expenditures. Then for companies that pay less than 15 percent tax, Moody’s compared their current tax percentage to the 15 percent book minimum tax and calculated the delta.

“From a liquidity perspective, this tax can be most harmful to large companies that are growing and have only recently met the income threshold to qualify for the tax,” Gonzales and Drake noted. “These companies may have reserves of net operating losses that allow them to defer paying cash taxes in the first years of profitability. Their net operating losses have been used to offset taxable income, but that offset will in most cases be undone by the book minimum tax of 15%, and can be a material portion of operating cash flow.”

They found that the oil and gas industry has a full 15 percent in its cash tax rate among the four industries analyzed. The analysts primarily attributes this to companies currently paying little or no tax. But now, they will have to pay the full 15 percent minimum tax rate on their book pre-tax income.

“From an income statement (profit after tax) perspective, for most affected companies (unless they project to be under the 15% threshold for the foreseeable future) there will be no change in overall tax expense in the income statement, as any additional tax expense will also give rise to a deferred tax asset that can be used in future years to offset tax bills for amounts over the 15% minimum,” the memo notes.

In the meantime, Moody’s noted that share buyback tax is not significant enough to change credit analysis or change companies’ capital allocation decisions.

“Oil and gas companies have been leaning heavily on buybacks as they benefit from high commodity prices and capital discipline to generate unprecedented amounts of free cash flow,” the analysts wrote. “While the tax is not likely to significantly affect the volume of share repurchases, it could be a considerable source of tax revenue over the next couple years.” And the 1 percent tax will not have a material impact on creditworthiness.


This article originally appeared in the September 6, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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