Oil and gas companies will be hit hardest by the Cut Inflation Act, Moody’s says
Oil and gas companies will have to pay more taxes under the Cut Inflation Act of 2022, according to accounting analysts at Moody’s Investors Service.
While the law includes provisions aimed at tackling climate change and health care policies, it also increases taxes on big business.
The Inflation Reduction Act requires companies with book profits over $1 billion to pay a 15% alternative minimum corporate tax, or accounting minimum tax. And companies that engage in share buybacks will pay a 1% excise tax.
“In our analysis, we found that large oil and gas issuers that pay little income tax also tend to have some of the largest share buyback plans, which will make them the most affected by the new taxes,” said David Gonzales, vice president of Moody’s. -Senior Accounting Analyst, and Alastair Drake, Senior Vice President-Senior Accounting Analyst, wrote in an August 2022 industry commentary. Gonzales was also a member of the Financial Accounting Standards Advisory Council of the Financial Accounting Standards Board.
They estimate that 9% of blue-chip U.S. companies rated by Moody’s are likely to pay higher cash taxes under the new accounting minimum tax. And that’s negative credit for those companies.
Gonzales and Drake did not expect speculative grade companies to be significantly affected as they tend to be smaller companies.
Moody’s analysts explained that the new law allows companies to continue to benefit from accelerated tax depreciation. This will help mitigate the impact of the short-term alternative minimum tax for businesses that are in capital-intensive industries.
The Tax Cuts and Jobs Act 2017 allows short-term capital investments to be fully spent – instead of amortizing them over time – for five years. After that, it gradually decreases by 20 percentage points per year.
So more capital-intensive businesses should be sucked into the minimum book tax over the next four years, Moody’s said.
“The accounting minimum tax, which will reduce the cash flow of affected individuals, targets large multinational corporations that would otherwise pay little or no tax during years of significant financial statement profitability,” Moody’s wrote. “This tax effectively eliminates a substantial portion of deferred tax benefits and net operating losses for companies that have constant pre-tax income of $1 billion.”
Moody’s analysis shows that four industries—oil and gas; advanced technology; chemicals, plastics and rubber; and hospitality, gaming and recreation – will be most affected by the minimum book tax.
Among oil and gas companies, there are 19 companies rated in the investment grade with a modified pre-tax profit of $1 billion, and 14 companies pay less than 15% cash tax rate.
To more easily illustrate accelerated depreciation under current tax laws, the analysts’ note explains that modified pre-tax income is calculated by taking pre-tax book income and replacing depreciation expense with capital expenditure. Then, for companies that pay less than 15% tax, Moody’s compared their current tax percentage to the accounting minimum tax of 15% and calculated the delta.
“From a liquidity perspective, this tax can be very detrimental to large, growing businesses that have only recently reached the revenue threshold to qualify for the tax,” Gonzales and Drake noted. “These businesses may have net operating loss reserves that allow them to defer cash tax payments in the early years of profitability. Their net operating losses have been used to offset taxable income, but this offset will in most cases be offset by the 15% accounting minimum tax and can represent a significant portion of operating cash flow.
They found that the oil and gas industry had a cash tax rate of 15% among the four industries analyzed. Analysts attribute this mainly to companies that currently pay little or no tax. But now they will have to pay the minimum tax rate of 15% on their pre-tax accounting income.
“From an income statement (profit after tax) perspective, for most affected businesses (unless they expect to be below the 15% threshold for the foreseeable future), there will be no change in the overall tax charge in the income statement, as any additional tax charge will also result in a deferred tax asset that can be used in future years to offset tax bills for amounts above the minimum of 15%,” the memo notes.
In the meantime, Moody’s noted that the tax on stock buybacks is not significant enough to alter credit analysis or corporate capital allocation decisions.
“Oil and gas companies have relied heavily on buyouts as they benefit from strong commodity prices and capital discipline to generate unprecedented free cash flow,” the analysts wrote. “Although the tax is not likely to significantly affect the volume of share buybacks, it could be a significant source of tax revenue over the next two years.” And the 1% tax will not have a significant impact on solvency.