Industry Director Directive #1 on Enhanced Oil Recovery Credit
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
Large and Mid-Size Business Division
Impacted IRM 4.51.2
May 2, 2007
MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB
DIRECTOR, FIELD SPECIALISTS, LMSB
DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB
DIRECTOR, INTERNATIONAL COMPLIANCE STRATEGY AND POLICY
FROM: Keith M. Jones
Natural Resources and Construction
SUBJECT: Tier II Issue - Enhanced Oil Recovery Credit Directive #1
This memorandum provides field direction on Tier II Issue – Enhanced Oil Recovery Credit.
Enhanced Oil Recovery (EOR) projects are undertaken by oil companies to increase the ultimate recovery of crude oil. These projects involve the application of an EOR method (sometimes called a “tertiary recovery method”) to a specific underground oil bearing reservoir. The IRC §43 EOR credit became effective with the 1991 tax year. The EOR tax credit is both highly factual and highly technical, and is almost exclusively worked by the Service’s Petroleum Engineers.
Only “qualified costs” will generate the tax credit. There are three general types of qualified costs - tangible property, intangible drilling and development costs (IDC), and tertiary injectants. Qualified EOR projects must be located within the U.S. and have commenced after 12-31-1990. The regulations provide an exception for the post-1990 "significant expansion” of projects that had begun before that date. The amount of the credit is 15% of qualified costs for tax years 1991-2005. According to Notice 2006-62 the credit is completely phased out for 2006 due to high oil prices. A notice is issued each year, and based on oil prices a determination is made on whether or not the credit is available.
Two major areas of controversy include the significant expansion issue and the tertiary injectant cost issue. In the late 1990’s the Service began to deny the credit for normal operating costs incurred to “self produce” tertiary injectants. Congress amended §43(c) (1) (C) in 2000 to insure that these costs would qualify for the credit in the same manner as the cost of purchased injectants. The amendment was retroactive to the original enactment of the credit in 1991. In 2003 the IRS issued Revenue Ruling 2003-82 to provide more detailed guidance on qualified tertiary injectant costs. It established a definition of tertiary injectant costs as costs related to the use of a tertiary injectant, such as costs for acquisition or production, injection, recovery and reinjection.
In the late 1990’s, various taxpayers began filing claims based on “significant expansion projects” that commenced on January 1, 1991. The Service’s engineers determined that these claims primarily related to costs incurred to carry out EOR projects that had been started long before 1991, and should not qualify. TAM 103300-05 (issued as PLR 200535028 on May 5, 2005) addressed whether a company’s post-1990 activities on its pre-1991 project area constituted a significant expansion of the project under Treasury Regulation § 1.43-2(d)(2). The TAM concluded that, in the absence of new drilling or new perforations, more intensive application of the same tertiary recovery method to the same reservoir volume could not constitute a significant expansion project.
UIL Code: 43.01-00 EOR Credit
SAIN: 604-06 General Business Credit
Second Tier SAIN: 335 EOR Credit
Planning and Examination Guidance:
For costs incurred during the taxable year, the EOR credit is claimed on Form 8830 (EOR Credit) and flows into Form 3800 (General Business Credit). There may be one or more Forms 8830 depending on whether the taxpayer consolidates the return of several corporations. Depending on the AMT or NOL position of the taxpayer, they may have to carry forward the EOR credit generated during the current exam year. Conversely, it is also possible that the general business credit which offsets tax liability in the current exam year is attributable to EOR credit generated in a previous year, possibly including a year that is otherwise barred by the statute of limitations.
Examiners should consult with the Team Coordinator to determine the procedure to examine the EOR credit carry forward if it was not previously examined. If you receive an 1120X or a claim for refund regarding new or unused EOR credit being carried forward and used on the 1120X or claim from a tax year that is barred, contact your local counsel for assistance.
Examiners should also review Form 4764 and the previous Revenue Agent Report (RAR) to see if and how the EOR credit was addressed in a previous examination.
Planning and Examination Risk Analysis:
Enhanced Oil Recovery Credit is considered a Tier II issue for LMSB Examiners. This issue is required to be addressed in examinations if present. If the EOR credit is present, the Petroleum Technical Advisors should be contacted. The examiner should make an SRS referral requesting the services of a Petroleum Engineer as early as possible in the examination. If the EOR credit is not fully developed with the assistance of a Technical Advisor and an engineer, the case may be returned from Appeals for further development.
IRM Oil and Gas Handbook (02-01-2006) section 184.108.40.206.4 (Enhanced Oil Recovery Tax Credit) contains the following instructions for examiners:
(5) Many EOR projects are operated by joint ventures and the operator
will frequently notify the non-operators as to the annual expenditures
for qualified costs. When an examiner has reviewed a project in
sufficient detail to determine the merits of the project and the
associated major expenditures, he or she should take the following
• Secure the identity of the operator, each working interest
owner, and the working interest percentage of all parties
• Request a copy of any information letter supplied to or
from the operator regarding the amount of qualified costs
• Provide the forgoing information and a synopsis of the
examiner’s determination to the technical advisors for the
The technical advisors for the petroleum industry shall be responsible for forwarding the examiner’s determination to the other examination teams for their consideration.
The technical advisors may also be knowledgeable of any examinations done on EOR projects co-owned by other taxpayers that can benefit the examiners when they perform risk analysis for their own taxpayer.
See Attachment 3 for direction on evaluating information gathered, and what factual patterns should be pursued and / or sustainable in the post-examination process.
The EOR tax credit is highly factual and the amount of the credit is based upon both engineering judgment and reasonable allocation methods. However, LMSB examiners are required to follow the positions listed below:
Except where there is compelling evidence to the contrary, any “significant expansion project” that purportedly started on January 1, 1991 (coinciding when the credit became effective), and involves no new drilling or perforations should be rejected as qualified. All the costs that were claimed as qualified for the credit should be disallowed. The examiner should obtain the identity of all the working interest owners in the project and contact the Petroleum Industry Technical Advisors with such information. Where new drilling or perforations did occur, examiners should consult the audit evaluation section in Attachment 3.
In computing tertiary injectant costs pursuant to Revenue Ruling 2003-82, certain costs would not be considered as “related to the use of a tertiary injectant,” or included in any pool of costs which may be allocated in part to tertiary injectant costs. These consist of:
plugging and abandonment costs,
overhead that is in excess of the amount that non-operators reimbursed (or normally would reimburse) the operator for overseeing the implementation of the project,
severance taxes and royalties,
the cost to repair a well when the purpose is to improve
its efficiency of producing fluids other than tertiary
the cost to dispose of a spent tertiary injectant, and
the cost of any activity that does not have a reasonable nexus to the acquisition, production, injection, recovery, or reinjection of a tertiary injectant.
The cost of operations that involve the processing of both hydrocarbons and other fluids can be allocated (using a reasonable method) to determine the portion that represents “costs related to the use of a tertiary injectant” only when the operations are necessary for the production, recovery, or injection of a tertiary injectant. Operations that are undertaken for the sole purpose of recovering hydrocarbons for sale do not meet this standard. For the cost of operations to recover and / or recycle tertiary injectants, an allocation method that results in a unit cost for the injectants that is in excess of the cost to acquire “fresh” injectants is not a reasonable allocation method.
Effect on Other Guidance:
Questions regarding this directive should be addressed to Robert (Bob) C. McCann, Petroleum Industry Technical Advisor ( Robert.C.Mccann@irs.gov or 713-209-4464), or Denise S. Jennings, NRC Territory Manager at 972-308-1346 or Denise.S.Jennings@irs.gov.
This Directive is not an official pronouncement of law, and cannot be used, cited, or relied upon as such.
Attachment 1 - Audit Steps for EOR Tax Credit
Attachment 2 - Proforma IDRs for EOR Tax Credit
Attachment 3 - Audit Evaluation for EOR Tax Credit
CC: Commissioner, LMSB
Deputy Commissioner, Operations
Deputy Commissioner, International
Division Counsel, LMSB
Directors, Field Operations
Director, Performance, Quality and Audit Assistance