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The Obama administration\u2019s proposal to make the research and development credit permanent and to allow for a temporary 100% tax deduction for qualified capital expenditures is sure to boost cash flows.\u00a0 However should the IRC deduction 199 benefits be rolled back for the major oil companies, as is being currently discussed,\u00a0 the impact to certain firms could be harmful in out years.
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Other firms, many of which are not obvious candidates for the 199 benefit, have seen drops in both their effective and real tax rates. For example, in its March, 2010 10Q, World Wrestling Entertainment Inc. (WWE) explained its reduction in its effective tax rate, from 35% to 33%, was due to the 199 allowance.<\/p>\n
All US enterprises with productive capacity take advantage of the 199 provision.<\/p>\n
Enacted in 2004 as an export tax incentive, this provision allows a deduction, as a business expense, for a specified percentage of the qualified production activity\u2019s income (or profit) subject to a limit of 50% of the wages paid that are allocatable to the domestic production during the taxable year. The deduction is 9% for 2010.<\/p>\n
Analysts must determine the effects a rollback would have on a case by case basis as\u00a0many oil majors are already in a low \u201ccash rate\u201d despite reporting\u00a0a higher effective rate. To the extent capital spending is continuing to grow, the positive impact of the 100% deduction will overcome the loss of the 199 credit in those tax years. However, the loss of later years tax depreciation (as this is a temporary measure), combined with the loss of the 199 credit, will most likely force these same enterprises into a much higher tax rate.<\/p>\n
Kenneth S. \u00a0Hackel, CFA.<\/p>\n