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Many have asked whether Ohio’s Commercial Activity Tax (“CAT”) applies to bonuses and royalties realized from oil and gas transactions. A bonus is paid on execution of the lease and “grants the lessee the exclusive right to drill for and produce oil, gas, or other minerals on the property described in the lease.” See Internal Revenue Manual §4.41.1.2.2(1). A “royalty interest” or “landowner’s royalty” is “the lessor’s share of the production interest” usually expressed as 1/8 of the oil and gas produced from production rights granted by a lease. See Internal Revenue Manual §4.41.1.2.2(2).
Ohio’s CAT is based on the “gross receipts” of a taxpayer and is calculated against the amount realized from taxable transactions without deduction for cost of goods sold or other expenses incurred. See Ohio Revised Code (“ORC”) §5751.01(F). Included in gross receipts are “Amounts realized from another’s use or possession of the taxpayer’s property or capital.” See ORC §5151.01(F)(1)(c).
Based on the foregoing, Ohio’s CAT applies both to bonus and royalty payments received by a lessor or landowner. The lessee pays the bonus because a lease has been signed that grants rights to the lessee to use the property and, further when the property is used by production of oil and gas, a production royalty must be paid as well tied to that use. As such, the lessor has granted to “another’s use or possession of the taxpayer’s property or capital” and has received compensation as a result. Both bonus and landowner’s royalties then would be subject to Ohio’s CAT. See ORC §5751.01(F)(1(c). Of course, the threshold of $150K of annual gross receipts must be exceeded.
Please contact David J. Lewis at 330-436-5300 regarding this article.