Conveying oil and gas interests in Pennsylvania raises the question as to whether the document conveying the interest is subject to realty transfer tax and, if so, how the value of the interest determined and the tax calculated. Oil and gas transactions create a variety of interests in property. An oil and gas lease creates two interests, the working interest in the minerals conveyed to the lessee (the exploration and production or E&P company), and the royalty interest reserved by the landowner. Some landowners, for estate planning or other purposes, may deed the mineral estate to a separate entity, such as a family limited partnership.
The E&P company may want to reward a landman who played an integral part in securing an oil and gas lease by granting an overriding royalty interest which, like the landowner’s royalty, is expressed as a percentage of production. Each of these interests is created or conveyed by executing and recording a document in the county land records such as an oil and gas lease, mineral deed, or conveyance of an overriding royalty interest. The Pennsylvania Realty Transfer Act (the “Act”) imposes the tax on any document or writing that transfers mineral rights, unless a statutory exemption or exclusion applies.
The tax is based on the consideration paid in a bona fide sale. In the absence of a bona fide sale, a gift for example, the interest is based on a computed value. Because oil and gas estates and interests are not separately assessed and not subject to real estate taxes, transfer taxes of oil and gas interests are not based on a computed value. As a result, in the absence of consideration in a bona fide sale, transfer taxes on documents conveying oil and gas interests are determined based on the best available evidence of monetary worth.
Oil and Gas Lease and Assignments
• Oil and gas leases and lessee assignments: Oil and gas leases would ordinarily be taxable under the Act, but leases and assignments of leases for the production of oil, gas and minerals are statutorily exempt from the tax.
• Assignment by the Landowner: A separate assignment of the oil and gas lease by the landowner lessor may present a problem. The Pennsylvania Department of Revenue (the “Department”) takes the position that the landowner’s royalty interest is an interest in real estate which would be subject to transfer tax. The Department’s position is contrary to a long line of cases which hold that an oil and gas lease leaves the landowner with only an interest in the royalties, which are personal property. See, e.g. Snyder Brothers, Inc. v. The Peoples Natural Gas Company, 676 A.2d 1226 (Pa. Super. 1996).
• A deed conveying all or any part of the subsurface mineral estate is subject to Pennsylvania transfer tax.
• If no sale occurred, the tax is based on the actual monetary worth of the estate or interest determined by the best available evidence. Applicable transfer tax regulations require that the value of real estate shall be determined by an appraisal only when (a) the real estate was transferred by deed in lieu of foreclosure, or (b) the conveyance was not subject of a bona fide sale and is not separately assessed for local real estate tax purposes.
Conveyance and Assignment of an Overriding Royalty Interest.
Whether transfer tax applies becomes an interesting question when one considers a conveyance or assignment of an overriding royalty interest. An overriding royalty interest is an interest in real estate. As such, a document transferring an overriding royalty interest is subject to the tax. Whether the tax is actually due and how it is calculated depends on whether the property is leased and producing. The Department’s Inheritance Tax Bulletin 2102-01 provides that the value of an oil and gas interest is determined as follows:
• For leased and producing properties: value at an amount equal to any amounts received that were attributable to actual production of the natural gas interests at issue during the prior 12 months multiplied by two.
• For leased, non-producing properties: interests shall be reported at a value of zero (hence, no tax) unless, at the time of the conveyance, the properties were part of a contractual arrangement whereby the properties generated fixed future payments, in which case the natural gas rights shall be calculated by reducing the fixed future payments to present value using established IRS actuarial tables found in IRS publication 1457 Actuarial Values Table B, Section 3 Annuity, income and remainder interests for a term certain.
• For non-leased, non-producing properties: the interests are reported at a zero value and no tax is due.
While the Department’s Inheritance Tax Bulletin addresses the taxable value of natural gas for inheritance tax purposes, the Department’s Realty Transfer Tax and Personal Income Tax Bulletin 2012-04 states that the Department may, in its discretion, accept other credible evidence of the value of mineral rights such as the methods described in the Inheritance Tax Bulletin. The various means by which a natural gas interest may be conveyed may result in transfer taxes. It is important to first determine whether the interest being conveyed is an interest in real estate. Then, if no exemption applies, assemble credible evidence of value that the Department may accept or that the Act and its regulations may require.