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Corporate Taxes

Provinces earn revenue from profitable companies by charging a corporate tax on profits. However, it should be noted that how the government calculates profits is different from how a company accountant calculates profits. The main difference is how the capital asset is expensed out.

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In the company books, the asset is given a market value. This market value is amortized over the life of the well on a per m3 of production. This is not a bad method to expense the capital asset over its lifetime.

When calculating corporate taxes, governments usually do not accept the amortization schedules by the company accountants. Instead they have their own accounting laws that companies must abide by when reporting their income for taxation purposes. In essence, the company is keeping two sets of books. The first is for determining its interpretation of actual profits. The second is based on the government's interpretation of profits. It is from this second set of books that the appropriate taxes are calculated.

The expense of assets in OilFinancier is based on a simplified version of the Canadian tax laws.

When the company purchases an oil well, the market value is put into a Capital Cost Account (CCA) in the province the well was purchased.

The company can expense up to a certain percentage of its CCA each year. This value is called a Capital Cost Expense (CCE). Each province has its own maximum percentage of CCA that can be used for CCE.

Note that the CCE is expressed in annual percent of CCA per year. For example, if a company has $100,000 of CCA and the CCE is 24%, that company can apply $24,000 ($100,000 x 0.24) against its income to reduce taxes. The next year, the company will have reduced its CCA to $76,000 ($100,000 - $24,000) and therefore can only apply $18,240 ($76,000 x 0.24) of CCE against the income.

However, an OF seminar works in OF Days, not calendar years. With each OF Day representing one calendar month, the CCE will be 1/12 of the stated rate. In the example above, the company can write 2% of its CCA in each OF Day to reduce taxes.

So here's how CCA and CCE will actually work in OilFinancier for the above example. The company has a CCA of $100,000. In the first OF Day of production, its CCE will be $2,000 ($100,000 x 0.02). This reduces the CCA to $98,000 ($100,000 - $2,000). In the next OF Day, the CCA of $98,000 translates into a CCE of $1,960 ($98,000 x 0.02). This will reduce the CCA for the next OF Day to $96,040 ($98,000 - $1,960).

The company need not use all of its CCE in a year. If its profits are low, it will use only as much CCE to keep its taxes at zero. Unused CCE stays in the CCA and can be used for future OF Days. The program automatically allocates CCE appropriately to the financier's advantage.

If profits are high, only the maximum CCE can be used. If there is still a taxable profit after applying the CCE, the taxes are then calculated and paid.

CCA and CCE are not well specific. If you have two wells in a province and suspend one of them, the suspended well's CCA still counts towards the active well's CCE. In other words, CCA and CCE are accounted on a provincial basis. Amortization is, conversely, accounted on a well basis.

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If this CCA and CCE seems a little complicated, be patient with yourself. As you go through the tutorial and get a few wells for yourself, all will become clear later. Learning to understand all this accounting is good practice for petroleum professionals.

© 2014 Dave Volek. All Rights Reserved.