CHAPTER 7 TAX CONSIDERATIONS IN NATURAL RESOURCE DEVELOPMENT PROJECTS ON INDIAN LANDS

• Jurisdiction: United States

Natural Resources Development and Environmental Regulation in Indian Country
(May 1999)
CHAPTER 7
TAX CONSIDERATIONS IN NATURAL RESOURCE DEVELOPMENT PROJECTS ON INDIAN LANDS
Michael P. O'Connell
Stoel Rives LLP
Seattle, Washington

I. Introduction

Most natural resource development projects require capital intensive investments. Federal, tribal, state, and local taxes can add significant costs to the development and operation of natural resource development projects on Indian reservations. Too often, tribal governments and other parties to natural resource development projects on Indian reservations overlook or leave to chance the effect of taxes on their business transaction. Based on the form of the business structure selected by the parties, the legal and economic burdens of some federal, tribal, state, and local taxes may be avoided in whole or in part or the burdens of such taxes may be transferred to third parties. Tax savings realized by choice among available business forms or structures may turn an otherwise marginal or uneconomic project into a profitable and prudent business investment. These tax savings also can be reallocated among the parties to the transaction. In some cases, parties may be able to restructure an existing natural resource development project, converting a lease to a management agreement for example, to minimize or shift the legal or economic burden of taxes, and to allocate among the parties economic rewards achieved thereby. This paper provides a general summary of rules relating to the tax treatment of various parties to and structural arrangements of natural resource development projects on Indian reservations. This paper also offers some suggestions on certain structural arrangements that may be available in some cases to reduce overall tax burdens among the parties to the transaction.

II. Federal Income Taxation

A. Tribal Government Entities.

1. Tribal governments. The Internal Revenue Service (Service) has ruled that income earned by a tribal government from a commercial business is not subject to federal income tax because tribal governments are not taxable entities under the Internal Revenue Code (Code). Rev. Rul. 94-16, 1994-1 CB 19.¹ Because a tribal government is not a taxable entity, the Service

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ruled that tribal government income is not taxable regardless of whether earned on or outside the tribal government's reservation.²

Some tribal governments have political subdivisions which have a measure of autonomy in local government matters. The Hopi Tribe and the Navajo and Tohono O'Odam Nations are examples.³ While Revenue Ruling 94-16 does not expressly address the tax treatment of political subdivisions of tribal governments, the logic of that ruling applies to political subdivisions of tribal governments. Logic aside, if it becomes necessary to determine how the Service will treat income earned by a political subdivision of a tribal government, a private letter ruling should be sought.

2. Tribal Enterprises. As used in this article, the phrase "Tribal Enterprise" refers to a broad class of entities owned and operated by a tribal government as instrumentalities, arms, agencies and departments of tribal government which are part of the tribal government and not incorporated under any federal, tribal or state law. Tribal Enterprises are to be distinguished from incorporated tribal government entities, such as tribal government corporations, Section 17 corporations, state chartered business corporations, limited liability companies, housing authorities, utility authorities, or other similar entities (Tribal Business Entities). The difference between Tribal Enterprises and Tribal Business Entities is formalistic and often difficult to determine in fact, but there may be differences in tax treatment and certainty as to tax treatment among various Tribal Enterprises and Tribal Business Entities. Tribal Enterprises serve as subordinate economic entities of tribal government and are similar in legal character to departments of tribal government such as the police, accounting, enrollment and other department in that they are more or less under the direct political control of the tribal council. While a Tribal Enterprise may have a board of directors or other person in day-to-day charge of the Tribal Enterprise, overall business policy, operations, investments, and budgetary control rests with the tribal government. Revenue Ruling 94-16 does not address the tax treatment of Tribal Enterprises. While, the logic of that ruling applies to Tribal Enterprises, a private letter ruling should be sought if it becomes necessary to determine how the Service will treat income earned by a Tribal Enterprise.

3. Section 17 corporations. Section 17 corporations are authorized by Section 17 of the Indian Reorganization Act.⁴ The Secretary of the Interior issues charters to tribal governments

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for Section 17 corporations to conduct the business affairs of the tribe. In Revenue Ruling 94-16, the Service ruled that a tribal government organized as a Section 17 corporation should be treated the same as the tribal government. Accordingly, any income earned by a Section 17 corporation will not be taxable under the Code, regardless of whether such income is earned on or outside the tribal government's reservation.

4. Tribal Government Corporations. Many tribal governments have incorporated tribal government corporations under tribal law. These tribal governmental corporations are wholly owned by and operate as subordinate economic entities of tribal government vested with authority to conduct one or more tribal business or economic functions as instrumentalities, arms, agencies, and departments of tribal government operating under a board of directors rather than the tribal council. The board of directors is typically charged with making decisions based on business judgment rather than political criteria. Tribal government corporations, like federal government corporations but unlike state chartered business corporations, are intended to be part of and not legal entities separate from the tribal government which incorporates them. The Service thus far has not taken a position on the federal income tax treatment of tribal government corporations.⁵

5. State and tribal government chartered business corporations. Where a tribal government organizes a business corporation under state law, Revenue Ruling 94-16 concludes that the income of such a corporation is taxable under the federal income tax code. The Service reasoned that a corporation organized under state law is a legal entity separate from the tribe and that the tribal government's choice of that form will not be ignored.⁶ Although the Service's ruling does not address the federal income tax treatment of a business corporation owned by a tribal government but chartered under tribal rather than state law, the tax treatment of business corporations chartered under tribal law should be the same as those chartered under state law.

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6. Limited Liability Companies. Under the Service's "check the box rule,"⁷ single member limited liability companies can chose to be disregarded as entities separate from their owners. 26 C.F.R. Part 301.7701-1(a)(4). Under this regulation a limited liability company whose sole member is either a tribal government or a Section 17 corporation could chose to be disregarded as an entity separate from the tribal government or Section 17 corporation. If it made that election, income earned by the single member limited liability company would not be subject to federal income tax regardless of whether that income was earned on or outside the tribal government's reservation.

B. Tribal Members.

Tribal members are subject to federal income taxes the same as other persons for income whether earned on or outside an Indian reservation, except where an exemption exists pursuant to the terms of a treaty or a federal statute.⁸ Such an exemption may exist where a tribal member receives a per capita distribution from certain judgments in favor of the tribal government or where there is a per capita distribution of certain tribal trust funds approved by the Department of the Interior.⁹ In general, exemptions from federal income tax are rare.

C. Non-Members.

As with tribal members, income earned by non-members is generally taxable regardless of whether earned on or outside an Indian reservation. Exemptions are rare and exist if at all pursuant to the express terms of a statute or treaty.

D. Federal Tax Incentives.

1. Accelerated Depreciation. Section 168(j) of the Code¹⁰ affords accelerated depreciation deductions for capital investment costs by certain businesses located on Indian reservations

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compared to businesses located outside Indian reservations.¹¹ To be eligible for these deductions, "qualified Indian reservation property" must have been placed into use after 1993 and before December 31, 2003, be used by the taxpayer in the active conduct of a trade or business within an Indian reservation, not be acquired (directly or indirectly) by the taxpayer from a person related to the taxpayer, not be used for gaming activity as defined by the Indian Gaming Regulatory Act,¹² and not be used or located outside the Indian reservation on a regular basis, except for "qualified infrastructure property." The applicable recovery periods are: 2 years for 3-year property, 3 years for 5-year property, 4 years for 7-year property, 6 years for 10-year property, 9 years for 15-year property, 12 years for 20-year property, and 22 years for nonresidential property (31.5 years outside Indian reservations).

2. Indian Employment Credit. Sections 38(b) and 45 A(a) of the Code¹³ provide a tax credit to any on reservation employer for 20 percent of any increase over similar amounts paid in 1993 in the sum of "qualified wages" (paid to a "qualified employee") and...