|3 Months Ended|
Mar. 31, 2020
|Income Tax Disclosure [Abstract]|
In 2017, the Company became the sole managing member of Rosehill Operating, the Company’s accounting predecessor. Rosehill Operating is a limited liability company that is treated as a partnership for U.S. federal income tax purposes and is not generally subject to U.S. federal income tax at the entity level. Any taxable income or loss generated by Rosehill Operating is passed through to and included in the taxable income or loss of its members, including the Company. The Company is a C corporation and is subject to U.S. federal income tax and state and local income taxes.
The Company’s income tax provision was an expense of $37.0 million and an expense of $3.3 million for the three months ended March 31, 2020 and 2019, respectively. The Company’s effective tax rate was (19)% and (3)% for the three months ended March 31, 2020 and 2019, respectively. The effective tax rate differs from the enacted statutory rate of 21% in 2020 primarily due to the allocation of profits and losses to Rosehill and the noncontrolling interest holder in accordance with the LLC Agreement, the impact of state income taxes, and effects of the valuation allowance. The effective tax rate differs from the enacted statutory rate of 21% in 2019 primarily due to the allocation of profits and losses to Rosehill and the noncontrolling interest holder in accordance with the LLC agreement and the impact of state income taxes.
As of March 31, 2020, the Company had approximately $55.7 million of U.S. federal net operating loss carryovers, which will begin to expire in 2037. The Company periodically assesses whether it is more likely than not that it will generate sufficient taxable income to realize its deferred tax assets, including NOL carry forwards. A valuation allowance for deferred tax assets is recognized when it is more likely than not that some or all of the benefit from the deferred tax assets will not be realized. As of March 31, 2020, the Company had a full valuation allowance to offset its net deferred tax assets in excess of deferred tax liabilities because the Company thinks it is more likely than not that its deferred tax will not be realized prior to their expiration due to uncertainty of the market, the significant decline in oil prices that began during the first quarter of 2020 and the Company having substantial doubt about its ability to continue as a going concern.
The Company is subject to the following material taxing jurisdictions: the United States and Texas. As of March 31, 2020, the Company has no current tax years under audit. The Company remains subject to examination for federal income taxes and state income taxes for tax years 2016 to present.
The Company has evaluated all tax positions for which the statute of limitations remains open and believes that the material positions taken would more likely than not be sustained upon examination. Therefore, as of March 31, 2020, the Company had not established any reserves for, nor recorded any unrecognized benefits related to, uncertain tax positions. The Company’s policy is to recognize interest and penalties related to uncertain tax positions in income tax expense.
Tax Receivable Agreement
On April 27, 2017, the Company entered into a tax receivable agreement (“Tax Receivable Agreement”) with the noncontrolling interest holder, Tema. The Tax Receivable Agreement provides that the Company will pay to Tema 90% of the net cash savings, if any, in U.S. federal, state and local income tax that the Company realizes (or is deemed to realize in certain circumstances) in periods beginning with and after the closing of the Transaction as a result of the following: (i) any tax basis increases in the assets of Rosehill Operating resulting from the distribution to Tema of $35 million in cash, the shares of Class B Common Stock and the issuance of 4,000,000 warrants to Rosehill Operating exercisable for shares of its Class A Common Stock, all in connection with the Transaction, and resulting from the assumption of Tema liabilities in connection with the Transaction, (ii) the tax basis increases in the assets of Rosehill Operating resulting from a redemption by Rosehill Operating with respect to Tema and (iii) imputed interest deemed to be paid by the Company as a result of, and additional tax basis arising from, payments it makes under the Tax Receivable Agreement.
The estimation of liability under the Tax Receivable Agreement is by its nature imprecise and subject to significant assumptions regarding the amount and timing of future taxable income. The Company is not obligated to make any payments under the Tax Receivable Agreement until the tax benefits associated with the transaction that gave rise to the payment obligation are realized. Amounts payable under the Tax Receivable Agreement are contingent upon, among other things, (i) generation of future taxable income over the term of the Tax Receivable Agreement and (ii) future changes in tax laws. If the Company does not generate sufficient taxable income in the aggregate over the term of the Tax Receivable Agreement to utilize the tax benefits, then the Company would not be required to make the related Tax Receivable Agreement payment.
On December 26, 2019, Tema exercised its right to cause the Company to redeem all or a portion of its Rosehill Operating Common Units, by exchanging 14,100,000 out of its 29,807,692 Rosehill Operating Common Units then outstanding at the time. A liability under the Tax Receivable Agreement relating to such redemption was recorded in the amount of $50.1 million as of the date of the redemption, increasing the Tax Receivable Agreement liability as of December 31, 2019 to $53.8 million. Due to the uncertainty of the market, the significant decrease in oil prices that began during the first quarter of 2020 and the Company having substantial doubt about its ability to continue as a going concern, the Tax Receivable Agreement liability was revalued to $0.2 million as of March 31, 2020 because it is not probable that the Company will have sufficient future taxable income to utilize all the tax benefits related to the Tax Receivable Agreement liability. The revaluation of the Tax Receivable Agreement liability resulted in income of $53.6 million recognized in ‘Other Income, net’ on the Condensed Consolidated Statement of Operations.
The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.
Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef