Gulf Oil Corp. v. C.I.R.

Citation914 F.2d 396
Decision Date11 September 1990
Docket NumberNo. 89-2049,Nos. 89-2049,No. 89-2050,89-2050,89-2049,s. 89-2049
Parties-5552, 90-2 USTC P 50,496 GULF OIL CORPORATION, Appellant inv. COMMISSIONER OF INTERNAL REVENUE. COMMISSIONER OF INTERNAL REVENUE, Appellant inv. GULF OIL CORPORATION.
CourtUnited States Courts of Appeals. United States Court of Appeals (3rd Circuit)

J.W. Bullion (argued), Emily A. Parker (argued), Thompson & Knight, Dallas, Tex., for Gulf Oil Corp.

Brian C. Griffin, Acting Asst. Atty. Gen., Gary R. Allen, Ann Belanger Durney, David I. Pincus (argued), Charles Bricken (argued), John A. Dudeck, Jr., Tax Div., Dept. of Justice, Washington, D.C., for C.I.R.

Before SLOVITER and MANSMANN, Circuit Judges, and THOMPSON, District Judge. *

OPINION OF THE COURT

MANSMANN, Circuit Judge.

Gulf Oil Corporation and the Commissioner of Internal Revenue cross-appeal several decisions of the U.S. Tax Court involving Gulf's corporate tax liability for tax years 1974 and 1975.

Gulf, both directly and through its foreign subsidiaries and affiliates, explores, develops, produces, purchases and transports crude oil and natural gas world-wide, and manufactures, transports and markets petroleum products. Gulf is an accrual method taxpayer using the calendar year as its tax year. During 1974 and 1975, Gulf was a Pennsylvania corporation with its principal office in Pittsburgh, 1 filing federal corporate income tax returns with the Internal Revenue Service in Philadelphia, Pennsylvania. During 1974 and 1975, Gulf and certain of its subsidiaries constituted an "affiliated group" as that term is defined in I.R.C. Sec. 1504. 2 As the common parent, Gulf timely filed consolidated federal income tax returns for these tax years on behalf of itself and certain of its subsidiaries. We refer to this affiliated group variously as "Gulf" or as "the taxpayer."

The Commissioner determined federal income tax deficiencies of $80,813,428 and $166,316,320 for Gulf's tax years 1974 and 1975, respectively. Gulf challenged these deficiencies in the U.S. Tax Court, alleging numerous erroneous rulings by the Commissioner. Due to their complex and diverse nature, certain issues were severed and tried at a special trial session, resulting in seven Tax Court opinions, four of which are involved in this appeal.

The first issue, referred to by the parties as the "Worthless Properties" issue, involves the question of whether Gulf could take abandonment loss deductions pursuant to I.R.C. Sec. 165 on geological strata which were found to be devoid of mineral deposits and, hence, were deemed worthless by the taxpayer, even though the entire lease was not abandoned. Gulf appeals from the Tax Court's determination that there was no abandonment.

The second dispute, referred to as the "Kuwait Nationalization" issue, presents several questions, the foremost of which is whether the value of the price discount under a five year crude oil supply agreement is ordinary income to the taxpayer or whether it was compensation by Kuwait for its nationalization of the taxpayer's interests and, hence, a capital gain. Gulf appeals from the Tax Court's determination that the price discount was not compensation for nationalization. The Commissioner appeals from the Tax Court's determination that the taxpayer could accrue and deduct, in tax year 1975, Kuwait income taxes related to the prospective five year crude oil supply agreement.

The third problem, referred to as the "Captive Insurance" issue, presents cross-appeals by Gulf and by the Commissioner concerning the Tax Court's determination that the premiums paid by the taxpayer to its subsidiary insurance company were not deductible expenses and that the payments on losses by the subsidiary insurance company to other subsidiaries owned by Gulf were not constructive dividends to the parent corporation.

Finally, in the section referred to as the "Iran Agreement," upon the Commissioner's appeal, we must determine whether the Tax Court erred by concluding that Gulf possessed an economic interest in minerals in place pursuant to a 1973 Agreement. The Tax Court determined that the taxpayer possessed an economic interest and, therefore, was permitted to take a depletion allowance deduction for tax year 1974 and was further permitted to have a foreign tax credit for taxes paid to Iran.

We will address these issues seriatim, keeping in mind our scope of review. We exercise plenary review of the Tax Court's construction and application of the Internal Revenue Code. Pleasant Summit Land Corp. v. Comm'r, 863 F.2d 263, 268 (3d Cir.1988). With respect to disputes of fact, we may reverse the Tax Court's decision only if the findings are clearly erroneous. A finding is clearly erroneous when "there is evidence to support it, [but] the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." Anderson v. City of Bessemer City, N.C., 470 U.S. 564, 573, 105 S.Ct. 1504, 1511, 84 L.Ed.2d 518 (1985); Double H Plastics, Inc. v. Sonoco Prods. Co., 732 F.2d 351, 354 (3d Cir.1984). We are quite aware that we cannot reverse findings of fact simply because we would have decided the case differently. Anderson v. Bessemer City, 470 U.S. at 573, 105 S.Ct. at 1511. Our jurisdiction rests on 26 U.S.C. Sec. 7482(a): United States Courts of Appeals have exclusive jurisdiction to review Tax Court decisions.

Under the appropriate standard of review for each issue, we are affirming in part and reversing in part the decisions of the U.S. Tax Court. Our reversing in part requires recomputation of Gulf's tax liability for these tax years. Thus, we will remand for a recomputation of Gulf Oil Corporation's 1974 and 1975 tax liability consistent with this opinion.

I. WORTHLESS PROPERTIES

On this first issue relating to Gulf's offshore oil and gas leases, Gulf presents two questions: (1) whether Gulf had "abandoned," as a matter of law, particular offshore leases in tax years 1974 and 1975, which would entitle it to an I.R.C. Sec. 165 loss deduction; and (2) if the deduction were permitted, the appropriate calculation of the amount of Gulf's basis in each lease which would properly be allocated to the worthless operating minerals interests. We will affirm the Tax Court's decision, reported at Gulf Oil Corp. v. Comm'r, 87 T.C. 135 (1986), that Gulf failed to prove abandonment of the leases involved.

A. Facts

During tax years 1974 and 1975, Gulf held undivided interests in twenty-three offshore oil and gas leases in the Gulf of Mexico, covering blocks located in the offshore areas of Louisiana and Mississippi, Alabama, and Florida (MAFLA). 3 The lessor for one lease, in offshore Louisiana, was the State of Louisiana (the Louisiana lease). The U.S. Department of Interior 4 was the lessor for the other twenty-two leases (the Department leases). Gulf based its bids for these leases on its perception of the value of the underlying minerals. The bids reflected basic geologic evaluations which were used to estimate the amount of oil and gas present in each block of land to be leased. 5 These were balanced against the potential costs of placing the lease into production. From this, Gulf would calculate a geological assessment of risk, the most important factor in determining how much to bid.

Successful lease bidders were required to pay the lessor an up-front cash bonus for each lease. For the leases at issue, Gulf and its co-lessees paid cash bonuses ranging from $1.127 to $61.166 million per lease ($15 million average). 6 In addition, lessees were also required to pay a yearly delay rental on each lease to ensure lease retention throughout the primary term, permitting lessees to complete exploration. Delay rentals on the Department leases were $3.00 per acre; 7 thus, to retain rights in twenty-two of the leases, Gulf and its co-lessees would be required to pay approximately $20,000 per lease per year. Delay rentals on the Louisiana lease were one-half of the cash bonus payment for each lease. Since the total cash bonus payment on this lease was $7.713 million, Gulf and its co-lessees would be required to pay approximately $3,856,600 per year to retain rights in this lease.

Lessees could relinquish rights to the Department leases in three ways. First, since the primary term of each lease was five years from the effective date of the lease, each lease would expire automatically by operation of law at the end of its five-year primary term, unless the lease was extended by either production in paying quantities or continuation of drilling. Second, the lessee could elect not to pay the required annual delay rental on the lease. Third, the U.S. Department of Interior, pursuant to its regulations, would accept a release or relinquishment of either an entire offshore lease or an "officially designated subdivision" thereof. However, per regulations in effect since 1954, the Department would not accept relinquishment of horizontal intervals, strata, or sands in an offshore lease. Once the lessee relinquished rights in a lease, the lease became available for bid at a subsequent lease sale.

Gulf acquired undivided interests in these twenty-three offshore oil and gas leases from 1972 through 1974. Shortly after acquiring these interests, Gulf personnel determined how many geological strata, i.e., horizontal layers, underlying each lease might contain gas or oil deposits. Determinations were based upon the known geology of other nearby parcels. Gulf personnel determined that each of the ten offshore Louisiana leases potentially contained between six and thirty-nine deposits, and that each of the thirteen offshore MAFLA leases potentially contained between three and eight deposits. Gulf then allocated its total basis in each lease, consisting of the initial cash bonus payment plus any geological and geophysical costs, among the strata believed to contain oil and gas deposits. 8 Pursuant to I.R.C. Sec. 614(b)(2),...

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