Baker Hughes, Inc. v. United States, 18-20585

• Decision Date: 21 November 2019
• Docket Number: No. 18-20585,18-20585
• Citation: 943 F.3d 255
• Parties: BAKER HUGHES, INCORPORATED, Plaintiff–Appellant v. UNITED STATES of America, Defendant–Appellee
• Court: U.S. Court of Appeals — Fifth Circuit

943 F.3d 255

BAKER HUGHES, INCORPORATED, Plaintiff–Appellant
v.
UNITED STATES of America, Defendant–Appellee

No. 18-20585

United States Court of Appeals, Fifth Circuit.

FILED November 21, 2019

Reagan Mark Brown, Stephen Allen Kuntz, Robert Clay Morris, Norton Rose Fulbright US, L.L.P., Houston, TX, for Plaintiff-Appellant.

Jacob Earl Christensen, Cory Arthur Johnson, Gilbert Steven Rothenberg, Esq., Senior Attorney, Rika Valdman, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC, for Defendant-Appellee.

Before SOUTHWICK, WILLETT, and OLDHAM, Circuit Judges.

LESLIE H. SOUTHWICK, Circuit Judge:

943 F.3d 257

In this dispute over an income tax deduction, the taxpayer appeals the decision of the district court that a $52 million payment from its predecessor in interest to the predecessor’s subsidiary was not a bad debt under 26 U.S.C. § 166 or an ordinary and necessary business expense under 26 U.S.C. § 162. Therefore, no income tax deduction was allowed for the payment. We AFFIRM.

FACTUAL AND PROCEDURAL BACKGROUND

During the relevant time period, BJ Services Company, which the parties have referred to as "BJ Parent" and so shall we, conducted fracking services in Russia. It operated through a Russian subsidiary, ZAO Samotlor Fracmaster Services, which also has an agreed shortform, "BJ Russia." The plaintiff Baker Hughes is the successor in interest to BJ Parent. In 2006, BJ Russia entered into a three-year contract with OJSC TNK-Management ("TNK-BP"), a joint venture between Russian National Oil company TNK and British Petroleum, to provide fracking services in Siberia. TNK-BP could terminate this contract if BJ Russia became bankrupt, if a liquidator was appointed for BJ Russia, or if BJ Russia defaulted on its contractual obligations. During the three-year term of the contract, BJ Russia did not default, and TNK-BP never claimed it had.

As a condition of BJ Russia’s bidding on this contract, TNK-BP required BJ Parent to provide a guarantee that BJ Parent would perform or ensure the performance of the fracking services that TNK-BP asked BJ Russia to provide. The final version of this guarantee in part provided:

1. We [BJ Parent] guarantee that [BJ Russia] shall duly perform all its obligations contained in the Contract.

2. If [BJ Russia] shall in any respect fail to perform its obligations under the Contract or shall commit any breach thereof, we undertake, on simple demand by [TNK-BP], to perform or to take whatever steps may be necessary to achieve performance of said obligations under the Contract and shall indemnify and keep indemnified against any loss, damages, claims, costs and expenses which may be incurred by [TNK-BP] by reason of any such failure or breach on the part of [BJ Russia].

BJ Russia sustained unanticipated losses on the contract in 2006 and 2007. BJ Russia decided to exit the Russian market. Nevertheless, it was critical that BJ Russia not breach its contract. In September 2008, BJ Russia informed TNK-BP of its intention not to renew the contract; it would exit the Russian market after BJ Russia fulfilled its contractual obligations.

By letter dated October 21, 2008, the Russian Ministry of Finance informed BJ Russia that it was not in compliance with Articles 90 and 99 of the Civil Code of the Russian Federation. Those provisions require a joint stock company, such as BJ Russia, to maintain net assets in an amount at least equal to the company’s chartered capital. A company may reduce its chartered capital to match the level of its net assets, but Russian Law establishes a minimum level for chartered capital. The Ministry explained that if a company’s net assets are less than the minimum level for chartered capital at the end of the financial year, then the company is subject to liquidation by the Russian taxing authority. In

943 F.3d 258

the letter, the Ministry provided calculations showing that BJ Russia’s net assets were less than the chartered capital minimum for both 2006 and 2007. Based on these calculations, the Ministry determined that the Russian "tax authority ha[d] the right to claim the liquidation of the company through the court." (underlining in original). The Ministry required BJ Russia to provide by November 14, 2008, information regarding actions taken to "improve [its] financial performance and increase the net assets in 2008."

BJ Russia responded to the Ministry in a letter dated November 13, 2008. In this letter BJ Russia stated that it "was taking steps to improve the financial and economic activities of the company and to increase the net assets in 2008" but did not specify what these steps were. The issue in this case is how to classify, for tax purposes, BJ Parent’s actions in response to the Ministry’s letter.

BJ Parent made wire transfers totaling $52 million to BJ Russia. The transfer caused BJ Russia’s net assets to be greater than its chartered capital, and the transfer ended the risk of liquidation. This transfer of funds was made as "Free Financial Aid" ("FFA") under a provision of the Tax Code of the Russian Federation. The finance manager of BJ Parent’s non–United States affiliates described FFA as "just giv[ing] money ... with no repayment obligation, ever." Under the Russian Tax Code, assets received by an organization from its majority shareholder without consideration are exempt from a profit tax. According to an email exchange between the BJ Parent finance manager and BJ Parent tax counsel, BJ Parent considered a transfer of funds via FFA as the most "tax efficient" way to provide BJ Russia with the capital needed to satisfy the net-asset requirements of Russian law. Had BJ Parent failed to prevent BJ Russia’s liquidation, BJ Parent estimates that its losses would have been at least $160 million.

To be eligible for the tax exemption under Russian law, the FFA had to be given on behalf of BJ Russia’s majority shareholder. BJ Russia and its majority shareholder, also a subsidiary of BJ Parent, entered into an "Agreement on Provision of Free Financial Aid" on November 26, 2008, whereby BJ Parent would transfer funds in the form of FFA to BJ Russia on behalf of the majority shareholder. The agreement stated that "[t]he Shareholder confirms hereby that its financial assistance is free and that it does not expect [BJ Russia] to return the funds to the Shareholder." The parties agree that BJ Russia had no obligation to repay BJ Parent for the provision of the FFA. The FFA was characterized in a BJ Russia shareholder meeting as a "free capital contribution" from BJ Parent to BJ Russia. BJ Russia used at least part of the $52 million BJ Parent wired to BJ Russia to partially repay a loan from another BJ Parent subsidiary. As a result of the FFA, BJ Russia’s net assets increased, resolving the undercapitalization problem identified in the Ministry letter.

BJ Parent claimed the $52 million FFA provided to BJ Russia as a "bad debt expense" on its United States income tax return for fiscal year 2008. The Internal Revenue Service ("IRS") disallowed the deduction. The IRS stated that BJ Parent failed to support that this transaction should be considered a "bad debt or guaranteed debt" as allowed by Section 166 of the Internal Revenue Code. Taxpayer BJ Parent also had not shown that payment should be deductible as an ordinary and necessary business expense under Section 162 or entitled to a deduction under any other section of the Internal Revenue

943 F.3d 259

Code. Instead, the IRS considered the payment to be a capital contribution.

Baker Hughes, as the successor in interest to BJ Parent, filed this suit in the United States District Court for the Southern District of Texas. It sought a refund for 2008 in the amount of $17,654,000, plus interest. Baker Hughes alleged that BJ Parent was entitled to a bad-debt deduction under 26 U.S.C. § 166 for the payment it made to BJ Russia. The district court later permitted Baker Hughes to assert an additional claim that the FFA was a deductible ordinary and necessary business expense under 26 U.S.C. § 162.

As to both claims, the district court granted summary judgment to the Government. Baker Hughes timely appealed.

DISCUSSION

We review a district court’s "grant of summary judgment de novo , applying the same standards as the district court." Ibarra v. UPS , 695 F.3d 354, 355 (5th Cir. 2012). Summary judgment is appropriate if the movant demonstrates "there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." FED. R. CIV. P. 56(a). When cross-motions for summary judgment have been ruled upon, "we review each party’s motion independently, viewing the evidence and inferences in the light most favorable to the nonmoving party." Green v. Life Ins. Co. of N. Am. , 754 F.3d 324, 329 (5th Cir. 2014). Baker Hughes bears "the burden of proving entitlement to a claimed deduction." BC Ranch II, L.P. v. Comm’r , 867 F.3d 547, 551 (5th Cir. 2017). Here, few facts are in dispute. The controlling issues are ones of law.

I. Section 166 : Bad-debt deduction

Section 166 of the Internal Revenue Code states that "[t]here shall be allowed as a deduction any debt which becomes worthless within the taxable...