Basic Eng'g, Inc. v. Comm'r, T.C. Memo. 2017-26
| Decision Date | 01 February 2017 |
| Docket Number | Docket No. 27691-13.,T.C. Memo. 2017-26 |
| Parties | BASIC ENGINEERING, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
L. Don Knight and Aaron P. Lloyd, for petitioner.
Bettina M. Nadler, for respondent.
PARIS, Judge: In a notice of deficiency dated August 22, 2013, respondent determined Federal income tax deficiencies of $8,670,933.19 and $266,567.82 and accuracy-related penalties under section 6662(a) of $1,734,186.64 and $53,313.56 for petitioner's 2009 and 2010 taxable years, respectively.1
The issues for decision are whether petitioner is: (1) eligible to account for two of its contracts using the completed contract method of accounting and (2) liable for accuracy-related penalties.
Some of the facts are stipulated and are so found. The first stipulation of facts and the first supplemental stipulation of facts, and the exhibits attached thereto, are incorporated herein by this reference. Petitioner, Basic Engineering, Inc., was a Texas corporation with its principal place of business in Texas when it timely filed its petition.
Petitioner's primary business is the engineering, designing, procuring, refurbishing, and delivering of crude oil processing and refining systems to customers in the petrochemical industry worldwide. Thomas Balke owned 51% of petitioner and James Smith owned 49%; Mr. Balke and Mr. Smith also owned Basic Equipment, Inc. (Basic Equipment), another Texas corporation, in the samerespective percentages. Mr. Balke was the president of both corporations during the years in issue. Mr. Balke has over 30 years of experience in working with oil refineries and refinery equipment; his international oil refinery business experience first occurred in 1977.
This case concerns the accounting treatment for tax purposes of two of petitioner's contracts that were ongoing in 2009 and 2010: (1) petitioner's contract with Petromaxx Energy Group GmbH, later known as Petromaxx Energy Group GmbH & Co KG, and later as Tagore Investments S.A. as universal successor (collectively Petromaxx); and (2) petitioner's contract with Amber Energy S.A. (Amber). Since its incorporation in 2004 petitioner has accounted for its long-term contracts using the completed contract method of accounting. Respondent's determinations that petitioner was ineligible to use the completed contract method of accounting for the Petromaxx and Amber contracts led to the deficiencies at issue.
Petitioner and Basic Equipment maintained relationships with salespersons working outside the United States who searched for potential customers on their behalf. In 2004 a salesman contacted a Basic Equipment representative to inform him that the international entity Petromaxx was interested in building a small oil refinery in Bulgaria with a 10,000 to 15,000 barrel per day (BPD) crude oil topping unit. Mr. Balke, acting on behalf of Basic Equipment, offered to build Petromaxx a new refinery, but Petromaxx wanted a refinery that was readily available and wanted petitioner to find an existing refinery, disassemble it, and refurbish various parts according to Petromaxx's specifications. The newly refurbished parts would then be reconstructed into a new refinery at Petromaxx's preferred international location.
Representatives for Basic Equipment and Petromaxx visited an existing oil refinery in Nixon, Texas (Nixon refinery), that had equipment similar to the equipment Petromaxx had initially described. After visiting the refinery Basic Equipment made a proposal to refurbish the refinery's parts and sell them to Petromaxx, which would then construct an operating refinery. Basic Equipment and Petromaxx ultimately reached an agreement on December 4, 2005 (Nixon equipment agreement).
Under the terms of the Nixon equipment agreement, Basic Equipment agreed to: design and manufacture one new 10,000 BPD atmospheric crude unit and one reconditioned 17,000 BPD crude topping unit; provide Petromaxx with designs and flow diagrams necessary to operate and perform maintenance on the crude units; provide Petromaxx with plant operation manuals; and supervise the commissioning of the crude units once they were assembled. In exchange, Petromaxx agreed to pay Basic Equipment $21.5 million; Petromaxx initially paid Basic Equipment $6,450,000 as a deposit on December 23, 2005.
Early in 2006 Petromaxx determined that it needed to build a larger production capacity refinery than the Nixon refinery could provide and withdrew the previous agreement.
After determining that the Nixon refinery would not meet its production capacity needs, Petromaxx provided Mr. Balke with new scope of work requirements. In an effort to find a refinery that would meet Petromaxx's production capacity requirements, Mr. Balke and a Petromaxx representative visited a larger refinery with a 50,000 to 55,000 BPD capacity in California (Cenco refinery). After examining the Cenco refinery, Mr. Balke offered to refurbish and sell the refinery's parts to Petromaxx, which would then construct an operating refinery. At some point Mr. Balke made the decision to transfer the order from Basic Equipment to petitioner.2 Basic Equipment transferred to petitioner Petromaxx's original $6,450,000 Nixon refinery deposit in installments of $3 million on February 8, 2006, $3 million on March 8, 2006, and $450,000 on March 28, 2006.
On March 22, 2006, petitioner purchased the Cenco refinery from JAS Marketing, Inc. (JAS), for $18.9 million for use in the Petromaxx project. Petitioner agreed to make its first payment to JAS on or before March 22, 2006, with subsequent payments due monthly through August 22, 2007.
Before executing a formal agreement, Petromaxx transferred to petitioner $10,750,000 in addition to the $6,450,000 deposit Petromaxx paid to Basic Equipment, which was subsequently transferred to petitioner. The advanced funds were paid to petitioner in two equal installments of $5,375,000 on May 22 and September 1, 2006.
On October 28, 2006, petitioner and Petromaxx executed a "Sale and Purchase Agreement" (Petromaxx SPA) whereby Petromaxx agreed to purchase certain crude oil processing units from petitioner. The Petromaxx SPA requiredpetitioner to refurbish the oil processing units and to provide Petromaxx with engineering specifications that Petromaxx would use to install the newly refurbished units and construct an operating refinery.3 Once the Cenco refinery was broken down and the necessary parts refurbished, petitioner was responsible for delivering the refurbished units to its facility in Houston, Texas, and Petromaxx was responsible for shipping the refurbished units from there to Bulgaria. Petromaxx was also responsible for creating the refinery site in Bulgaria and erecting and installing the newly refurbished units into a refinery. Once Petromaxx had erected and installed the refurbished units, petitioner was required to supervise the commissioning4 of the newly erected units. Upon successfulcommissioning of the refinery, a qualified engineer would conduct performance tests and issue a "final acceptance report and certificate" upon successful testing. At that point, petitioner would have fulfilled all of its obligations under the Petromaxx SPA and Petromaxx would assume full responsibility for the refinery and its operation. In consideration for a complete, satisfactory, and timely performance by petitioner of all of its obligations under the Petromaxx SPA, Petromaxx agreed to pay petitioner $90.5 million.5
The Hardt Investment Group, headquartered in Vienna, Austria, controlled the underlying funding of Petromaxx, and the parties negotiated the following governing law provision in section 19.3.1 of the Petromaxx SPA:
This Agreement shall be governed by, and construed in accordance with, the laws of the Republic of Austria including the UN Convention on Contracts for the International Sale of Goods of 1980 (CISG). The Parties' rights and obligations with respect to title to and security interests in the Equipment shall be governed by the law of the jurisdiction in which such Equipment is located.
After executing the Petromaxx SPA, Petromaxx once again determined that it wanted to increase the capacity of its refinery. On October 6, 2007, almost one year after the original contract was executed, petitioner and Petromaxx executed an amendment to the Petromaxx SPA whereby petitioner agreed to refurbish additional equipment that would allow Petromaxx to meet its capacity requirements. Petromaxx agreed to pay an additional $31,750,000 to petitioner for the additional equipment, bringing the total contract price to $122,250,000. In October of 2007, at the time the parties executed the amendment to the Petromaxx SPA, Petromaxx had made payments to petitioner totaling $72.4 million.6
For purposes of accounting for the Petromaxx contract, petitioner's estimate of the time the contract would take to complete is important. The Court will look to the terms of the Petromaxx SPA and will consider testimony from Mr. Balke and respondent's expert witness, John Harris.
With respect to the Petromaxx project's expected timeframe, section 3.2.2. of the Petromaxx SPA provided:
Agreed Project Schedule. BASIC shall commence * * * [its work] in accordance with the project schedule and management plan set forth in Exhibit 3.2.2 (the "Preliminary Project Schedule"). Within one (1) month after signing this Agreement, BASIC shall submit, for BUYER's review and approval, an updated and more detailed schedule (as approved by Qualified Engineer and by BUYER, the "Agreed Project Schedule") amending the Preliminary Project Schedule which sets forth the timing of completing the [Cenco refinery]...
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