Exxon Mobil Corp. v. U.S., PLAINTIFF-APPELLANT

• Decision Date: 03 April 2001
• Docket Number: DEFENDANT-CROSS,PLAINTIFF-APPELLANT,No. 00-5048,5049,00-5048
• Citation: 244 F.3d 1341
• Parties: (Fed. Cir. 2001) EXXON MOBIL CORPORATION AND SUBSIDIARIES,, v. UNITED STATES,APPELLANT
• Court: U.S. Court of Appeals — Federal Circuit

Page 1341

244 F.3d 1341 (Fed. Cir. 2001)

EXXON MOBIL CORPORATION AND SUBSIDIARIES, PLAINTIFF-APPELLANT, v. UNITED STATES, DEFENDANT-CROSS APPELLANT.

No. 00-5048,-5049

United States Court of Appeals for the Federal Circuit

April 3, 2001

Appealed from: United States Court of Federal Claims Senior Judge Reginald W. Gibson

Robert L. Moore, II, Miller & Chevalier, Chartered, of Washington, Dc, argued for plaintiff-appellant. With him on the brief were Thomas D. Johnston, Alan I. Horowitz, Patricia J. Sweeney, and Mark v. Holmes.

Thomas J. Sawyer, Attorney, Tax Division, Department of Justice, of Washington, Dc, argued for defendant-cross appellant. With him on the brief were Thomas J. Clark, Attorney.

Before Newman, Michel, and Rader, Circuit Judges.

Michel, Circuit Judge.

This is a federal income tax case. Appellant Exxon Mobil Corporation ("Exxon") appeals the December 29, 1999 judgment of the United States Court of Federal Claims denying-in-part Exxon's claim for a reimbursement for federal income taxes paid for the 1975 tax year on proceeds from sales of natural gas. The United States cross-appeals the trial court's decision, arguing that the court applied an incorrect legal standard in determining whether Exxon was entitled to its claimed deductions. Exxon filed a timely notice of appeal to this court on February 14, 2000. The government filed a timely cross-appeal on February 17, 2000. This court has jurisdiction pursuant to 28 U.S.C. §§ 1295(a)(3). We heard oral arguments in this appeal on February 5, 2001. Because we find that the trial court applied the proper legal standard in determining whether Exxon was entitled to calculate its deduction based on percentage depletion, we affirm the trial court's judgment on the government's cross-appeal. On Exxon's appeal, we find no clear error in the trial court's ruling that Exxon failed to carry its burden of demonstrating that the casinghead gas sold pursuant to the contracts at issue was entitled to the claimed deduction, and accordingly we affirm the trial court's judgment on the casinghead gas issue. However, we conclude that the Excess Royalty Reimbursement clause of Exxon's contract with Houston Light & Power Company ("HL&P") is equivalent, as a matter of law, to the permissible price increase provisions recited in Treas. Reg. §§ 1.613A-7(c)(5). Moreover, we conclude that the Additional Gas clause of the HL&P contract did not disqualify the contract from being treated as a "fixed contract" under I.R.C. §§ 613A(b)(2)(A) because the challenged price increases were equivalent to an above-market surcharge on additional gas, and because HL&P, not Exxon, retained control over whether the price increases would occur. Accordingly we reverse the conclusion of the trial court that the HL&P contract was disqualified from treatment as a "fixed contract" under I.R.C. §§ 613A(b)(2)(A). We remand for calculation of the amount of the tax refund owed to Exxon.

I. Factual and Procedural Background

At issue is whether Exxon is entitled to calculate federal income tax deductions for sales of natural gas sold under fixed-price contracts during the 1975 tax year pursuant to a highly favorable representative market or field price ("RMFP"), and whether certain particular transactions qualify for this favorable tax treatment. The legal background concerning the federal income tax deductions at issue is described with great clarity and detail in the trial court's summary judgment and post-trial opinions, which total more than 300 pages in length. The following summary of the most pertinent aspects of the Tax Code and governing regulations, as well as the procedural history of the present case, has been adapted in part from the trial court's opinion.

A. The Role of "Percentage Depletion" and the "RMFP"

"Ever since enacting the earliest income tax laws, Congress has subsidized the development of our nation's natural resources." Commissioner v. Engle, 464 U.S. 206, 208 (1984). Until 1975, Congress generally permitted holders of economic interests in oil and gas wells "to deduct from their taxable incomes the larger of two depletion allowances: cost or percentage." Id. Cost depletion, which is not at issue in this case, permits the taxpayer to amortize the cost of his wells over the wells' total productive life. Id. Percentage depletion is based upon the income generated by the property throughout its entire productive life, rather than the cost of such property, and accordingly may yield deductions significantly exceeding the amount the taxpayer paid for the property. Id. ("Taxpayers have historically preferred the allowance for percentage, as opposed to cost, depletion on wells that are good producers because the tax benefits are significantly greater.").

Prior to 1975, section 613 of the Tax Code set forth a formula governing the extent to which oil and gas producers were entitled to calculate percentage depletion. This formula based the amount of the deduction on the "gross income from the property." I.R.C. §§ 613(a) (1974). The pertinent sections of the Code provided:

(a) General rule.

In the case of the mines, wells, and other natural deposits listed in subsection (b), the allowance for depletion under section 611 shall be the percentage, specified in subsection (b), of the gross income from the property . . . .

(b) Percentage depletion rates.

The mines, wells, and other natural deposits, and the percentages, referred to in subsection (a) are as follows:

(1) 22 percent

(A) oil and gas wells[.]

I.R.C. §§§§ 613(a), (b)(1)(A) (1974) (emphasis added). Thus, under pre-1975 law, an oil or gas producer's annual allowance for percentage depletion was 22% of the producer's gross income from sales of natural gas extracted from the property, subject to certain limitations. See id.; Exxon Corp. v. United States, 88 F.3d 968, 971 (Fed. Cir. 1996) ("Exxon I"). The Code did not define the term "gross income from the property," but delegated to the Secretary of the Treasury the task of determining allowances for percentage depletion. See I.R.C. §§ 611(a) (1974) (providing that allowances for percentage depletion are "in all cases to be made under regulations prescribed by the Secretary or his delegate").

Pursuant to the foregoing delegation of rulemaking authority, the Secretary promulgated a Treasury Regulation providing a method of calculating "gross income from the property." As effective in 1974, Treasury Regulation §§ 1.613-3(a) provided:

Gross income from the property.

(a) Oil and gas wells. In the case of oil and gas wells, "gross income from the property", as used in section 613(c)(1), means the amount for which the taxpayer sells the oil or gas in the immediate vicinity of the well. If the oil or gas is not sold on the premises but is manufactured or converted into a refined product prior to sale, or is transported from the premises prior to sale, the gross income from the property shall be assumed to be equivalent to the representative market or field price of the oil or gas before conversion or transportation.

Treas. Reg. §§ 1.613-3(a) (1974) (emphasis added). On appeal, neither party questions the validity of this regulation. This regulation is designed to equalize a disparity in the deductions that may be taken by non-integrated and integrated oil and gas producers. Non-integrated producers simply produce raw gas and sell that gas in the field to a pipeline or a gas processing plant. Integrated producers, like Exxon, process and transport the gas prior to sale. Exxon I, 88 F.3d at 968. Because integrated producers bear the cost of post-extraction processing and transportation, they are able to sell gas at a higher price than non-integrated producers, and hence realize more gross income per unit of natural gas sold. Accordingly, integrated producers would be able to claim a higher deduction per unit of gas than non-integrated producers, absent a corrective mechanism. See id. at 970.

Treasury Regulation §§ 1.613-3(a) (1974) provided a method of maintaining integrated and non-integrated producers on an equal competitive footing for purposes of computing percentage depletion allowances. The regulation provided that a constructive value shall be calculated for gas that is "not sold on the premises but is manufactured or converted into a refined product [or transported] prior to sale." Treas. Reg. §§ 1.613-3(a) (1974). This constructive value, or representative market or field price ("RMFP"), represents the value of comparable gas sold in the immediate vicinity of the well, without the added value of post-extraction processing and transportation. The RMFP of natural gas "is calculated as the weighted average price of wellhead sales of comparable gas in the taxpayer's market area." Exxon I, 88 F.3d at 976. As explained by the trial court, the RMFP determination has three distinct elements: (i) the relevant market area; (ii) the comparability of the gas produced in such market area to the taxpayer's gas; and (iii) the qualification of sales of comparable gas in such market area as wellhead sales of unprocessed gas, i.e., sales of raw gas made "in the immediate vicinity of the well," within the meaning of Treas. Reg. §§ 1.613-3(a). Exxon Corp. v. United States, 45 Fed. Cl. 581, 592-93 (1999) ("Exxon II").

B. Exxon's Fixed Contracts and the Impact of the Arab Oil Embargo

The sales of natural gas at issue pertain to natural gas sold at relatively low prices pursuant to 18 long-term contracts entered into between 1955 and 1972. Exxon characterizes these contracts as "fixed price" contracts, as Exxon purportedly lacked the ability to increase the price of the gas sold pursuant to these contracts to reflect increases in the market price of the gas. In the late 1960s and early 1970s, the price of oil and gas soared, in part due to the Arab oil embargo. Regarding its gas sales under the 18 contracts at issue in this case, Exxon was purportedly unable to take advantage...