Marathon Oil Co. v. C.I.R.
| Decision Date | 09 November 1987 |
| Docket Number | Nos. 85-2643,85-2644,s. 85-2643 |
| Citation | 838 F.2d 1114 |
| Parties | -5974, 87-2 USTC P 9609 MARATHON OIL COMPANY, Survivor By Merger of Husky Oil Company, Petitioner-Appellant, Cross-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee, Cross-Appellant. |
| Court | U.S. Court of Appeals — Tenth Circuit |
J.W. Bullion (J.Y. Robb III, with him, on the brief), of Thompson & Knight, Dallas, Tex., for petitioner-appellant/cross-appellee Marathon Oil Co.
Ernest J. Brown, Atty. (Roger M. Olsen, Asst. Atty. Gen., Michael L. Paup and Richard J. Driscoll, Attys., Tax Div., with him, on the brief), Dept. of Justice, Washington, D.C., for respondent-appellee/cross-appellant C.I.R.
Before LOGAN, McWILLIAMS and MOORE, Circuit Judges.
Husky Oil Company ("Husky") petitioned the United States Tax Court for a redetermination of alleged deficiencies in taxes due for the years 1975, 1976 and 1977. 1 Husky challenged, inter alia, (1) the Commissioner's denial of deductions claimed for interest and redemption premium payments made in connection with the retirement of certain debentures; (2) the Commissioner's treatment of $1,082,999 paid by Husky to its parent corporation and sole shareholder, Husky Oil, Ltd. ("Husky Canada"), as an item of income subject to withholding; and (3) the Commissioner's denial of a portion of the deductions and investment tax credits claimed in connection with Husky's operation of certain oil and gas properties (the Home-Stake properties). The Tax Court found in favor of the Commissioner on the first two issues and in favor of Husky on the third. Husky Oil Co., 83 T.C. 717 (1984). Both parties have appealed.
In January 1972, Husky offered and sold to the public $25,000,000 of 6 1/4% convertible subordinated debentures dated January 15, 1972, and maturing January 15, 1997. The debentures were issued under an indenture, the parties to which were Husky as issuer, Husky Canada as guarantor, and Bankers Trust Company as trustee.
The debentures were issued in $1,000 denominations and were convertible, at the holder's option, into common shares of Husky Canada at an initial conversion price of $20 per share, subject to adjustment for contingencies not relevant here. To convert the stock, the holder was required to surrender the debenture to a New York agency maintained by Husky and Husky Canada pursuant to Sec. 6.02 of the indenture. Husky retained an option to redeem the debentures at any time for a price equal to the principal amount and interest accrued through the redemption date, plus, if the redemption occurred before June 15, 1992, a premium based on schedules set forth in the indenture.
Debentures in the principal amount of $1,515,000 were retired by transactions before the taxable years at issue. 2 During 1975, $295,000 of debentures were retired through purchase by Husky. Also, between January 1, 1975, and May 31, 1977, $1,136,000 of debentures were converted into shares of Husky Canada. Husky Canada retained these debentures rather than surrendering them to the trustee for cancellation, but collected no interest on them until the July 1, 1977 intercompany note transactions discussed hereafter.
On June 1, 1977, Husky gave notice of its election to redeem all of its outstanding debentures on July 1, 1977. At that time $22,054,000 of debentures were outstanding in the hands of the public. The redemption price per $1,000 of these debentures was computed as follows:
Principal amount $1,000.00
Premium (4.68%) 46.80
Interest (from 1/15/77 to 7/1/77) 28.60
---------
Total $1,075.40
As of May 31, 1977, the market price of Husky Canada's common stock was $25.50 per share. Conversion at the specified rate of fifty shares per $1,000 debenture would therefore have resulted in $1,275 market value of shares for each $1,000 debenture.
By the close of business on June 16, 1977, the last date on which debenture holders could exercise conversion rights, $22,005,000 of the called debentures had been converted into shares of Husky Canada. On July 1, 1977, Husky redeemed the remaining $49,000 of publicly held debentures. On that day, to pay Husky Canada for the debentures that had been converted to its stock, Husky issued two five percent subordinated notes to Husky Canada, one in the amount of $1,136,000, representing the debentures converted before the June 1 call, and the other in the amount of $22,005,000, representing the principal amount of the debentures converted during June. In July and August 1977, Husky paid a total of $1,723,287 in cash to Husky Canada for accrued interest and redemption premiums allegedly due on the converted debentures held by Husky Canada on the redemption date. 3
In its tax return for 1977, Husky deducted the following: premium and interest of $1,836,279 ($1,723,287 paid plus $112,992 withholding for taxes) which Husky allegedly owed to Husky Canada for redemption of the debentures that the latter held; $578,525 in accrued interest on the promissory notes issued to Husky Canada; and premium and interest of $3,694 paid on debentures redeemed from the public ($75.40 X 49). All deductions were taken pursuant to I.R.C. Sec. 163(a). The Commissioner denied all but the $3,694 deduction, on the theory that no valid indebtedness existed between parent and subsidiary because Husky's obligation on the debentures was expunged upon conversion to Husky Canada stock.
The Tax Court held that the principal amount of the converted debentures remained an outstanding debt of Husky, and allowed the deduction of interest on the promissory notes given to retire those debentures. Husky Oil, 83 T.C. at 734-35. The Commissioner does not appeal this holding. The Tax Court also held, however, that, under the indenture, Husky had no obligation to pay interest or redemption premiums to Husky Canada on converted debentures. Id. at 735. It therefore disallowed the $1,836,279 deduction. Husky has appealed this disallowance.
Husky's argument on appeal centers on Sec. 5.11 of the indenture, which provides:
Husky contends that Sec. 5.11, particularly the language referring to subordination of interest and premium payments on converted debentures, clearly indicates that the parties intended that converted debentures would remain outstanding in Husky Canada's hands unless voluntarily surrendered for cancellation, and that Husky Canada would have a right to accrued interest and premium payments in the event of redemption. 4
Husky's position assumes that Husky had to treat its parent Husky Canada the same as any other third party guarantor, and that the indenture, particularly Sec. 5.11, substituted and treated Husky Canada essentially as an outside debenture holder after the public holders chose conversion to Husky Canada shares rather than redemption by Husky pursuant to its call.
The Commissioner challenges this assumption by presenting several arguments, two of which focus on the economic reality of the Husky-Husky Canada transaction. The first is that Husky and Husky Canada must be treated as one entity for purposes of the case before us. The Commissioner also argues that Husky Canada, by issuing its stock to the public debenture holders who chose conversion over Husky's redemption offer, is in the same position as any sole shareholder who discharges corporate debt to enhance the value or secure the safety of its investment and thereby makes a capital contribution to the corporation.
Because Husky is wholly owned by Husky Canada and Husky's stock is not traded, Husky can gain access to the lower interest rates available in the convertible debenture debt market only by offering conversion to the stock of its publicly traded parent. Such a transaction is common, and here was beneficial to Husky Canada as 100% owner of Husky. See, e.g., National Can Corp. v. United States, 687 F.2d 1107, 1108-10 (7th Cir.1982). The public debenture holders choosing to take equity, stock in Husky Canada, rather than extinguishment of the debt through redemption, gave up the accrued interest and the redemption premium. See Chock Full O'Nuts Corp. v. United States, 453 F.2d 300, 305-06 (2d Cir.1971). If Husky, rather than Husky Canada, had issued the stock received by those who chose conversion, then under the established case law Husky could not obtain a tax deduction for interest or premium the debenture holders gave up by converting into equity. See, e.g., Tandy Corp. v. United States, 626 F.2d 1186, 1193-94 (5th Cir.1980); Columbia Gas System, Inc. v. United States, 473 F.2d 1244, 1247-49 (2d...
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