OKC Corp. v. Comm'r of Internal Revenue
| Decision Date | 25 April 1984 |
| Docket Number | 15100-80.,Docket Nos. 15099-80 |
| Citation | 82 T.C. 638 |
| Parties | OKC CORP. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
(1) During 1971, in settlement of a lawsuit over the price to be paid under a refined products output contract, X forgave over $2.6 million in principal, indebtedness that Y owed it for Y's purchase of a refinery from X in 1966. Held: The discharge of indebtedness constituted a payment in settlement of a claim for profits; accordingly, the settlement “proceeds” are ordinary income to Y. The exclusion provided by sec. 108, I.R.C. 1954, does not apply.
(2) During 1969, Y began construction of an HF alkylation unit at the refinery. Prior to April 19, 1969, Y staked out the jobsite and had test soil borings taken, but no other work was done. The unit was placed in service during 1970. Held, the alkylation unit is not pretermination property and is not eligible for the investment tax credit under sec. 49(b)(3), I.R.C. 1954. Kemble White, for the petitioners.
Rebecca W. Wolfe, for the respondent.
The Commissioner determined the following deficiencies in the petitioners' Federal income taxes:
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¦Docket No. ¦Petitioner ¦TYE Sept. 30— ¦Deficiency ¦
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¦ ¦ ¦ ¦ ¦
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¦15100-80 ¦OKC Refining, Inc.¦1967 ¦$328,827.26 ¦
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¦ ¦ ¦1968 ¦459,287.61 ¦
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¦ ¦ ¦ ¦ ¦
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¦15099-80 ¦OKC Corp. ¦1969 ¦109,383.56 ¦
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¦ ¦and Subsidiaries ¦1970 ¦7,472.56 ¦
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¦ ¦ ¦1971 ¦713,954.58 ¦
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After concessions by the parties, the issues remaining for decision are: (1) Whether OKC Refining, Inc., must recognize income on the discharge during 1971 of indebtedness owed by it; and (2) whether the alkylation unit built by OKC Refining, Inc., during 1969 is eligible for the investment tax credit under section 49 of the Internal Revenue Code of 1954.1
Some of the facts have been stipulated, and those facts are so found.
Petitioner OKC Corporation (OKC) is a corporation organized under the laws of the State of Delaware with its principal place of business at Dallas, Tex., when it filed its petition. OKC and its subsidiaries filed their consolidated Federal corporate income tax returns for their taxable years ended September 30, 1969, September 30, 1970, and September 30, 1971, with the Internal Revenue Service Center, Austin, Tex. We shall refer to a taxable year by the year in which it ends. Petitioner OKC Refining, Inc. (formerly Okmulgee Refining Co., Inc.) (Refining) is a wholly owned subsidiary of OKC having its principal place of business in Dallas, Tex., when it filed its petition. Refining filed Federal corporate income tax returns for its taxable years ended September 30, 1967, and September 30, 1968, with the Internal Revenue Service Center, Austin, Tex.
During 1966, OKC (then known as Oklahoma Cement Co.) manufactured portland cement at plants in Oklahoma and Louisiana. Most of the cement sold by OKC was used in road building. During 1966, OKC became interested in acquiring an oil refinery. Such an acquisition would allow OKC to produce asphalt, and thus offer its customers a complete line of road building products.
Prior to 1966, the Phillips Petroleum Company (Phillips) owned and operated a small oil refinery at Okmulgee, Okla. Phillips was not making a profit on that refinery. Bob Hulsey, a petroleum consultant, approached OKC president Cloyce Box with the proposal that OKC, acting as a small, independent refiner, might more profitably operate the Okmulgee refinery. OKC entered into negotiations with Phillips for the purchase of the refinery. To evaluate the profitability of the proposed acquisition, OKC retained Mr. Hulsey who in turn hired the consulting engineering firm of Purvin & Gertz, Inc.
In the report it prepared for Mr. Hulsey in July 1966, Purvin & Gertz reviewed three potential ways in which OKC might operate the refinery. The engineers concluded that the most profitable method of operation involved the installation of an HF alkylation unit permitting the production of more high octane premium gasoline. Purvin & Gertz also stated that if OKC qualified for the oil import quota, it could earn $1,133,000 per year on the sale of oil import “tickets.”
The crude oil import quota was established during the 1950s to protect the United States oil industry from harmful competition from cheaper foreign oil, primarily from the Middle East, and to allow inland oil refineries which lacked port facilities and pipelines access to the cheaper oil. The Oil Import Administration (OIA) of the Department of the Interior governed the allocation of oil import licenses (or tickets) to refinery or petrochemical plant operators, and the formula under which such allocations were made could be changed each year. The import licenses were usually issued for a period of 1 year. Each ticket represented the right to import one barrel of oil, and under the allocation formula, a smaller, independent refinery was entitled to more tickets than a larger, integrated producer such as Phillips. The value of a ticket was measured by the difference between the cost of domestically produced crude oil and the cost of imported oil delivered to the United States. Although Interior Department regulations forbade the sale of oil import quotas, an inland refiner could realize their value by exchanging them for the inland production of a refiner with port facilities. The Purvin & Gertz report also noted that OKC's operation of the refinery might qualify for the Department of Defense small business “set aside” for jet fuel contracts. The report stated that the “set aside” assured the small refiner of an outlet for its jet fuel production.
Based upon the Purvin & Gertz report and upon his own study, on July 25, 1966, Mr. Hulsey recommended that OKC form a wholly owned subsidiary to purchase the Okmulgee refinery from Phillips. He recommended the following purchase terms:
I. Purchase price not to exceed $8,860.00 as follows:
II. The new company (Purchaser) to enter into a contract with Phillips through which Phillips agrees to provide a market for all products as necessary other than asphalt and jet fuel.
III. Purchaser will retain all the present refinery operating personnel including the Plant Manager.
IV. Purchaser will enter into an agreement with Phillips whereby crude imported by Purchaser under quota will be exchanged for Oklahama crude. It was assumed for the purpose of this study that Purchaser would receive the equivalent of $1.25 per barrel on 2,484 BPD.
V. Phillips will assist Purchaser in obtaining 1008 financing for this acquisition.
On the basis of these provisions and conditions, a payout of the purchase of less than 5 years is anticipate . This payout is based on prices consistent with 1965 - 1966 levels and assumes an interest rate of 5% on the financing and payment of $525,000 royalty on the alkylation unit.
During the negotiations for the purchase of the refinery, representatives of both Phillips and OKC recognized that unless OKC could obtain import quotas as a small refinery, ‘it would be uneconomical for Oklahoma Cement to consider the purchase of the Okmulgee refinery from Phillips.” Accordingly, on September 30, 1966, OKC and Phillips sent a letter to the OIA requesting assurance that OKC would obtain the necessary import quotas. The OIA objected to several aspects of the proposed transactions and required, among other things, that Phillips not purchase more than 50 percent of total refinery output. On October 29, 1966, the OIA advised OKC that OKC would qualify for the oil import quota.
During the negotiations, Phillips and OKC contemplated that, after OKC acquired the refinery, Phillips would supply crude oil to it and would purchase a portion of its output. During October 1966, the parties continued to negotiate the refinery purchase price as well as the prices to be charged under the crude oil supply contract and the refined products sales contract. Mr. Hulsey recommended that OKC should not purchase the refinery unless OKC could be reasonably certain of retiring the purchase money debt within 5 years. Without the quota income, OKC would be unable to make the anticipated principal payments and would be unable to retire the debt within 5 years.
The estimates of the refinery's profitability were based on projections of the future value of the oil import quotas as well as the future prices for crude oil (refinery input) and the future prices for refined products (refinery output). The price of the refinery was set at an amount that the parties believed, based on 1966 projections, could be fully paid by the profits generated...
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