Pennzoil-Quaker State Co. v. U.S.

• Court: U.S. Court of Appeals — Federal Circuit
• Writing for the Court: Jacobs
• Citation: Pennzoil-Quaker State Co. v. U.S., 511 F.3d 1365 (Fed. Cir. 2008)
• Decision Date: 08 January 2008
• Docket Number: No. 2006-5142.,2006-5142.
• Parties: PENNZOIL-QUAKER STATE COMPANY and subsidiaries, (successor to Quaker State Corporation and subsidiaries), Plaintiff-Appellee, v. UNITED STATES, Defendant-Appellant.

511 F.3d 1365

PENNZOIL-QUAKER STATE COMPANY and subsidiaries, (successor to Quaker State Corporation and subsidiaries), Plaintiff-Appellee, v. UNITED STATES, Defendant-Appellant.

No. 2006-5142.

United States Court of Appeals, Federal Circuit.

January 8, 2008.

Peter A. Lowy, of Houston, Texas, argued for plaintiff-appellee. Of counsel on the brief was J. Bradford Anwyll, Alston & Bird LLP, of Washington, DC.

Deborah K. Snyder, Attorney, Tax Division, United States Department of Justice, of Washington, DC, argued for defendant-appellant. With her on the brief were Eileen J. O'Connor, Assistant Attorney General, and Richard Farber, Attorney.

William L Goldman, McDermott Will & Emery LLP, of Washington, DC, for amicus curiae.

Before MAYER, Circuit Judge, JACOBS, Chief Judge^* and PROST, Circuit Judge.

Opinion by the Court filed by Chief Judge, JACOBS.

Opinion concurring-in-part filed by Circuit Judge PROST.

JACOBS, Chief Judge.

The government appeals from a judgment entered in the Court of Federal Claims on July 27, 2006, granting partial summary judgment to Pennzoil-Quaker State Company ("Quaker") in its suit seeking a refund under Section 1341 of the Internal Revenue Code, 26 U.S.C. § 1341. That section gives relief to a taxpayer when an item of income previously included in gross income is repaid in a year in which the tax rate is lower. Quaker cited payments it made in settlement of an antitrust suit brought by its suppliers of crude oil and argued that those payments retroactively increased Quaker's cost of goods sold ("COGS") in past years, and thus supported retroactive recalculation of taxes previously paid. The Court of Federal Claims agreed. We reverse.

BACKGROUND

A. Section 1341

"Income taxes must be paid on income received (or accrued) during an annual accounting period." United States v. Lewis, 340 U.S. 590, 592, 71 S.Ct. 522, 95 L.Ed. 560 (1951). Annual accounting calculates tax due on events taking place during the taxable year without regard to events in prior or subsequent years. Under the "claim of right" doctrine, the taxpayer must include an item of income over which it has a claim of right, or full control, even if that right is imperfect — that is, even if the taxpayer may have to give up, or repay, that income down the road. "Should it later appear that the taxpayer was not entitled to keep the money, . . . he would be entitled to a deduction in the year of repayment; the taxes due for the year of receipt would not be affected." United States v. Skelly Oil Co., 394 U.S. 678, 680-81, 89 S.Ct. 1379, 22 L.Ed.2d 642 (1969). The offset afforded by the claim of right doctrine can become imperfect if "the tax benefit from the deduction in the year of repayment [differs] from the increase in taxes attributable to the receipt." Id. at 681, 89 S.Ct. 1379.

Congress passed § 1341 to make the taxpayer whole in cases where the tax rate is lower in the year of repayment than in the year of original receipt. Section 1341 "applies when a taxpayer repays money in a current year that belongs to someone else, but was money that [the taxpayer] received and included in gross income in a prior year." Culley v. United States, 222 F.3d 1331, 1332 (Fed.Cir.2000). The title of the section is: "Computation of tax where taxpayer restores substantial amount held under claim of right." The provision operates in the following contingency:

If

(1) an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item;

(2) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and

(3) the amount of such deduction exceeds $3,000. . . .

26 U.S.C. § 1341(a). In that event, the taxpayer "is entitled to either the equivalent of a refund for income tax paid in the earlier year, or a deduction from income in the year of repayment, whichever is more beneficial to the taxpayer." Chernin v. United States, 149 F.3d 805, 815 (8th Cir. 1998).

To qualify for § 1341 relief, the taxpayer must satisfy various non-textual requirements, two of which are relevant here. First, "the taxpayer's obligation to repay must arise out of the specific `circumstances, terms and conditions' of the transaction whereby the amount was originally included in . . . income." Bailey v. Comm'r, 756 F.2d 44, 47 (6th Cir.1985) (quoting Pahl v. Comm'r, 67 T.C. 286, 289-91, 1976 WL 3655 (1976)). This has been called the "same circumstances" test. Second, the deduction must be "allowable" under a provision of the Code other than § 1341. See Skelly Oil Co., 394 U.S. at 683, 89 S.Ct. 1379.

Section 1341 is further limited by the so-called "inventory" exception, which precludes relief for "any deduction allowable with respect to an item which was included in gross income by reason of the sale" of inventory or stock in trade. 26 U.S.C. § 1341(b)(2).

B. Quaker's Claim for Relief.

Quaker refines and blends crude oils, and sells its petroleum products to consumers. In 1994, Quaker was sued in a class action by its suppliers of Penn Grade crude. The suppliers charged that, beginning in 1981, Quaker fixed crude oil prices, and lowered and maintained them, in violation of § 1 of the Sherman Act, 15 U.S.C. § 1. Quaker settled with the class in December 1995 for $4.4 million, of which $2.9 million was paid to the suppliers.

On its 1995 and 1996 tax returns, Quaker deducted the settlement payments as "other deductions," a treatment the IRS did not challenge. Later, Quaker filed amended tax returns seeking a refund under § 1341 on the theory that its taxable gross income for the years 1981 through 1995 had been overstated by $4.4 million, the cost of settling the class action lawsuit.

The IRS disallowed Quaker's claim for § 1341 relief. Quaker challenged that determination in the Court of Federal Claims, contending that: if it had incurred the settlement costs during the years when it was buying Penn Grade crude from the suppliers, its COGS would have been higher and its gross income lower by a corresponding amount; the settlement payments established that Quaker no longer had an unrestricted right to its prior understatement of COGS; § 1341 applies to the settlement payments, which paid or restored to its suppliers an item included in gross income, i.e., understated COGS. The Court of Federal Claims granted Quaker's motion for partial summary judgment on that claim (the only claim then left in the case¹). Pennzoil-Quaker State Co. v. United States, 62 Fed.Cl. 689 (2004). The government appealed.

The Federal Circuit has jurisdiction over this appeal pursuant to 28 U.S.C. § 1295(a)(3).

STANDARD OF REVIEW

A grant of summary judgment is reviewed de novo. Adams v. United States, 471 F.3d 1321, 1324 (Fed.Cir.2006).

DISCUSSION

The government argues chiefly that § 1341 relief is unavailable (1) because Quaker fails to link its settlement payments to its understatement of COGS and (2) because (even if Quaker otherwise satisfies the elements of § 1341(a)) the inventory exception bars relief.

We agree that Quaker's claim fails because the settlement payments did not arise from the same circumstances as Quaker's past understatement of COGS. Moreover, even if Quaker's claim did not suffer that fatal flaw, relief under § 1341 would be barred by the inventory exception.

I.

"The `claim of right' interpretation of the tax laws has long been used to give finality to [the annual accounting] period, and is . . . deeply rooted in the federal tax system." Lewis, 340 U.S. at 592, 71 S.Ct. 522. Section 1341 is an exception to the claim of right doctrine. The "same circumstances" test, formulated by the Tax Court, "provides appropriate, workable limits" to that exception. Dominion Res. Inc. v. United States, 219 F.3d 359, 367 (4th Cir.2000). The limitations are that "`the requisite lack of an unrestricted right to an income item permitting deduction must arise out of the circumstances, terms, and conditions of the original payment of such item to the taxpayer.'" Id. (quoting Pahl, 67 T.C. at 290).

An example of the rule in practice is Bailey, in which the taxpayer received dividends, salary, and bonuses as the officer of a corporation, and later paid a civil penalty for violating an FTC order in the work he did for the company. The taxpayer claimed that his payment of the penalty restored an item of income included in his gross income in previous years. The Sixth Circuit invoked the "same circumstances" test to deny § 1341 relief, reasoning that the FTC penalty "arose from the fact that Bailey violated the consent order, and not from the `circumstances, terms, and conditions' of his original receipt of salary and dividend payments," and that "the amount of the penalty was not computed with reference to the amount of his salary, dividends, and bonuses, and bears no relationship to those amounts." Id. at 47.

The "same circumstances" test likewise barred relief in Uhlenbrock v. Commissioner, 67 T.C. 818, 1977 WL 3755 (1977). There, the executor of estate received compensation (as executor) and funds (as legatee); subsequently, the IRS assessed the estate and found the executor partly liable for additional taxes (as both transferee and fiduciary of estate). The Tax Court held that § 1341 did not apply to the executor's share of the assessment because his

receipt of commissions and his liability for payment of the penalty were separate and distinct transactions; unquestionably, he would have incurred the liability, even if he had received no commissions. Moreover, the amount he received from the estate as commissions bore no relationship to the amount he became obligated to pay the United States

Id. at 823. Similarly, in Kraft v. United States, 991 F.2d 292 (6th Cir.1993), the court barred application of § 1341 where the item included...