Texaco Inc. v. U.S.

• Decision Date: 13 June 2008
• Docket Number: No. 06-16098.,06-16098.
• Citation: 528 F.3d 703
• Parties: TEXACO INC., Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

528 F.3d 703

TEXACO INC., Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

No. 06-16098.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted April 17, 2008.

Filed June 13, 2008.

Eileen J. O'Connor, Assistant Attorney General, Richard T. Morrison, Deputy Assistant Attorney General, Nathan J. Hochman (argued), Gilbert S. Rotherberg, Richard Farber, and Judith A. Hagley, of Washington, D.C., for the defendant-appellant.

William L. Goldman (argued), Robin L. Greenhouse, and Michael F. Kelleher of McDermott Will & Emery LLP of Washington, D.C., and Joseph H. Selby of McDermott Will & Emery LLP of Boston, Massachusetts, for the plaintiff-appellee.

Appeal from the United States District Court for the Northern District of California; Saundra B. Armstrong, District Judge, Presiding. D.C. No. CV-04-00316-SBA.

Before: PROCTER HUG, JR., MARY M. SCHROEDER, and CONSUELO M. CALLAHAN, Circuit Judges.

CALLAHAN, Circuit Judge:

This appeal requires that we undertake the task of interpreting a provision of the Internal Revenue Code, 26 U.S.C. § 1341. In essence, this statute allows a taxpayer, who is required to pay to a third party income on which it has already paid income tax, credit for the tax it paid on that income. Subsection (b)(2), however, provides that this credit is not available "with respect to an item which is included in gross income by reason of the sale [of inventory]." 26 U.S.C. § 1341(b)(2).

Texaco Inc.¹ sought a tax refund of $101,043,085 under 26 U.S.C. § 1341(a) because it was required to pay out pursuant to a settlement agreement with the Department of Energy sums that it had previously included in its gross income. The government denied the refund claims on the ground that the inventory exception in § 1341(b)(2) barred Texaco from using § 1341(a). Texaco brought suit challenging the denial. The district court agreed with Texaco and ordered the government to pay the refund. The government appeals and we reverse. We hold that the language in § 1341(b)(2) plainly precludes Texaco from using the computation of tax set forth in § 1341(a).

I. Background

Texaco was engaged in an integrated petroleum business. Between 1973 and 1981, Texaco made certain sales of crude petroleum and refined petroleum products at prices that exceeded the price ceilings set by federal petroleum price regulations. Texaco included these overcharges as gross income on its corporate tax returns for the years 1973 through 1981.

The Department of Energy (DOE) took various administrative actions against Texaco which eventually resulted in a consent degree requiring Texaco to pay $1,250,000,000 plus interest. Texaco made the payments and deducted the settlement amount on its federal income tax returns for those years as ordinary and necessary business expenses.

In February 2001, Texaco filed Refund Claims for the years 1988, 1990, 1991, and 1992, claiming that the tax benefit of the ordinary and necessary business expense deductions should have been calculated in accordance with 26 U.S.C. § 1341(a). The government denied the Refund Claims on the ground that § 1341(b)(2) rendered § 1341(a) inapplicable.

In January 2004, Texaco filed a complaint against the United States in the District Court for the Northern District of California. On cross-motions for summary judgment, the district court determined that subsection (b)(2) did not preclude Texaco from seeking tax treatment under § 1341(a), reasoning that the statute was ambiguous and sources outside the text of the statute supported Texaco's argument that § 1341(b)(2) only prohibited the use of § 1341(a) computation for "sales returns, allowances and similar items."

Following the entry of a final judgment, the Government filed a timely appeal.

II. The Statutory Scheme

The Supreme Court observed in 1931, that "[a]ll the revenue acts which have been enacted since the adoption of the Sixteenth Amendment have uniformly assessed the tax on the basis of annual returns showing the net result of all the taxpayer's transactions during a fixed accounting period, either the calendar year, or, at the option of the taxpayer, the particular fiscal year which he may adopt." Burnet v. Sanford & Brooks Co., 282 U.S. 359, 363, 51 S.Ct. 150, 75 L.Ed. 383 (1931). Under the "claim of right doctrine," which follows from the annual accounting principle, a taxpayer who has received an item of income over which he has full control must include that item in his income in the year of receipt, even if his right to retain that item is imperfect and he is later required to return part or all of that item. See generally 2 Mertens, Law of Federal Income Taxation §§ 12A:119-132 (1996 & Supp. July 2006).

Absent some statutory exception, such as § 1341(a), a taxpayer who was required in a later year to restore to a third party income previously received is entitled to a deduction if the repayment is deductible under some provision of the Internal Revenue Code. See United States v. Lewis, 340 U.S. 590, 591, 71 S.Ct. 522, 95 L.Ed. 560 (1951). In other words, a taxpayer may be able to reduce his taxes for the year of repayment by deducting the repayment amount from his taxable income, but he has no recourse against the increased taxes that he had paid in the year that he received the money. The taxpayer might benefit if the tax savings from the deduction in the year of repayment is greater than the increase in tax due to the inclusion of the amount in the year that the amount was received. However, if the deduction in the year of repayment results in a savings of less than the amount of increased tax paid as a result of the inclusion of the amount repaid in income for the year in which the amount was received, the taxpayer, absent some statutory provision, cannot recover the taxes he paid in the initial year on income that he subsequently restored to a third party.²

Section 1341(a) provides some taxpayers with an option.³ If the taxpayer satisfies the criteria set forth in subsections (a)(1)(3), as Texaco does, a taxpayer has a choice. It can still take a deduction for the repayment in the year of repayment. 26 U.S.C. § 1341(a)(5)(A). However, it can alternatively calculate what its tax would have been in the initial year without the income that was restored to a third party. If the difference between the tax it actually paid and the tax it would have paid if the restored amount had not been included in its gross income is greater than the deduction it would receive by claiming the deduction in the repayment year, it may use the difference instead of the deduction. 26 U.S.C. § 1341(a)(5)(B), see Alcoa, Inc. v. United States, 509 F.3d 173, 177 (3rd Cir.2007) ("By allowing the taxpayer the choice between a simple deduction and a recalculation of the prior year's tax liability, section 1341 ensures that any change in tax rates or in the taxpayer's tax bracket is a tax neutral event with respect to the disputed item of income."). Here, the parties agree that if § 1341(a) is applicable, then for the four years in issue, Texaco, using the alternative provided by § 1341(a)(5)(B), is entitled to a refund of $101,043,085.

The government, however, contends that Texaco is barred from using § 1341(a) by § 1341(b)(2).⁴ The government's position is that § 1341(a) is not applicable to Texaco because the first sentence of § 1341(b)(2) provides that "Subsection (a) does not apply to any deduction allowable with respect to an item which was included in gross income by reason of the sale or other disposition of stock in trade of the taxpayer." Texaco concedes that "[d]uring the years 1973 through 1981, all of Texaco's sales of crude oil and petroleum products were sales of inventory or property held by Texaco primarily for sale to customers in the ordinary course of Texaco's trade or business." Because the income in issue arose out of the sale of inventory, the government asserts that Texaco is barred from using § 1341(a) to compute its taxes. Texaco disagrees, contending that § 1341(b)(2) does not bar it from using § 1341(a). Thus, this litigation turns on the meaning and scope of § 1341(b)(2).⁵

III. Interpreting Section 1341(b)(2)

The Supreme Court has directed that the first step in interpreting a statute "is to determine whether the language at issue has a plain and unambiguous meaning with regard to the particular dispute in the case." Robinson v. Shell Oil Co., 519 U.S. 337, 340, 117 S.Ct. 843, 136 L.Ed.2d 808 (1997). "The inquiry ceases if the statutory language is unambiguous and the statutory scheme is coherent and consistent." Barnhart v. Sigmon Coal Co., Inc., 534 U.S. 438, 450, 122 S.Ct. 941, 151 L.Ed.2d 908 (2002) (internal citation omitted). The Supreme Court has further noted that "[i]f a court, employing traditional tools of statutory construction, ascertains that Congress had an intention on the precise question at issue, that intention is the law and must be given effect." Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 843 n. 9, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984).

The language of 26 U.S.C. § 1341(b)(2) is clear. The statute provides that a "deduction" otherwise "allowable" under subsection (a) is prohibited if the deduction was based on "an item" included in gross income "by reason of" the sale of inventory. Thus, the statute directs us to the basis of the deduction allowable under subsection (a). The deduction arises if a taxpayer included in its tax return income that it subsequently had to pay to a third party. Subsection (b)(2) asks what was the basis for the item included in gross income that year. If the item was included in gross income because of the sale of stock in trade (inventory), then the taxpayer is prohibited by subsection (b)(2) from using the deduction otherwise allowed by subsection (a).

The Federal Circuit agrees that this is the plain meaning of subsection (b)(2). In analyzing the statute, the Federal Circuit parsed §...