Transco Exploration Co. v. Comm'r of Internal Revenue
| Decision Date | 04 October 1990 |
| Docket Number | Docket No. 5628-88. |
| Citation | 95 T.C. No. 27,95 T.C. 373 |
| Parties | TRANSCO EXPLORATION COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner was engaged in oil and gas exploration and production and was liable for windfall profit tax. HELD, in calculating the net income limitation on windfall profit under sec. 4988, I.R.C., it was proper for petitioner to exclude from ‘taxable income from the property‘ a portion of lease bonuses which it paid and it was also proper for petitioner to capitalize a like amount in calculating ‘cost depletion‘ solely for purposes of the net income limitation. Woods Investment Co. v. Commissioner, 85 T.C. 274 (1985), followed. Emily A. Parker, Carla A. Howard, and Dennis J. Grindinger, for the petitioner.
John F. Eiman and Jeffrey N. Kelm, for the respondent.
The Commissioner determined a deficiency of $789,567.97 in petitioner's windfall profit tax under section 4986 1 for the taxable year 1980. In an Amendment to Answer, respondent increased petitioner's deficiency by $55,493.85, based on an alternative argument.
The parties submitted this case fully stipulated pursuant to Rule 122. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
The issue is whether petitioner properly calculated the net income upon which its net income limitation (also referred to as NIL) was applied. Specifically, we must decide whether petitioner, in computing ‘taxable income from the property‘ under section 4988(b)(3)(A), may exclude part of the lease bonuses it paid but then capitalize the same portion of lease bonuses as part of its basis upon which the ‘as if‘ cost depletion allowance is computed under section 4988(b)(3)(C).
Petitioner is a Delaware corporation with its principal place of business in Texas. It is engaged in oil and gas exploration and production, both offshore in the Gulf of Mexico, and onshore in the Gulf Coast and Rocky Mountain areas. Petitioner is an ‘independent producer‘ for windfall profit tax purposes within the meaning of section 4992(b)(1).
Petitioner leased eight properties from the U.S. Government for the purpose of oil and gas exploration and production. Only these leases are involved in this controversy. In exchange for the granting of the lease on each of these properties, petitioner paid lease bonuses to the U.S. Government. A lease bonus is an amount paid to a lessor for entering into a mineral lease in addition to the royalty for the hydrocarbons extracted. R. Westin, Taxation of Natural Resources: Oil, Gas, Minerals, and Timber 14 (1987).
Petitioner was not required to file quarterly windfall profit tax returns, Form 720, with respect to its share of oil from the eight properties because the windfall profit tax was subject to withholding by the first purchaser of oil. Sec. 4995(a)(1)(A). During 1980, the first purchasers withheld $9,426,968.80 from petitioner's share of the oil produced from these leases and paid that amount to the Internal Revenue Service. After applying the NIL, petitioner claimed an overpayment of windfall profit tax in the amount of $2,830,535.79 with respect to these leases. It did, however, pay windfall profit tax on the income from these leases in the amount of $6,596,433.01. Petitioner offset its total overpayment of windfall profit tax against its Federal income tax liability as allowed in section 51.6402-1, Excise Tax Regs.
The Commissioner issued a statutory notice of deficiency in which he determined a deficiency in petitioner's windfall profit tax in the amount of $789,567.97. He determined that petitioner, in calculating the NIL under section 4988 for the taxable year 1980, ‘included payments totaling $10,123,428.00 for lease bonuses in [petitioner's] basis for the properties listed * * * for the purpose of computing the ‘as if‘ cost depletion deduction under I.R.C. 4988(b)(3)(C) and excluded the same lease bonus payments from gross income [from the property] in determining taxable income from the property under I.R.C. 4988(b)(3)(A) resulting in an improper double tax benefit.‘ The Commissioner further determined that the lease bonuses should be excluded from the properties' cost bases for the purpose of computing ‘as if‘ cost depletion, or, in the alternative, the lease bonuses should not be excluded in determining taxable income from the properties.
In his Amendment to Answer, respondent proposed that, if we conclude that petitioner must exclude the lease bonuses from taxable income from the properties, then petitioner is not entitled to include the lease bonuses in its depletable basis for the ‘as if‘ cost depletion computation. Such holding would result in a deficiency of $845,061.82.
The windfall profit tax is an excise tax which is imposed upon crude oil removed from the premises during each taxable period. Section 4986(a) imposes the tax upon the ‘windfall profit‘ calculated for each taxable period. 2
‘Windfall profit‘ is calculated under section 4988(a) and is the excess of the removal price of each barrel of crude oil over the sum of (1) the adjusted base price of such barrel, and (2) the amount of the severance tax adjustment with respect to such barrel. After this calculation has been performed, a limitation is placed upon the amount subject to the tax; i.e., the windfall profit on each barrel of crude oil shall not exceed 90 percent of the ‘net income‘ attributable to such barrel. Sec. 4988(b)(1). The ‘net income‘ for each such barrel is calculated under section 4988(b)(2), which provides:
(2) Determination of Net Income. -- For purposes of paragraph (1), the net income attributable to a barrel shall be determined by dividing --
(A) the taxable income from the property for the taxable year attributable to taxable crude oil, by
(B) the number of barrels of taxable crude oil from such property taken into account for such taxable year.
The dispute which we must resolve is the correct calculation of ‘taxable income from the property.‘ That calculation is specifically provided for in section 4988(b)(3) as follows:
(3) Taxable Income From the Property. -- For purposes of paragraph (2) --
(A) In General. -- Except as otherwise provided in this paragraph, the taxable income from the property shall be determined under section 613(a).
(iii) section 263(c) costs, or
(iv) qualified tertiary injectant expenses to which an election under subparagraph (E) applies.
(C) Taxable Income Reduced by Cost Depletion. -- Taxable income shall be reduced by the cost depletion which would have been allowable for the taxable year with respect to the property if --
incurred by the taxpayer had been capitalized and taken into account in computing cost depletion, and
The calculation of taxable income from the property for purposes of the NIL commences from the use of that same term as it is used in section 613(a). Section 613(a) is an income tax provision, which provides the general rule to be applied in calculating percentage depletion for all minerals that are subject to an allowance for percentage depletion upon their extraction.
After calculating taxable income from the property under section 613(a), certain deductions are eliminated under the specific terms of section 4988(b)(3)(B) above, i.e., depletion, the windfall profit tax (imposed by section 4986), intangible drilling and development costs which the taxpayer has elected to expense rather than capitalize under section 263(c), and qualified tertiary injectant expenses to which an appropriate election has been made.
At this point the calculation of taxable income from the property reposes without any allowance for depletion. Section 4988(b)(3)(C), set out above, constructs an allowance for cost depletion which we shall refer to as the ‘as if‘ cost depletion because, by its terms, it consists of the cost depletion which the taxpayer would have been allowed if the taxpayer had used cost depletion for all taxable years and if all intangible drilling and development costs and all qualified tertiary injectant expenses (covered by the appropriate election) had been capitalized by the taxpayer and taken into account in calculating its allowance for cost depletion.
Cost depletion which is allowable for income tax purposes is a deduction of long standing which has been explained and interpreted many times by regulation and case law. It is allowable for income tax purposes under section 611 and the basis for cost depletion for income tax purposes is covered by section 612. In providing for the ‘as if‘ cost depletion in section 4988(b)(3)(C) above, the intangible drilling and development costs are treated as if the taxpayer elected to capitalize them instead of electing to expense them. This treatment provides consistency with the provision that eliminates the intangible drilling and development costs from the computation of taxable income from the property as explained above. Section 4988(b)(3)(C) likewise provides for consistent treatment of qualified tertiary injectant expenses by considering them as capitalized for the ‘as if‘ cost depletion.
To state the issue more precisely, we must decide the correct treatment to be accorded under the calculations just described for lease bonuses which petitioner paid with respect to the eight Government oil and gas leases. Petitioner eliminated them in calculating taxable income from the property and capitalized them as part of the cost basis of the property upon which it calculated the ‘as if‘ cost depletion. Respondent characterizes...
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