UNITED STATES OF AMERICA, Plaintiff-Counter-Defendant-Appellee,
CONOCOPHILLIPS COMPANY, Defendant-Counter-Claimant-Appellant
Appeal from the United States District Court for the Northern District of Oklahoma. (D.C. No. 4:11-CV-00071-JHP-TLW).
Andrew M. Weiner, Attorney, Tax Division (Kathryn Keneally, Assistant Attorney General; Tamara W. Ashford, Principal Deputy Assistant Attorney General; Gilbert S. Rothenberg, Attorney, Tax Division; Teresa E. McLaughlin, Attorney, Tax Division; and Danny C. Williams, United States Attorney, on the briefs), Department of Justice, Washington, D.C., for Plaintiff-Counter-Defendant, Appellee.
Stephen Gardner, Cooley LLP, New York, NY (Kathleen Pakenham, Cooley LLP, New York, NY; and Richard Noulles, GableGotwals, Tulsa, OK, on the briefs) for Defendant-Counter-Claimant, Appellant.
Before LUCERO, MURPHY, and BACHARACH, Circuit Judges.
BACHARACH, Circuit Judge.
In the 1970s and 1980s, the Internal Revenue Service was embroiled in a tax dispute with multiple companies (including Phillips Petroleum Company and Arco Transportation Alaska, Inc.) that had jointly developed a pipeline system. The parties agreed to settle the dispute through a closing agreement. After entering the agreement, Phillips Petroleum Company (now ConocoPhillips Company) acquired Arco Transportation. In 2000 and 2001, Conoco revisited the tax implications of its acquisition and claimed " going-forward" and " basis-increase" deductions on its amended consolidated tax returns. The IRS refunded Conoco's 2000 going-forward deductions and does not challenge them here. But the IRS disputes the remaining deductions and the parties brought the dispute to federal district court, where the district court decided the issue on cross-motions for summary judgment. The court rejected Conoco's position and granted summary judgment to the IRS.
We agree with the district court. " Going-forward" deductions are impermissible for interests that Arco Transportation did not own as of July 1, 1977, and " basis-increase" deductions are impermissible because the Closing Agreement did not fix the amount of a liability or exempt that liability from § 461(h) of the Internal Revenue Code. Thus, we hold that Conoco is not entitled to the going-forward or basis-increase deductions.
I. Factual Background
This suit involves the interplay between two events: The collective effort to develop
a pipeline system and changes in the tax code. These events led to: (1) disagreement between the pipeline owners and the IRS, and (2) settlement of the disagreement through a closing agreement.
A. Development of the Pipeline System
In the late 1960s and early 1970s, a group of companies (including Conoco) joined to develop a pipeline system eventually known as " TAPS" (the Trans-Alaska Pipeline System). To participate in this venture, each company had to assume part of the cost to dismantle the pipeline system, remove all improvements and equipment, and restore the land (" DR& R costs" ) when the system would eventually stop operating. Appellant's App. vol. 1, at 238. By 2010, these costs were expected to exceed $3 billion. Id. at 240; id. vol. 2, at 435.
B. The Original Dispute
During construction of the pipeline system, TAPS's owners (including Arco Transportation) had to determine when they could start claiming deductions for the DR& R costs. See id. vol. 5, at 1849. The owners correctly assumed they would not incur any DR& R costs for several decades. See id. vol. 4, at 1362. Nonetheless, the owners started to claim DR& R deductions on their 1974 tax returns. Id. vol. 5, at 1854.
These deductions were defensible at the time because accrual taxpayers (such as Arco Transportation) could deduct expenses in the year " in which all the events [had] occurred which determine[d] the fact of the liability and the amount thereof [could] be determined with reasonable accuracy" under the " all events" test. 26 C.F.R. § 1.461-1(a)(2) (1974); see Appellant's App. vol. 5, at 1858.
TAPS's owners argued that the DR& R costs satisfied this test because the fact of liability and its amount could be determined with reasonable accuracy. Appellant's App. vol. 5, at 1858. Relying on this argument, the owners claimed various deductions for the DR& R costs they expected to incur. Id. at 1854. The IRS disallowed these deductions. Id. at 1855.
The law changed in 1984 with Congress's passage of 26 U.S.C. § 461(h) (1984 supp.). Under § 461(h), accrual taxpayers could not deduct liabilities (like DR& R costs) on their tax returns before " economic performance." 26 U.S.C. § 461(h) (1984 supp.). Because § 461(h) was not retroactive, however, it did not apply to deductions claimed prior to 1984. See United States v. General Dynamics Corp., 481 U.S. 239, 243 n.3, 107 S.Ct. 1732, 95 L.Ed.2d 226 (1987). Thus, § 461(h) did not bar owners' pre-1984 DR& R deductions, but would unambiguously bar unrelated purchasers after 1984 from claiming DR& R deductions before economic performance. See id. at 244.
C. The Closing Agreement
The parties settled their dispute in the 1988 Closing Agreement. Appellant's App. vol. 3, at 973-87. This agreement allows TAPS's " owners" and their " successors in interest" to take an aggregate $900 million DR& R deduction before TAPS's dismantlement " subject to" the agreement's terms. Id. at 974-75 ¶ 1. The agreement bound not only each listed owner, but also " any successor in interest of any owner" who " expressly assumed such owner's DR& R obligations." Id. at 978 ¶ 8. For owners and their successors in interest, § 461(h) would not apply to the deductions allowable under the first three paragraphs in the agreement. Id. at 977-78 ¶ 6. The Closing Agreement spread the aggregate deduction over the 318 months
from July 1, 1977, until December 31, 2003. Id. at 975 ¶ 2. Each owner or successor in interest was entitled to take a monthly deduction during this period. Id. This monthly deduction was defined by the formula: 1/318 * $900 million * OI, " where OI is such Owner's or successor in interests' proportionate ownership interest in TAPS." Id.
The amount available for deduction before economic performance is capped at $900 million. Id. at 976 ¶ 3. If an owner or successor in interest had incurred DR& R costs before 2004, these costs would have reduced the total ($900 million) otherwise available for deduction prior to economic performance. Id. And, if the deductions under the Closing Agreement exceeded the DR& R costs eventually incurred, the owner or successor in interest had to treat the excess as ordinary income. Id.
The Closing Agreement also addressed what would happen if an owner or successor in interest sold its ownership in TAPS after taking a deduction. In this situation, the owner or successor in interest would ordinarily need to recapture its prior deduction. Id.
An exception was carved out for transfers involving related companies that file a consolidated return. Id. at 977 ¶ 5. Under this exception, transfers between group members who file a single consolidated tax return can create a successor in interest. See id. (referring to " [a]ny successor in interest acquiring an ownership interest as a result of such transfer" ).
D. Changes in TAPS Ownership Interests
In 1977, Arco Transportation had a 21% ownership interest in TAPS. Id. at 974, 980. Three transfers then took place: (1) Arco Transportation acquired additional interests in TAPS totaling 1.295% between 1977 and 2000, (2) Conoco acquired Arco Transportation in 2000, and (3) Arco Transportation acquired an additional 3.0845% interest in 2001.
1. Arco Transportation's Acquisition of an Additional 1.295% Interest in TAPS Between 1977 and 2000
Between 1977 and 2000, Arco Transportation acquired additional interests in TAPS totaling 1.295%. Id. vol. 5, at 1937; id. vol. 6, at 2483. Thus, by 2000, Arco Transportation owned a 22.295% interest in TAPS. Id. vol. 2, at 516-17.
2. Conoco's Acquisition of Arco Transportation Stock in 2000
In 2000, Conoco acquired Arco Transportation by purchasing its stock and assets from BP America, Inc. Id. vol. 2, at 516, 563. Though the acquisition involved a stock transaction, the parties jointly elected to treat the transfer as an asset sale for federal income tax purposes. Id. at 517, 595; see 26 U.S.C. § 338(h)(10)(A) (2000).
This election resulted in the existence (for tax purposes) of " two separate corporations, old target and new target." 26 C.F.R. § 1.338-1T(a)(1) (2000). The old target was deemed to sell its assets to the new target, which acquired the assets and the liabilities. Id. But the new target was generally " treated as a continuation of [the] old target for purposes other than subtitle A of the Internal Revenue Code." 26 C.F.R. § 1.338-1T(b)(3) (2000).
3. Arco Transportation's Acquisition of an Additional 3.0845% Interest in 2001
In 2001, Arco Transportation bought an additional 3.0845% interest in TAPS from BP Pipelines (Alaska), Inc. Appellant's App. vol. 2, at 519. Arco Transportation
expressly assumed BP's DR& R obligations related to this TAPS interest. Id. at 672-73. With this acquisition, Arco Transportation continued to own its initial 21% interest in TAPS and the additional 4.3795% interests acquired from 1977 to 2001.
II. Conoco's Two Types of Deductions
The appeal addresses Conoco's amended returns for 2000 and 2001. Id. vol. 1, at 9 ¶ 1, 13 ¶ 1, 18 ¶ 3. The government granted Conoco a tax refund based on its 2000 amended return, but contends that most of the refund was erroneous. Id. at 9 ¶ ¶ 1, 13. Thus, the government sued to reclaim most of the money refunded to Conoco in 2001. In a counterclaim, Conoco claims that it is entitled to a tax refund based on its 2001 amended return. Id. at 18 ¶ 3.
The parties disagree about two types of deductions: (1) going-forward deductions for 2001, and (2) basis-increase deductions for 2000 and 2001.
Conoco's going-forward deductions are deductions under the Closing Agreement's amortization schedule for Arco Transportation's 4.3795% ownership interests in ...