Landreth v. U.S. ( 1992 )

United States Court of Appeals,
Fifth Circuit.
No. 91–1468.
William A. LANDRETH, Sr., Mary Adele Landreth Smith, Co–Trustees of W.A. Landreth, Jr.,
Trust, under the Will of Adele H. Landreth, et al., Plaintiffs–Appellants,
v.
UNITED STATES of America, Defendant–Appellee.
June 18, 1992.
Appeals from the United States District Court for the Northern District of Texas.
Before REAVLEY, JOLLY and HIGGINBOTHAM, Circuit Judges.
REAVLEY, Circuit Judge:
The Landreth trust (Landreth)1 received no cash distributions in 1981, 1982, or 1983 on its
net profits interest (NPI)2 in certain oil propert ies operated by Amoco Oil Company (Amoco).
Landreth, a cash method taxpayer, argues that because it received no distributions, it had no gross
income and thus no net income for purposes of the windfall profit tax. So Landreth claims that it is
due a refund of all windfall profit tax paid for those tax years. The district court rejected Landreth's
arguments and dismissed its refund claim. Landreth v. United States, 756 F. Supp. 284
(N.D.Tex.1991). We affirm.
1
The claims of several similarly-situated taxpayer plaintiffs are consolidated in this appeal. All
claims involve similar facts and identical legal issues, and we simplify our presentation of the case
by discussing these issues only in reference to Landreth.
2
Generally, an NPI, which derives from a working interest, entitles its owner to a percentage of
the net profits from the operation of the property to which it is attached. This means that the NPI
owner's share of contractually specified production expenses is subtracted from the owner's share
of oil sale proceeds before any distribution is made to the owner. However, the owner is not
liable for costs in excess of the percentage of oil sale revenues to which its interest is attached.
See Christy E. Milner, Resolving Producer/Interest Questions Under the Crude Oil Windfall
Profit Tax, 37 TAX.L. 607 (1984). So the NPI interest owner receives credit for excess operating
expenses in any year in which these expenses exceed revenues, but remains conditionally obligated
to pay these expenses in a future year, if any, when proceeds exceed expenses. Landreth agrees
that an NPI is an interest subject to the windfall profit tax.
I. BACKGROUND
Landreth's interest exists under a contract with Amoco as operator of the oil properties as to
which Landreth claims refund. The contract requires Amoco each year to charge against Landreth's
interest all taxes (other than income taxes) assessed upon the properties, current-year operating costs,
and unpaid operating costs incurred in any previous year when costs exceeded revenues. As a result
of these contractual charges, Landreth received no distributions under the contract in the years at
issue. Landreth filed a claim with the Internal Revenue Service (IRS), seeking refund of the windfall
profit tax that Amoco withheld and paid to the IRS on Landreth's account for those years.
Landreth's approach to windfall profit tax accounting would eliminate gross income in the
years in question by deducting from Landreth's share of oil sale proceeds the amounts Amoco charged
for both windfall profit tax and unpaid operating expenses accumulated from prior years. And with
no gross income, Landret h could have no net income for purposes of computing the net income
limitation to the windfall profit tax, and thus could have no windfall profit tax liability. The IRS,
however, decided that Landreth was not entitled to deduct from gross income either the windfall
profit tax or the excess production expenses Amoco charged from prior taxable periods. That
decision prompted this suit.
The district court agreed that Landreth received no cash distribution during the relevant tax
periods because the amount of windfall profit tax that Amoco withheld, plus the operating expenses
that Amoco carried over from prior accounting periods, exceeded oil sale proceeds. Landreth, 756
F. Supp. at 286. However, the court concluded that, "[b]ecause the Code does not provide for the
deduction of either amount ..., [Landreth is] liable for windfall profit taxes." Id. at 287. Landreth
appeals.
II. DISCUSSION
Congress enacted the Crude Oil Windfall Profit Tax Act of 1980 (the Act), I.R.C. §§
4986–98, in conjunction with its deregulation of oil prices. The Act's title is misleading. The tax
imposed by the Act is not a tax on profits or income,3 as is the federal income tax that is codified in
I.R.C. subtitle A,4 and therefore liability under the Act does not directly depend upon the profitability
or income of the producer or interest owner.5 Rather, it is an excise tax, a tax that burdens the
exercise of one or more of the powers incident to ownership. See Bromley v. McCaughn, 280 U.S.
124, 137–38, 50 S. Ct. 46, 48, 74 L. Ed. 226 (1929); Mangum, supra note 5, at 768.
Congress levied this tax on the difference between the deregulated sale price of oil and the
regulated price that would have applied had deregulation not occurred. Amerada Hess, 109 S. Ct.
at 1619; see also Barry R. Miller & Dan G. Easley, The Windfall Profit Tax—An Overview, 12
ST.MARY'S L.J. 414, 415 & n. 2 (1980). The Act taxes the producer's right to sell oil for more than
the regulated price by taxing the removal of oil from the producer's property. I.R.C. § 4986(a); see
Mangum, supra note 5 at 767–68, n. 4. The Act includes a provision, called the "net income
limitation," which prevents production from being taxed beyond the point of profitability. The net
income limitation has the effect of capping taxable windfall profit at ninety percent of the net income
from the property, as net income is defined for purposes of section 4988(b)(1). See Rev.Rul. 85–79,
1985–1 C.B. 337 (explaining operation of net income limitation).
Section 4988(b)(2) defines net income per barrel as "the taxable income derived from the oil
3
Profits are taxed as income under I.R.C. § 63.
4
We note, however, that the windfall profit tax is similar to an income tax in its "structure and
computation." See Amerada Hess Corp. v. Director, Div. of Taxation, New Jersey Dep't of
Treasury, 490 U.S. 66, 109 S. Ct. 1617, 1623 n. 9, 104 L. Ed. 2d 58 (1989), quoting I.R.S. Manual
Supplement—Windfall Profit Tax Program, 42 RDD–57 (Rev. 3) para. 2.01 (August 28, 1987),
reprinted in II CCH Internal Revenue Manual—Audit, p. 7567. Presumably because of this
similarity, Landreth correctly places controlling emphasis on the distinction "between the income
of the Taxpayers from the properties and the income of the properties themselves."
5
Taxation under the Act depends only upon the classification of oil, the type of producer, and
the selling price of the oil. See Paul Mangum, Evolution of the Crude Oil Windfall Profit
Tax—An Examination of Recent Changes, 13 ST.MARY'S L.J. 767, 768 (1982) (explaining basis
of windfall profit taxation).
removed from a particular property for a given year divided by the number of barrels from that
property taken into account for that year." Treas.Reg. § 51.4988–2(b)(1)(ii) requires that taxable
income be computed according to I.R.C. section 613(a), subtracting certain expenses from the
property's gross income. Gross income from the property is the amount for which the taxpayer sells
the oil in the immediate vicinity of the well, minus any rent s or royalties paid or incurred by the
taxpayer in respect to the property. Treas.Reg. § 1.613–3(a).
A. DEDUCTIBILITY OF THE WINDFALL PROFIT TAX
The net income limitation circumscribes windfall profit tax liability according to the
profitability of production. Landreth would define income under the net income limitation as it is
defined under I.R.C. subtitle A, which codifies the taxes imposed on income. Indeed, for the purpose
of the tax on income, the windfall profit tax is already deductible under I.R.C. section 164.6 The
I.R.C. provisions governing computation of the windfall profit tax, however, and the associated
regulations interpreting the net income limitation, dispose of Landreth's contention that the tax itself
is deductible from section 4988 income.
Section 4988(b)(3)(B) states that, in calculating taxable income from the property, "[n]o
deduction shall be allowed for ... the tax imposed by section 4986," the windfall profit tax. And the
associated Treas.Reg. § 51.4988–2(b)(1)(ii) computes taxable income by reducing the property's
gross income "by all allowable deductions attributable to the production of taxable crude oil ... except
windfall profit tax " (emphasis added). See also Rev.Rul. 85–79, 1985–1 C.B. 337 (explaining
rationale for nondeductibility of windfall profit tax in computing section 4988 net income). I.R.C.
provisions and regulations pertaining specifically to the windfall profit tax of I.R.C. subtitle D govern
the definition of income for the purposes of that tax. Those regulations are set forth in Treas.Reg.
§ 51.4988–2(b)(1)(ii) and, by reference, I.R.C. § 613–3(a). We find no evidence that Congress
6
The Act provides for a deduction of the windfall profit tax from income. Pub.L. No. 96–223,
§ 101(b), 94 Stat. 229 (1980); see S.REP. No. 394, 96th Cong., 2nd Sess. 30 (1980), reprinted in
1980 U.S.C.C.A.N. 410, 439.
intended for the net income limitation either to change the windfall profit tax from an excise tax to
an income tax, or to incorporate the definition of income from I.R.C. subtitle A provisions that
concern taxes imposed on income.
Nor do we find Rev.Rul. 83–185, 1983–2 C.B. 200, applicable. That ruling only addresses
the question of how a cash method taxpayer is to account for barrels of oil removed in one year and
sold in the next, and holds that the windfall profit tax applies to all of the oil removed from the
premises in the taxable year, but is limited by the net income limitation to ninety percent of the income
from oil actually sold from the property in the taxable year, regardless of when removed. Landreth
does not raise an issue regarding the timing of the removal and sale of oil from the property.
B. DEDUCTIBILITY OF EXPENSES FROM PREVIOUS TAX PERIODS IN COMPUTING WINDFALL PROFIT
TAX
Landreth also seeks to deduct previous tax period expenses carried forward into the tax
periods at issue in this case in computing taxable income for purposes of the net income limitation
to the windfall profit tax. The district court rejected Landreth's claim to this deduction, holding that:
[i]n determining windfall profit taxes, the Code first requires a determination of taxable
income from the property for the taxable year attributable to taxable crude oil. I.R.C. §
4988(b)(2) ... makes clear that the only relevant time period is the taxable year. Taxable
income is determined under I.R.C. § 613(a), which does not allow a net operating loss under
§ 172 of the Code to be deducted from gross income from the property in determining a
taxpayer's taxable income from the property. Moreover, Treasury Regulation §
51.4988–2(b)(1)(ii) makes clear that amounts deductible in determining taxable income from
the property must be attributable to taxable crude oil removed during that particular taxable
year.
Landreth, 756 F. Supp. at 287–88 (citations omitted). The district court understood section
51.4988–2(b)(1)(ii) correctly. A cash-method taxpayer loses the windfall profit tax deduction for
production costs incurred during previous tax periods, to the extent that those costs exceed gross
revenues from that period's production. The I.R.C. provides for the deduction of those costs under
the income tax provision of section 172.
Rev.Rul. 83–185, 1983–2 C.B. 200, suggests that this deduction is not permissible for a
cash-basis taxpayer:
[G]enerally, under the cash receipts and disbursements method, in the computation of taxable
income all items that constitute gross income are to be included fo r the tax year in which
actually or constructively received. Expenditures are to be deducted for the taxable year in
which actually made.
Landreth did not actually pay out production expenses, and the contract did not obligate Landreth
to do so, at least to the extent those expenses exceeded oil sale revenues. At the same time, Amoco
charged Landreth's interest with those prior years' excess expenses in years when Amoco took in
sufficient oil sale revenues. Therefore Landreth paid, according to its contract, prior excess expenses
in the first year when revenues were sufficient, regardless of the year in which the excess expenses
were generated. Under this rationale, Landreth claims the deduction of prior years' expenses. But
we must also reject this argument.
Treas.Reg. § 51.4988–2(b)(1)(ii) specifies the method for determining each year's taxable
income from a particular property's production for purposes of the net income limitation. Taxable
income results from subtracting all deductible production expenses for that year from the gross
income associated with production from t he property for that year. The Regulation so states.7
Section 51.4988–2(b)(1)(ii) facially supplies no basis for deducting the allowable costs attributable
to the production from earlier taxable years. While unpaid excess operating losses from one tax
period generally may be carried forward into a subsequent period for purposes of federal income tax
under I.R.C. § 172, we find no parallel provision that allows Landreth to carry forward excess
operating expenses for purposes of the windfall profit tax net income limitation.
7
Section 51.4988–2(b)(1)(ii) specifically requires that we "[d]etermine the taxpayer's taxable
income from the property attributable to taxable crude oil for the taxable year by reducing the
taxpayer's gross income from the property determined under paragraph (b)(1)(i) of this section by
all allowable deductions attributable to the production of taxable crude oil that would be
subtracted in determining taxable income from the property under section 613(a) allowable for the
taxable year."
AFFIRMED.