113 T.C. No. 24

UNITED STATES TAX COURT

EXXON CORPORATION AND AFFILIATED COMPANIES, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 23331-95, 16692-97. Filed November 2, 1999.

Held: Petroleum revenue tax paid by

petitioners to the United Kingdom was not

paid in exchange for specific economic

benefits and constitutes a creditable foreign

tax under sec. 901, I.R.C.

Robert L. Moore II, Jay L. Carlson, Bradford J. Anwyll,

Kevin Lee Kenworthy, Patrick James Thornton, Richard Steven

Klimczak, Susan Ann Friedman, and David B. Blair, for

petitioners.

Allan E. Lang, Raymond L. Collins, Martin Van Brauman, and

Roberta L. Shumway, for respondent.
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SWIFT, Judge: The issue for decision is whether petroleum

revenue tax (PRT) petitioners paid to the United Kingdom for 1983

through 1988 constitutes, for U.S. income tax purposes, a

creditable income or excess profits tax under section 901 or a

creditable tax in lieu thereof under section 903.

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in question,

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

FINDINGS OF FACT

The parties have stipulated numerous facts and admissibility

of numerous exhibits. The stipulated facts are so found. 

During the years in issue, petitioners constituted an

affiliated group of more than 175 U.S. and 500 foreign subsidiary

corporations. Petitioner Exxon Corp. was the common parent of

the affiliated group, with its principal place of business in

Irving, Texas. Hereinafter, petitioners will be referred to

simply as “Exxon”.

The businesses in which Exxon was engaged primarily involved

exploration for and production, refining, and sale of crude oil,

natural gas, and other petroleum products. 
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1 The Petroleum (Production) Act, 1934, 24 & 25 Geo. 5, ch. 36

(Eng.), vested in the United Kingdom ownership of all oil and gas

resources within Great Britain and authorized the U.K. Secretary

of State for Trade and Industry to grant exploration and mining

licenses. The Continental Shelf Act, 1964, ch. 29, sec. 1

(Eng.), extended to the North Sea the United Kingdom’s license

powers under the Petroleum (Production) Act, 1934, supra. 

Exxon’s North Sea Licenses

The North Sea presents one of the harshest working

environments in the world. As of the mid-1960's, oil and gas

companies had not attempted production of oil and gas in

conditions as severe and difficult as those that existed in the

North Sea, and oil and gas companies generally lacked experience

and technology to explore for and to recover oil and gas from the

North Sea. 

Under Article 2 of the Geneva Convention on the Continental

Shelf, Apr. 29, 1958, 15 U.S.T. 473 (ratified in U.S. Apr. 12,

1961), various countries were granted jurisdiction and control

over seabed areas adjacent to their coastlines. Individual

treaties were negotiated between countries bordering the North

Sea to fix boundaries between their respective offshore areas.

In the Continental Shelf Act, 1964, ch. 29, sec. 1 (Eng.),

the United Kingdom implemented provisions of the 1958 Geneva

Convention on the Continental Shelf with regard to the United

Kingdom portion or segment of the North Sea. Hereinafter, such

portion or segment will be referred to simply as the North Sea.1
- 4 -

In May of 1964, the United Kingdom first issued to oil and

gas companies licenses for exploration of and, if commercial oil

and gas reserves were discovered, for development and production

of oil and gas resources in the North Sea. The next three United

Kingdom license rounds relating to the North Sea took place in

August of 1965, September of 1969, and June of 1971. During

these four license rounds, crude oil prices generally remained at

approximately $3 per barrel. 

In 1970, oil discoveries were reported in the North Sea. 

However, oil reserves in the North Sea remained unproven. The

North Sea was considered a marginal oil prospect, and oil

production did not begin in the North Sea until 1975. 

In the first four license rounds, the United Kingdom offered

areas that covered almost all of the North Sea, but oil and gas

companies did not apply for most of the areas because of the

risks and uncertainties involved. Of the areas offered,

applications for licenses were received for only 35 percent of

the areas. Licenses for a number of areas not applied for when

first offered included what in later years became the largest and

most profitable oil-producing fields in the North Sea.

The areas that turned out to be the most significant oil

fields in the North Sea were licensed by the end of the fourth

license round in 1971. 
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With regard to North Sea petroleum resources, the United

Kingdom generally used a discretionary licensing system under

which the United Kingdom selects oil companies to which licenses

are issued from a pool of companies that apply for the licenses. 

This enabled the United Kingdom to further governmental

objectives such as rapid and appropriate exploitation of North

Sea petroleum resources. In contrast, under an auction licensing

system, licenses are issued to the highest bidders who are not

necessarily the most financially sound or competent companies to

develop petroleum resources associated with the licenses. 

Further, at least in the 1960's and early 1970's, due to

uncertainties and risks associated with exploitation of North Sea

petroleum resources, it was generally expected that with regard

to the North Sea resources, the United Kingdom would not raise as

much revenue from an auction licensing system as from a

discretionary licensing system. 

In June of 1971, as part of the fourth license round that

was generally conducted on a discretionary basis, the United

Kingdom experimented with an auction system and invited bids for

15 areas. The winning bid (by Exxon and Shell) for one of the

auctioned areas (involving a field adjacent to where Exxon and

Shell had already discovered oil) was for £21 million, but the
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2 In these cases, the parties generally refer to U.K. pounds,

without providing U.S. dollar equivalents. We, therefore, in

this opinion also use U.K. pounds, and we leave for the Rule 155

computation questions relating to proper exchange rates between

U.K. pounds and U.S. dollars.

average bid price with respect to the remaining 14 areas that

were available under the auction was less than £1.2 million.2 

At the time, in the 1960's and early 1970's, the United

Kingdom concluded that the financial terms of the discretionary

North Sea licenses that it issued to Exxon and to other oil and

gas companies were appropriate for the particular circumstances

of the United Kingdom, which at the time had virtually no

indigenous oil and gas production and which was in competition

with other countries for resources that the oil industry would

allocate to the North Sea. 

After the fourth license round in 1971 in which the United

Kingdom had experimented with an auction licensing system, the

United Kingdom has continued to use, with limited exceptions, a

discretionary licensing system. The United Kingdom and most

major oil-producing countries other than the United States rely

primarily on discretionary licensing systems with regard to the

recovery of petroleum resources.

Generally, under the discretionary licenses issued by the

United Kingdom for exploitation of North Sea petroleum resources,

terms of the licenses required licensees to pay to the United

Kingdom up-front fees based on the size of the areas subject to
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the leases followed by escalating annual fees and a 121⁄2-percent

royalty based on gross value of total oil and gas production at

the wellhead. The 121⁄2-percent royalty rate was approximately the

same as the royalty rate that was used by most oil-producing

countries throughout the world. The terms of the licenses also

required the licensees to conduct seismic survey work and to

drill a specified number of exploratory wells.

Royalties due under the North Sea licenses issued by the

United Kingdom were allowed to be paid in kind by the oil

companies.

To actually operate in the North Sea, oil and gas companies

holding licenses were required to pay the license fees and

royalties and to complete exploratory work programs specified in

the licenses. 

During 1972 and early 1973, the Public Accounts Committee

(PAC) of the U.K. House of Commons held hearings on U.K. tax and

energy policies with regard to the North Sea. At the time, there

were indications that crude oil prices might increase

significantly, although the price increases that later occurred

as a result of the 1973-74 Arab oil embargo were not anticipated.

In February of 1973, PAC issued a report summarizing the

discretionary licensing system that primarily had been used by

the United Kingdom for the first four license rounds for the

North Sea. In the 1973 report, PAC made no recommendation that
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the discretionary licensing system be changed to an auction

system or that the 121⁄2-percent royalty rate associated with North

Sea licenses be increased. 

In the 1973 report, PAC also reviewed the then existing U.K.

corporation tax applicable to oil company profits to be earned

from North Sea oil and gas and expressed concern that the U.K.

corporation tax was poorly structured in that petroleum companies

could offset profits from North Sea oil and gas activity by

losses from unrelated activities. PAC also recommended

legislative changes to the U.K. corporation tax to increase the

effective U.K. tax rate on profits relating to North Sea oil and

gas production. In that report, no recommendation was made to

impose a tax similar to the PRT. 

In October of 1973, war broke out in the Middle East,

leading to the embargo by the Organisation of Petroleum Exporting

Countries (OPEC) on exports of crude oil to the United States

and, by the end of 1974, to a 5-fold increase in world crude oil

prices. 

During 1974, the U.K. economy was experiencing a serious

recession with high inflation and severe balance of payment

problems. Because of the United Kingdom’s dependence on imported

crude oil, the 1974 increase in the price of crude oil

exacerbated the United Kingdom’s fiscal crisis. As a result, in

July of 1974, the U.K. Secretary of State to Energy issued a
- 9 -

report to the U.K. Parliament (1974 White Paper) in which it was

concluded that unless the United Kingdom modify its tax regime,

the United Kingdom would receive only a small portion of North

Sea oil and gas company profits. In the 1974 White Paper, it was

also recommended: (1) That the United Kingdom modify its tax

regime with regard to North Sea oil and gas production activity

in order to, among other things, eliminate the ability of oil and

gas companies to offset profits from North Sea operations by

losses realized by the companies elsewhere in the world, and

(2) that the United Kingdom assert increased control over oil and

gas companies’ North Sea operations. 

No recommendation was made in the 1974 White Paper to make

any significant change to the United Kingdom discretionary

licensing system for the North Sea.

Between 1976 and 1988, there were seven additional license

rounds conducted by the United Kingdom relating to the North Sea. 

Over the years, North Sea licenses were issued and

administered, and the related fees and royalties were collected

by the U.K. Ministry of Power, the U.K. Department of Technology,

the U.K. Department of Energy, and the U.K. Department of Trade

and Industry. At no time have North Sea licenses been

administered, or have the related fees and royalties been

collected, by the U.K. Treasury or by the U.K. Inland Revenue.
- 10 -

Significant uncertainties, risks, and investment commitments

for Exxon were associated with Exxon’s North Sea licenses --

risks that insufficient oil deposits would be discovered, that

oil resources that might be discovered would not be commercially

exploitable, and that the large capital and operating costs

associated with exploring for and developing oil and gas

resources in the North Sea would be lost.

The licenses between the United Kingdom and Exxon regarding

North Sea petroleum resources were entered into in good faith. 

They were negotiated at arm’s length. They constituted

enforceable contracts under U.K. law. 

License fees and royalties that have been collected by the

United Kingdom from oil and gas companies with regard to North

Sea petroleum resources have constituted a substantial source of

income to the United Kingdom.

Through 1992, Exxon has paid to the United Kingdom more than

£16 billion in royalties in connection with the North Sea

licenses it received. Under the licenses Exxon received and

taking into account risks and costs associated therewith at the

time the licenses were issued, the fees and royalties Exxon paid

to the United Kingdom for the licenses to exploit North Sea

petroleum resources constituted reasonable and substantial

compensation therefor.
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Ring Fence Tax and PRT

As indicated, during the Arab oil embargo world crude oil

prices increased approximately 5-fold. As a result, in 1975, out

of concern that the U.K. corporation income tax might fail

effectively to tax anticipated extraordinary profits to be

realized by oil and gas companies, the U.K. Government enacted a

new tax regime on income earned from oil and gas recovery

activities in the North Sea. The new tax regime consisted of the

ring fence provisions of the U.K. corporation income tax (Ring

Fence Tax) and PRT. The Ring Fence Tax and PRT replaced the U.K.

corporation income tax as it otherwise would have applied to

activities of oil and gas companies in the North Sea.

The purpose and objective of the United Kingdom in enacting

the Ring Fence Tax and PRT were to accelerate tax revenues

relating to development of North Sea petroleum resources and to

tax extraordinary profits of oil and gas companies relating to

the North Sea. 

To make it more difficult for oil and gas companies to

offset profits derived from the North Sea with losses and

expenses from unrelated activities, the Ring Fence Tax was

enacted as a modified or customized version of the U.K.

corporation income tax and was made applicable to activity of oil

and gas companies in the North Sea in lieu of the general
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3 In this Opinion, we often use the present tense to describe

provisions of the Ring Fence Tax and PRT even though PRT was

eliminated in 1993.

provisions of the U.K. corporation tax generally applicable to

U.K. corporate taxpayers. 

The Ring Fence Tax applies3 only to companies producing oil

and gas and to related activities in the North Sea, and it erects

a “ring fence” around oil and gas activities in the North Sea by

requiring oil and gas companies to segregate income and expenses

attributable to North Sea activity from income and expenses

attributable to activity unrelated to the North Sea. 

The Ring Fence Tax was enacted under the U.K.’s sovereign

taxing power, and under U.K. law it constitutes a tax on income. 

The Ring Fence Tax is structured as a corporate income 

tax. 

Along with other U.K. taxes such as the U.K. corporation

income tax and the Ring Fence Tax, under U.K. law, PRT was

intended, is structured, and is regarded as a tax. PRT was

imposed unilaterally by the United Kingdom and was administered

as a tax by the U.K. Inland Revenue. 

With regard to North Sea oil and gas recovery activities,

the Ring Fence Tax and PRT are imposed in substitution for, and

not in addition to, the generally applicable U.K. corporation

tax. Oil and gas companies operating in the North Sea are

liable, with regard to such activity, for the Ring Fence Tax and
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PRT, not for the otherwise generally applicable U.K. corporation

tax. 

In order to provide uniform administration of the Ring Fence

Tax and PRT, in 1975 the Oil Taxation Office of the U.K. Inland

Revenue was established and was delegated that responsibility. 

The fees and royalties due under the licenses issued by the

United Kingdom to Exxon and other oil and gas companies regarding

the North Sea were not modified, supplemented, or altered by the

PRT that was enacted in 1975. 

Gross income relating to North Sea oil and gas recovery

activities, with limited exceptions, constitutes the tax base for

PRT, and losses relating to activity outside the North Sea ring

fence are not allowed to offset income from activity occurring

within the North Sea ring fence. PRT is imposed on income

relating to extraction of oil and gas from the North Sea, income

earned by taxpayers providing transportation, treatment, and

other services relating to oil and gas resources in the North Sea

(tariff receipts), and income relating to sale of North Sea

assets (disposal receipts). 

Interest income, income from sales of purchased and resold

crude oil, and income relating to sale of gas exempt from PRT

liability are not included in the income base for PRT purposes. 

In computing net profits for PRT purposes and on which PRT

liability is calculated, all significant costs and expenses,
- 14 -

except interest expense, of producing taxable income relating to

North Sea petroleum resources are currently deductible. To

prevent the use of intercompany debt as a means of avoiding or

minimizing liability under the Ring Fence Tax and PRT, deductions

for interest expense are limited under the Ring Fence Tax and are

not allowed under PRT. 

Initial calculations of profits under PRT are made at the

field level, with current deductions from gross revenue generally

allowed for all ordinary as well as capital expenses relating to

the field. Current deductions are allowed for, among other

things, costs of exploration and appraisal activities, start-up

activities, operations, production, storage, treatment,

transportation, administrative and overhead activities, buildings

and structures (if placed on the seabed or used in production,

measurement, transportation, or initial treatment and storage of

petroleum products), and abandonment activity relating to a

field, as well as costs of conducting arm’s-length sales of

petroleum products and of exploring and evaluating areas outside

a field that do not result in discovery of new fields. 

As indicated, under PRT, current deductions are not allowed

for interest expense, and current deductions are not allowed for

costs of acquiring licenses from private parties, for payments to

private parties holding overriding royalty and similar interests

in a field, for expenses incurred in producing income exempt from
- 15 -

4 Over the life of each field, the oil allowance or exemption

varied from 75 to 35 million barrels of crude oil.

PRT, and for payments of tax that should have been paid by

foreign contractors providing services to the taxpayer in the

North Sea. 

Under PRT, operating losses from any period are carried back

or carried forward without limit to income associated with the

field.

 Additional prominent features of PRT, as originally enacted

and as amended over the years, may be described generally as

follows: 

(1) As an incentive to development of marginal North

Sea fields, an “oil allowance” or exemption from PRT is

allowed for each field in an amount equivalent to the

value of 500,000 metric tons of oil per 6-month period

up to a total of 10 million metric tons over the life

of the field;4

(2) A tariff receipts allowance is allowed, which for each

6-month chargeable period exempts from PRT tariff receipts

attributable to transportation of up to 250,000 metric tons

(i.e., up to 1,875,000 barrels) of oil from each field); 

(3) Various nonfield-specific expenses are deductible

against income from a field (e.g., exploration,

appraisal, and research expenses);

(4) As a limit on the amount of PRT that would be

owed, a “safeguard” provision limits the amount of PRT

payable in each 6-month period in which it applies

except to the extent that adjusted profits from a field

exceed 15 percent of accumulated capital investment in

a field and then PRT only applies to 80 percent of such

adjusted profits;
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(5) An exemption from PRT is allowed for revenue relating

to North Sea natural gas production derived from pre-July

1975 contracts with the British Gas Corporation;

(6) Upon abandoning fields, carryover of unused losses

are allowed without limit to other North Sea fields; 

(7) PRT was enacted as a “prior charge” to the Ring

Fence Tax which means that PRT is computed, assessed,

and paid before the Ring Fence Tax, and PRT is

deductible in computing the Ring Fence Tax; 

(8) Of the limited types of expenses that are not allowed

as deductions for PRT purposes, interest expense is the only

nonallowable expense that is significant, and in lieu of

interest expense, a deduction is allowed for “uplift”

(discussed further, infra). 

Because of the above features of PRT, activities in a North

Sea field generally are not subject to PRT until they reflect a

cumulative profit. 

PRT liability of a company is to be paid only in cash, not

in kind. 

On a number of occasions, in response to changes in world

oil markets and in order to make certain adjustments to PRT, 

provisions of PRT were amended by the United Kingdom. Such

amendments that, over the years, have been made to PRT are not

particularly significant to the issue before us and generally are

not described herein. 

As indicated, in order to minimize PRT avoidance through

intercompany interest charges, interest expense deductions

relating to North Sea oil and gas recovery activities are not

allowed in computing PRT liability. Current deductions from
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5 As originally enacted in the Oil Taxation Act of 1975 and

until amended in 1979, the rate of the uplift allowance was 75

percent.

income, however, are allowed for what is referred to as uplift,

consisting of amounts equal to 35 percent of most capital

expenditures relating to a North Sea field (over and above the

current deductions allowed in computing PRT for 100 percent of

such capital expenditures).5 The deduction for uplift is

provided in lieu of a deduction for North Sea related interest

expenses.

Similar to the cost of capital expenditures to which uplift

relates and on the basis of which uplift is calculated, uplift is

allowable in full as a current deduction at the time the related

capital expenditures are incurred and fully deducted. Allowances

for uplift are computed and determined only during the period of

time prior to when an activity in a field becomes profitable, the

period during which interest expense relating to a field

typically is necessary. Once calculated and determined, unused

uplift may be carried back or carried forward without limit.

In calculating Exxon’s PRT liability, for 1975 through 1988,

the cumulative total amount of uplift deduction allowed to Exxon

was £1.8 billion, almost twice the cumulative total £900 million

interest expense that under PRT was not allowed as a deduction to

Exxon. 
- 18 -

Based on industry data that is in evidence and that was

gathered from Exxon and approximately 33 other oil companies

involved in North Sea oil and gas production, the cumulative

total uplift allowed the companies for 1975 through 1988 was

£12.4 billion, as compared to cumulative total interest expense

not allowed the companies under PRT of £8.6 billion. In the

Appendix to this Opinion, for 1975 through 1988, we set forth the

amount of uplift and other deductions allowed to Exxon and to the

other oil and gas companies and the amount of ring fence interest

expense not allowed to Exxon and the other oil and gas companies

in the computation of PRT liability.

As a result of the special allowances such as oil, tariff

receipts, safeguard, and uplift, PRT represents and constitutes a

tax on a subset of net income subject to the Ring Fence Tax. 

Through 1992, Exxon had interests in 23 oil-producing North

Sea fields, but significant PRT was paid only with regard to five

of the fields (Brent, Forties, Dunlin, Fulmar, and North

Cormorant). More than 60 percent of total PRT paid by Exxon

through 1992 was paid with respect to only one field -- the Brent

field which was the highest oil-producing field in the North Sea. 

Generally for the industry, the bulk of PRT was paid with

respect to a limited number of the largest and most profitable

fields. More specifically, through 1988, approximately 75

percent of total cumulative PRT collected by the United Kingdom
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was paid by only five oil and gas companies which owned the

largest and most profitable fields in the North Sea. 

Because of the special allowances, small oil and gas

companies with interests in marginal fields typically owe no PRT

with regard to fields licensed to them. 

Pre-existing licensees (i.e., companies such as Exxon to

whom North Sea licenses were issued prior to enactment of PRT in

1975) were obligated to pay PRT upon its enactment in 1975 and in

subsequent years even though they were in full compliance with

terms of their pre-1975 North Sea licenses. All PRT paid by

Exxon during the years in issue and the character of which is in

dispute in these cases was paid by Exxon with respect to fields

licensed to Exxon before 1975 and before PRT was enacted. 

As a result of paying PRT, Exxon neither received any

special benefits under the North Sea licenses that it had been

issued before 1975, nor received any special benefits from the

United Kingdom in obtaining new North Sea licenses after 1975. 

By 1979, with the rise of oil prices relating to the Iranian

Revolution, there was a general perception that the PRT rate was

too low and that the United Kingdom ought to be collecting more

PRT from oil companies operating in the North Sea. In 1982,

however, with a drop in world oil prices, there was a general

perception that the PRT rate was too high and that PRT and
- 20 -

increased operating costs were becoming a disincentive to North

Sea oil and gas development activity. 

As a result of the above increases and decreases in world

oil prices and the changing perceptions regarding PRT and the PRT 

rate, in 1979, 1980, 1982, and 1993 the tax rate for PRT was

changed from the original rate of 45 percent as enacted in 1975

to the rates indicated:

1979 1980 1982 1993

PRT Rate 60% 70% 75% 50%

In 1993, PRT was eliminated for all subsequent North Sea oil

and gas activity under licenses to be issued thereafter, and, as

indicated, the PRT rate was reduced to 50 percent for existing

licenses. 

For 1975 through 1988, Exxon paid £3.5 billion in PRT,

approximately 11 percent of the approximate total £32 billion in

PRT that was paid to the United Kingdom by all oil and gas

companies for those years.

Because primarily of timing differences associated with

calculations of PRT at the field level and because PRT was

deductible in computing the Ring Fence Tax, for any 1 year

companies may owe PRT but no Ring Fence Tax, they may owe Ring

Fence Tax but no PRT, and they may owe both PRT and Ring Fence

Tax or neither. These differing results are not inconsistent

with the objective of PRT to tax extraordinary profits and to
- 21 -

accelerate tax revenues relating to development of North Sea

petroleum resources. 

OPINION

With limitations not here pertinent, taxpayers may claim

credits under section 901 against their Federal income taxes for,

among other things, the amount of income and excess profits taxes

paid to foreign countries. See sec. 901(b)(1). As an exemption

from tax, the credit provisions of section 901 are to be strictly

construed. See Inland Steel Co. v. United States, 230 Ct. Cl.

314, 677 F.2d 72, 79 (1982); Bank of Am. Natl. Trust & Sav.

Association v. United States, 61 T.C. 752, 762 (1974), affd.

without published opinion 538 F.2d 334 (9th Cir. 1976).

Under regulations applicable to the years in issue, foreign

levies are to be regarded as income or excess profits taxes if

they satisfy two tests: (1) The foreign levies constitute taxes,

and (2) the predominant character of the taxes is that of an

income tax in the U.S. sense. See sec. 1.901-2(a)(1), Income Tax

Regs. 

Generally, governmental levies imposed by and paid to

foreign countries are to be treated as taxes if they constitute

compulsory payments pursuant to the authority of the foreign

countries to levy taxes. The regulations, however, also provide

that foreign levies will not be regarded as taxes to the extent

that payors of the levies receive specific economic benefits,
- 22 -

directly or indirectly, from the foreign countries in exchange

for payment of the levies. See sec. 1.901-2(a)(2), Income Tax

Regs. The regulations also provide that economic benefits that

foreign Governments do not make available on substantially the

same terms to substantially all persons subject to the generally

imposed income tax (such as a concession to extract Governmentowned petroleum) will be regarded as specific economic benefits. 

See sec. 1.901-2(a)(2)(ii)(B), Income Tax Regs. 

Exxon acknowledges that the licenses it received from the

United Kingdom to exploit North Sea petroleum resources

constitute the receipt of specific economic benefits and

therefore that Exxon is to be treated under the regulations as a

“dual capacity” taxpayer and as subject to the regulations with

regard thereto under sections 1.901-2(a)(2) and 1.901-2A, Income

Tax Regs. Thereunder, dual capacity taxpayers (who pay levies

and who also receive specific economic benefits from the

Government) have the burden to establish the extent, if any, to

which foreign levies they pay constitute taxes -- as opposed to

payments for the specific economic benefits received -- either by

relying on the regulations’ safe harbor method or on the facts

and circumstances method. See sec. 1.901-2A(c)(1) and (2),

Income Tax Regs. Exxon herein relies on the facts and

circumstances method, and Exxon is required to establish, under

all of the relevant facts and circumstances associated with its
- 23 -

6 Sec. 1.901-2(a)(2)(i), Income Tax Regs., provides as

follows:

Notwithstanding any assertion of a foreign country to

the contrary, a foreign levy is not pursuant to a

foreign country's authority to levy taxes, and thus is

not a tax, to the extent a person subject to the levy

receives (or will receive), directly or indirectly, a

specific economic benefit (as defined in paragraph

(a)(2)(ii)(B) of this section) from the foreign country

in exchange for payment pursuant to the levy. Rather,

to that extent, such levy requires a compulsory payment

in exchange for such specific economic benefit. If,

applying U.S. principles, a foreign levy requires a

compulsory payment pursuant to the authority of a

foreign country to levy taxes and also requires a

compulsory payment in exchange for a specific economic

benefit, the levy is considered to have two distinct

elements: a tax and a requirement of compulsory

payment in exchange for such specific economic benefit. 

In such a situation, these two distinct elements of the

foreign levy (and the amount paid pursuant to each such

element) must be separated. No credit is allowable for

a payment pursuant to a foreign levy by a dual capacity

taxpayer (as defined in paragraph (a)(2)(ii)(A) of this

section) unless the person claiming such credit

establishes the amount that is paid pursuant to the

distinct element of the foreign levy that is a tax. 

* * * 

payment of PRT, what portion, if any, of PRT paid by it to the

United Kingdom constitutes taxes, as distinguished from payments

in exchange for the license rights it received.6 See sec. 1.901-

2A(b), (c), Income Tax Regs.

With regard to the second test involving the predominant

character of the foreign taxes, the regulations provide, among

other things, that foreign taxes will be treated as income taxes

in the U.S. sense if the foreign taxes operate in such a manner

as to reach net gain in the normal circumstances in which they
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7 Pertinent language of sec. 1.901-2(b)(4)(i), Income Tax

Regs., is as follows:

(4) Net Income–(i) In general. A foreign tax

satisfies the net income requirement if, judged on the

basis of its predominant character, the base of the tax

is computed by reducing gross receipts * * * to

permit–-

(A) Recovery of the significant costs and

expenses (including significant capital expenditures)

attributable, under reasonable principles, to such

gross receipts; or

(B) Recovery of such significant costs and

expenses computed under a method that is likely to

produce an amount that approximates, or is greater

than, recovery of such significant costs and expenses. 

* * *

A foreign tax law that does not permit recovery of one

or more significant costs or expenses, but that

(continued...)

apply. See sec. 1.901-2(a)(3)(i), Income Tax Regs. More

specifically, the regulations provide that foreign taxes will be

treated as income taxes if and only if the taxes, judged on the

basis of their predominant character, satisfy each of the

realization, gross receipts, and net income requirements of

section 1.901-2(b), Income Tax Regs. 

Generally, under section 1.901-2(b)(4)(i), Income Tax Regs., 

foreign taxes will be regarded as satisfying the net income

requirement if, measured by their predominant character, they

permit recovery of the significant costs and expenses relating to

the income or if they provide other allowances that effectively

compensate for nonrecovery of such costs and expenses.7
- 25 -

7(...continued)

provides allowances that effectively compensate for

nonrecovery of such significant costs or expenses, is

considered to permit recovery of such costs or

expenses. * * *

The regulations also provide that taxes either are or are

not to be regarded as income taxes in their entirety for all

persons subject to the taxes. See sec. 1.901-2(a), Income Tax

Regs. Respondent does not interpret this provision as requiring

that, in order to qualify as an income tax, a tax in question

must satisfy the predominant character test in its application to

all taxpayers. Rather, respondent interprets this provision as

requiring that in order to qualify as an income tax a tax must

satisfy the predominant character test in its application to a

substantial number of taxpayers.

On brief, respondent explains the net income test as

follows: PRT satisfies the net income test if its base is

computed by reducing gross receipts to permit recovery of

significant costs and expenses attributable to gross receipts,

or, if some of these costs and expenses are not deductible,

recovery of such costs and expenses computed under a method that

is likely to produce an amount approximating or exceeding the

nondeductible costs or expenses.

The parties have stipulated that PRT meets the realization

and gross receipts requirements of section 1.901-2(b)(2), (3),

Income Tax Regs., that PRT constitutes a compulsory payment
- 26 -

8 Of the total £3.2 billion in PRT that Exxon paid for 1983

through 1988 respondent would allow approximately £1.2 billion 

as creditable taxes for U.S. tax purposes under the United

States-United Kingdom Income Tax Treaty, Dec. 31, 1975, 31 U.S.T.

5668 (U.S./U.K. Tax Treaty). Respondent contends that the £2

million balance does not qualify under secs. 901 or 903 for

credit against Exxon’s Federal income tax liability. Neither

party herein makes any argument that what amount of PRT is or is

not creditable under the U.S./U.K. Tax Treaty is in any way

relevant to the issue addressed in this Opinion (namely, the

amount, if any, of PRT that is creditable under the provisions of

secs. 901 or 903). If the issue herein is resolved in favor of

respondent, the parties have reserved for subsequent resolution

the question as to the appropriate amount of PRT that would be

creditable under the U.S./U.K. Tax Treaty.

imposed by the United Kingdom within the meaning of section

1.901-2(a)(2)(i), Income Tax Regs., and that PRT does not

constitute a soak-up tax within the meaning of section 1.901-

2(c), Income Tax Regs. The only issues before us are whether PRT

paid by Exxon is to be treated as a tax (as opposed to payment

for specific economic benefits) and whether the predominant

character of PRT may be regarded as an income tax in the U.S.

sense and thereby as satisfying the net income test.8

PRT and Compensation for Specific Economic Benefits

The evidence in these cases establishes that PRT paid by

Exxon does not constitute compensation in exchange for license

rights or other specific economic benefits received by Exxon. 

Upon enactment of PRT and upon or in exchange for payment of PRT,

Exxon was granted no additional rights, under its licenses or

otherwise, with respect to North Sea petroleum resources. 
- 27 -

Exxon’s rights to explore for, develop, and exploit petroleum

resources in the North Sea during the years in issue arose from

and were dependent upon licenses Exxon obtained from the United

Kingdom in prior years (before PRT was enacted) and on Exxon’s

payment to the United Kingdom of license fees and royalties due

under those licenses.

The United Kingdom’s purpose in enacting PRT in 1975 was to

take advantage of rising oil prices and to ensure that the United

Kingdom realize an appropriate share of excess profits to be

realized by Exxon and by other oil and gas companies from

exploitation of petroleum resources in the North Sea under the

licences granted to them.

License fees owed and paid by Exxon under terms of the

discretionary licenses (consisting of the up-front fees, annual

fees, and 121⁄2-percent royalties) represented substantial and

reasonable compensation to the United Kingdom for the licenses. 

As indicated, through 1992 the oil and gas companies have paid to

the U.K. Government more than £16 billion in royalties alone in

connection with the North Sea licenses. 

Under its sovereign taxing power, the United Kingdom

intended to and did impose PRT as a tax, not as payment for

specific economic benefits. Respondent stipulates that PRT was

not negotiated but was imposed unilaterally, as a compulsory

payment, and that PRT was enacted and is administered as a tax
- 28 -

under U.K. law -- all characteristics of taxes, not of payments

for specific economic benefits. 

The parties herein rely heavily on expert witnesses -- from

the petroleum industry, from the U.K. Government, and from legal,

tax, accounting, and economic professions –- as to the character

of PRT as a tax or as payment for specific economic benefits. 

The basis of the opinions rendered by respondent’s economic

experts seems to be that, in hindsight, oil companies “got a good

deal” when they entered into North Sea license agreements, that

the licenses turned out to be more valuable than anyone

anticipated at the time the licenses were issued, and therefore

that the oil companies “probably felt there was an implicit

contract” to pay some type of additional charges, and that these

additional charges (whatever they may be called, however they are

administered, and regardless of their features) should be

regarded as what respondent’s expert witnesses refer to as

“economic rent” (i.e., as deferred payments in exchange for the

licenses granted in earlier years to the oil companies) and not

as taxes.

Respondent’s experts overemphasize the fact that North Sea

licenses issued by the United Kingdom to the oil and gas

companies in the late 1960's and in the 1970's were issued

largely without an auction system. As we have found, throughout

the world most countries traditionally have not relied on auction
- 29 -

systems to issue licenses for the right to exploit petroleum

resources. 

In considering North Sea licenses Exxon received and under

which it operated in the North Sea, respondent’s experts fail to

recognize and to give proper weight to the significant

uncertainties, risks, and investment commitments associated with

oil and gas exploration and production in the North Sea that, at

the time the licenses were issued to Exxon, were associated with

the licenses -- risks that insufficient oil and gas deposits in

the North Sea would be found, that petroleum resources that might

be discovered would not be commercially recoverable, and that the

large investments required to explore for oil and gas and to

operate in the North Sea would be lost.

Respondent’s experts speculate that in light of increased

oil prices in the late 1970's and early 1980's, the United

Kingdom could have set the license fees higher and obtained

higher revenues under the North Sea licenses. That, however, is

not the proper inquiry. We are not particularly concerned with

speculation, about whether in retrospect the United Kingdom

extracted all the revenues it could have from oil companies under

the licenses. Rather, as Exxon’s witnesses emphasize, the proper

focus is whether PRT was imposed and paid “in exchange for” North

Sea license rights. This is the focus of the regulations under

section 901 and that focus is to be maintained here. See
- 30 -

sec. 1.901-2(a)(2), Income Tax Regs; see also Phillips Petroleum

Co. v. Commissioner, 104 T.C. 256, 297 (1995).

In Phillips Petroleum Co., we held that Norway’s Special Tax

on oil and gas activity in the Norwegian sector of the North Sea

constituted, for U.S. Federal income tax purposes, a creditable

tax under section 901. Norway’s Special Tax is similar in a

number of significant respects to PRT. 

Under temporary Treasury regulations applicable to the years

involved in Phillips Petroleum Co., Norway’s Special Tax was to

be treated as a tax as long as “no significant part of the charge

[represents] compensation for the specific economic benefit

received”. See sec. 4.901-2(b)(2)(iii), Temporary Income Tax

Regs., 45 Fed. Reg. 75649 (Nov. 17, 1980), as applicable to 1979

to 1982. Applying that test, we held in Phillips Petroleum

Co. v. Commissioner, supra at 289-297, that Norway’s Special Tax

constituted a tax and not payment for specific economic benefits. 

The Norway Special Tax was enacted in 1975 and was imposed

on oil and gas companies operating under discretionary licenses

granted by Norway requiring payment of initial fees, annual fees,

and 10-percent royalties. We concluded that by payment of the

Special Tax the oil and gas companies were not granted additional

rights under their licenses, that the fees and royalties paid

under the licenses represented substantial compensation for such

licenses, that the Special Tax constituted a tax and not an
- 31 -

additional royalty, and that the purpose of the Special Tax was

to impose taxes on excess and unexpected profits, not to impose

additional charges on oil companies for rights to extract oil,

and therefore that the Special Tax constituted a tax, not a levy

in exchange for specific economic benefits. In Phillips

Petroleum Co. v. Commissioner, supra at 295, we explained:

The word “tax” in [the U.S.] * * * is generally

understood to mean an involuntary charge imposed by

legislative authority for public purposes. It is

exclusively of statutory origin. Tax burdens and

contractual liabilities are very different things. A

tax is compulsory, an exaction of sovereignty rather

than something derived by agreement. A tax is a

revenue-raising levy imposed by a governmental unit. 

It is a required contribution to the governmental

revenue without option to pay. A royalty refers to a

share of the product or profit reserved by an owner for

permitting another to use a property. [Citations

omitted.] 

In Phillips Petroleum Co., we then concluded that the

Norwegian Special Tax was enacted:

to take advantage of a new profit situation created by

surging oil prices, and to receive a larger share of what

Norway saw as extraordinarily high and unforeseen profits

generated from Norwegian resources, and at the same time to

allow petroleum companies to earn a reasonable profit. [Id.

at 292.] 

Phillips Petroleum Co. v. Commissioner, supra, supports our

finding and conclusion herein that PRT is not to be regarded as

payment in exchange for specific economic benefits Exxon received

under its North Sea licenses. 
- 32 -

All of the PRT the character of which is in dispute in these

cases was paid by Exxon with respect to oil production from

fields licensed to Exxon before 1975 and before PRT was enacted.

As one of respondent’s experts acknowledges, Exxon did not

receive any special benefits under its licenses, or otherwise,

for paying PRT, and Exxon in later years, as a result of paying

PRT, did not receive any special advantages in obtaining

additional North Sea licenses.

The credible and persuasive evidence strongly supports and

we conclude that all PRT paid by Exxon for the years in question

constitutes taxes, not payments for specific economic benefits.

PRT and the Net Income Test

The purpose, administration, and structure of PRT indicate

that PRT constitutes an income or excess profits tax in the U.S.

sense. The provisions of PRT include in the tax base, with

limited exceptions, income earned from North Sea-related activity

and permit allowances, reliefs, and exemptions that effectively

compensate for nondeductibility of certain oil company expenses,

particularly interest. 

Although a deduction is not allowed for interest expense

related to North Sea operations, uplift, oil, safeguard, and

tariff receipts allowances provide sufficient relief to offset

for nonallowance of a deduction for interest expense. See sec.

1.901-2(b)(4)(i), Income Tax Regs. For 1975 through 1988,
- 33 -

representative industry data indicate that oil companies received

uplift allowances alone of £12.4 billion as compared to North

Sea-related interest expense not allowed of £8.6 billion.

Evidence at trial covering approximately 88 percent of total

oil production in the North Sea and 98 percent of total PRT paid

by oil companies during 1975 through 1988 shows that special

allowances and reliefs under PRT significantly exceed the amount

of disallowed interest expense for Exxon and other oil companies. 

These special allowances and reliefs reduce the base of PRT to a

subset of net income representing excess profits and establish 

that, in its predominant character, PRT constitutes and is to be

treated as an income tax.

Although PRT does not allow a deduction for interest expense

-- certainly a significant expense -- under the special

provisions allowed (particularly uplift), the oil companies are

provided under PRT allowances that effectively compensate for the

nondeductibility of interest expense. 

As explained by the Government official who on April 10,

1975, first presented for formal legislative consideration the

proposed Ring Fence Tax and PRT to the U.K. House of Lords, “In

fact, of course, this tax [PRT] represents an excess profits

tax.”

Respondent’s experts assert that uplift provides too “crude”

a substitution for a deduction for interest expense, that PRT
- 34 -

fails to provide an allowance that “mimics” interest expense, and 

that the relationship of PRT allowances to nonrecoverable

expenses is not sufficiently “predictable”. We reject these

labels as merely argumentative and as without merit.

We note statements in respondent’s pretrial brief, in

respondent’s counsel’s opening statement, and in a number of

respondent’s experts’ reports or testimony that in essence

acknowledge the “income” or “profits” nature of PRT. One of

respondent’s experts testified contrary to prior published

statements he has made regarding PRT and its nature as an “excess

profits tax”. 

In Texasgulf, Inc. & Subs. v. Commissioner, 107 T.C. 51

(1996), affd. 172 F.3d 209 (2d Cir. 1999), we held that the

Ontario Mining Tax (OMT) satisfied the net income test of the

section 901 regulations and constituted a creditable income tax. 

Among other things, we relied on industry data showing that a

special processing allowance available to taxpayers in computing

OMT liability adequately compensated for significant nonallowed

costs, including interest. The evidence, among other things,

indicated that the processing allowance, in the aggregate for the

industry, exceeded the amount of significant nondeductible costs. 

See id. at 66.

On appeal, the Court of Appeals for the Second Circuit

focused on how OMT applied to the mining industry as a whole and
- 35 -

on return-by-return data (rather than on aggregate industry data

on which this Court in its opinion in Texasgulf, Inc. & Subs.,

had focused) and affirmed this Court’s opinion. Noting that only

33 percent of the income tax returns showed nonrecoverable

expenses in excess of the processing allowance and that, of the

income tax returns that reflected OMT liability, only 16 percent

showed nonrecoverable expenses that exceeded the processing

allowance, the Court of Appeals concluded that the taxpayer had

met its burden of proving that under OMT the taxpayer was

effectively compensated for nonrecoverable costs.

In its opinion in Texasgulf, Inc. & Subs. v. Commissioner,

172 F.3d at 216, the Court of Appeals for the Second Circuit

expressly noted that, where available, quantitative and empirical

evidence relating to taxpayer and to industry experience in

calculating and paying foreign taxes is appropriate and relevant

in analyzing the net income requirement. The Court of Appeals

explained as follows:

the language of sec. 1.901-2--specifically,

“effectively compensate” and “approximates, or is

greater than”--suggests that quantitative empirical

evidence may be just as appropriate as qualitative

analytic evidence in determining whether a foreign tax

meets the net income requirement. * * * [Id.]

In Texasgulf, Inc. & Subs. v. Commissioner, 107 T.C. at 64-65,

70, we used similar language to describe the type of evidence

that may be used in evaluating the nature of foreign taxes for
- 36 -

purposes of section 901. See also Texasgulf, Inc. v. United

States, ___ Fed. Cl. ___ (Oct. 15, 1999).

Credible expert witness testimony, industry data, and other

evidence in these cases establish that allowances available under

PRT effectively and adequately compensate Exxon for expenses

disallowed under PRT and that PRT, in its predominant character,

constitutes a tax in the nature of an excess profits tax (i.e.,

an income tax) in the U.S. sense. 

Respondent contends that Exxon’s industry data is biased in

favor of large oil and gas companies like Exxon and that a

company-by-company analysis indicates that a majority of the

companies operating in the North Sea for a majority of years did

not have uplift allowance greater than or equal to nonrecoverable

interest expense. As Exxon points out, however, respondent’s

approach ignores the fact that PRT was designed to tax excess

profits from North Sea oil and gas production which generally

were earned by major oil and gas companies which owned the

largest and most profitable fields in the North Sea. Through

1988, approximately 75 percent of PRT was paid by only five major 

companies. Small companies with licenses for marginal fields,

because of the special allowances, typically owe no PRT, and for

companies which owe no PRT it is irrelevant whether uplift is

adequate to offset nonallowed interest expense. Through 1988, 34

of the 79 oil companies included in the studies paid no PRT. 
- 37 -

We agree with Exxon that if a company-by-company approach is

used to analyze the effect of uplift and other allowances, some

particular focus should be given to those companies which earn

excess profits from North Sea oil production and which pay PRT. 

This is the type of empirical and particular industry data that

would seem particularly relevant. Of the 45 companies which 

through 1988 paid approximately 98 percent of total PRT paid to

the United Kingdom, 34 companies or 76 percent (and accounting

for 91 percent of total PRT paid through 1988) had uplift

allowance in excess of nonallowed interest expense. If the oil

allowance is factored into the data, 39 of 45 companies or 87

percent (and accounting for 94 percent of total PRT paid through

1988) had allowances in excess of nonallowed interest expense.

We conclude that PRT constitutes a tax, that the predominant

character of PRT constitutes an excess profits or income tax in

the U.S. sense, and that PRT paid by Exxon to the United Kingdom

for the years in issue is creditable under section 901 against

Exxon’s U.S. Federal income tax liability.

In light of our resolution of the above issues, we need not

address Exxon’s alternative argument that PRT qualifies under

section 903 as a creditable tax in lieu of an income tax.

To reflect the foregoing,

Decisions will be entered

under Rule 155.
- 38 -

APPENDIX

PRT Paid by Exxon and Comparison of Exxon’s

PRT Special Allowances to its Ring Fence

Interest Expense (1975-1988) (in U.K. Pounds)

Year

PRT Paid By

Exxon

Uplift

Allowance

Oil

Allowance

Tariff

Receipts

Allowance

Safeguard

Allowance

Safeguard 

Allowance 

Deduction 

Equivalent

Total

Allowances

Nonallowed

Ring Fence

Interest

Expense

1975 0 8,959,359 0 0 0 0 8,959,359 1,533,000

1976 0 105,625,116 0 0 0 0 105,625,116 8,628,000

1977 0 5,867,192 21,360,737 0 0 0 27,227,929 46,008,000

1978 16,078 58,511,216 23,173,022 0 0 0 81,684,238 56,960,000

1979 17,837 133,451,025 12,682,868 0 0 0 146,133,893 116,828,000

1980 20,510,300 449,294,439 33,021,404 0 0 0 482,315,843 164,140,000

1981 100,458,130 168,296,228 42,728,040 0 0 0 211,024,268 139,546,000

1982 119,239,356 544,618,089 50,992,174 1,105,951 0 0 596,716,214 107,783,000

1983 423,014,556 70,420,726 88,959,862 3,456,109 118,415,934 157,887,912 320,724,609 22,397,000

1984 965,101,175 144,402,403 136,924,700 13,149,141 252,148,968 336,198,624 630,674,868 7,246,000

1985 984,865,434 27,666,094 166,966,203 23,309,676 318,580,059 424,773,412 642,715,385 10,065,000

1986 194,654,714 16,913,408 67,417,623 32,668,303 414,997,698 553,330,264 670,329,598 67,244,000

1987 321,598,479 24,183,485 72,943,737 30,801,424 415,223,138 553,630,851 681,559,497 84,374,000

1988 371,670,157 22,900,846 58,943,277 31,344,050 115,289,728 153,719,637 266,907,810 98,351,000

Totals 3,501,146,216 1,781,109,626 776,113,647 135,834,654 1,634,655,525 2,179,540,700 4,872,598,627 931,103,000

PRT Paid by 34 Companies and Comparison of

Companies’ PRT Special Allowances to their Ring

Fence Interest Expense (1975-1988) (in U.K. Pounds)

Year

PRT Paid By

34 Companies

Uplift

Allowance

Oil

Allowance

Tariff

Receipts

Allowance

Safeguard

Allowance

Safeguard 

Allowance 

Deduction 

Equivalent

Total

Allowances

Nonallowed

Ring Fence

Interest

Expense

1975 0 549,645,555 13,959 0 0 0 549,659,514 66,542,527

1976 0 551,570,154 33,419 0 0 0 551,603,573 285,303,726

1977 0 371,995,678 97,374,963 0 0 0 469,370,641 441,409,166

1978 430,689,327 1,699,237,659 153,852,120 0 0 0 1,853,089,779 461,981,340

1979 1,156,589,715 551,928,097 105,214,447 0 0 0 657,142,544 704,165,739

1980 2,197,291,915 1,366,859,351 328,456,501 0 0 0 1,695,315,852 863,608,555

1981 2,396,943,312 1,435,689,699 519,913,143 0 18,948,155 27,068,793 1,982,671,635 841,824,111

1982 3,176,093,221 1,351,596,634 656,231,353 8,960,856 231,062,739 330,089,627 2,346,878,470 824,298,172

1983 5,572,524,246 1,490,033,648 851,539,832 33,884,463 644,892,193 859,856,257 3,235,314,200 767,424,949

1984 6,369,523,079 981,248,452 1,186,636,787 60,199,128 669,948,021 893,264,028 3,121,348,395 832,922,625

1985 5,760,629,333 1,054,005,842 1,337,372,027 135,511,998 733,604,214 978,138,952 3,505,028,819 708,244,278

1986 1,366,854,617 347,209,776 685,332,228 128,623,314 1,272,258,531 1,696,344,708 2,857,510,026 674,092,084

1987 1,912,894,346 324,720,056 763,354,267 135,830,479 1,349,555,544 1,799,407,392 3,023,312,194 540,583,476

1988 1,503,526,701 318,463,734 647,660,574 135,573,763 586,517,012 782,022,683 1,883,720,754 634,094,662

Totals 31,843,559,812 12,394,204,335 7,332,985,620 638,584,001 5,506,786,409 7,366,192,440 27,731,966,39 8,646,495,410