Opinion ID: 548352
Heading Depth: 1
Heading Rank: 2

Heading: kuwait nationalization

Text: 27 The issues presented in these cross-appeals arise from events occurring during the 1975 nationalization of the Kuwaiti Government's oil resources. Specifically, Gulf challenges the Commissioner's finding and the Tax Court's decision that the value of a price discount given to Gulf by Kuwait in a five-year crude oil supply agreement is properly categorized as ordinary income rather than as additional compensation for the Kuwait Concession nationalization, which would qualify the transaction for preferred capital gains tax treatment under I.R.C. Sec. 1231. The Commissioner appeals the Tax Court's determinations that the present value of this price discount is properly accrued and reported in tax year 1975 under I.R.C. Sec. 451 rather than reported in each of the five years of the agreement, and that the Kuwaiti income taxes on this price discount are properly accrued and deducted in tax year 1975. 28 We will affirm that part of the Tax Court's decision holding that the price discount is not compensation for the Kuwait Concession nationalization since this finding of fact is not clearly erroneous. Therefore, the Kuwaiti income taxes related to the price discount constitute a deduction under I.R.C. Sec. 164 rather than a foreign tax credit under I.R.C. Sec. 901. We will reverse the Tax Court's decision that the present value of the price discount is properly accrued and reported in tax year 1975 because the record demonstrates that all of the events fixing the right to receive the income had not occurred. Consequently, the income taxes related to the price discount cannot be accrued and deducted in tax year 1975.
29 We begin with the facts, not generally in dispute, as set forth by the Tax Court in its opinion, Gulf Oil Corp. v. Comm'r, 86 T.C. 937 (1986). The Middle Eastern country of Kuwait first granted operational rights to Gulf Oil Corporation in 1934. In 1951, however, Gulf's interest was redefined in a document known as the 1951 Concession Agreement. 11 In this agreement, Gulf was granted rights to one-half of the Kuwait Concession while BP Kuwait Ltd., a subsidiary of the British Petroleum Co. Ltd., obtained rights to the other half. Gulf's stake in the Kuwait Concession was one of its most valuable holdings in the Middle East oil area from the time of the grant until completion of the 1975 nationalization. During this time, Gulf established its customer base and built production facilities dependent on Kuwaiti crude oil. 30 In 1972, oil prices increased dramatically as a result of disruptions in the flow of Middle East oil. 12 During this unstable period, oil producing governments began nationalizing in order to exert pressure to increase their participation in the oil concessions. OPEC's stated policy concerning compensation, by which all members were to comply, was that members should pay the oil companies only the book value for physical assets. Nothing should be paid for the value of the minerals in place since oil in place was deemed to be owned by each member's government. 31 Through the 1973 General Agreement, 13 an imposed non-negotiated agreement, Kuwait acquired 25 percent interest in the Kuwait Concession and related assets in Kuwait with the option to obtain up to 50 percent of the Kuwait Concession and related assets by 1982. 14 However, through the 1974 Concession Agreement, 15 Kuwait increased its Concession ownership to 60 percent by formation of Kuwait Oil Co., a Kuwaiti corporation, owned 60 percent by Kuwait, 20 percent by BP Kuwait and 20 percent by Gulf Kuwait. The agreement also stated that the affiliation between Kuwait, Gulf Kuwait and BP Kuwait should be reevaluated prior to 1979. As consideration for each of the 1973 and 1974 agreements, Kuwait complied with OPEC policy, paying only the book value of the appropriate proportionate share of the physical assets related to the Concession. 32 On March 5, 1975, the Kuwaiti Minister of Oil 16 announced Kuwait's intent to nationalize the remaining 40 percent of the Concession. 17 In response, Gulf began to negotiate with the Kuwaiti Government to obtain as good an overall package as possible for relinquishing its entire interest in the Kuwait Concession. At a March 29, 1975 meeting, the Kuwaiti Prime Minister assured Gulf that the government did not intend to force the oil companies out of Kuwait, stating that Kuwait needed the oil companies and respected their past contributions to the country. Gulf attributed great significance to the Prime Minister's words since they indicated that a negotiated settlement between the Kuwaiti Government and the [oil] companies was possible. Gulf Oil Corp., 86 T.C. at 943. After the initial meetings in late March, Gulf and BP continued to negotiate with the Kuwaiti Government, attempting to conclude a settlement acceptable to all parties. Kuwait's initial and final position was that the only compensation to be paid to Gulf and BP for the nationalization was $25,250,000 each, representing the net book value of the physical assets, in accord with the OPEC formula. Gulf countered that it had to be reimbursed on the basis of an overall package furnishing not only cash payment for its physical holdings, but also a sufficient economic benefit representing the loss of expected profits from its Kuwait Concession interest. Gulf was reluctant to surrender its rights in the Kuwait Concession for payment based exclusively on the OPEC formula. 33 Nonetheless, the final 1975 Nationalization Agreement specified that Gulf Kuwait and BP Kuwait would each be paid $25,250,000. The parties executed the agreement on December 1, 1975; the agreement was ratified by the Kuwaiti National Assembly on March 18, 1976. Additional agreements not subject to ratification (including the Crude Oil Supply Agreement at issue in this case) were effected contemporaneously with the Nationalization Agreement on December 1, 1975. None of the executed documents included any manifestation that Kuwait intended the additional commercial arrangements to be compensation for the Kuwait Concession nationalization. 18 34 The primary additional agreement was the Crude Oil Supply Agreement, 19 which covered six items. The first and most detailed item covered Gulf's agreement to purchase 650,000 barrels per day of Kuwaiti crude oil from April 1 through December 31, 1975, and 500,000 barrels per day from January 1, 1976 through March 31, 1980. 20 86 T.C. at 945. The price per barrel was the price initiated by the Kuwaiti Government for sale to usual purchasers, less a sum which after the deduction of Kuwaiti Income Tax payable with respect thereto shall be 15 U.S. cents per barrel. Id. Gulf was required to market the acquired oil in Kuwait at the pre-discounted price. The Crude Oil Supply Agreement contemplated that a binding contract with more definite terms would be executed shortly, indicating that the foregoing terms would be treated as a binding contract until the formal contract was executed. Id. 35 The Kuwaiti government alluded to all the agreements--other than the Nationalization Agreement--as commercial arrangements and not as recompense for the nationalization of the Kuwait Concession. Kuwait's unfailing public and private posture was that the discount had been given to Gulf because Gulf was such a large buyer of Kuwaiti crude oil. Although no other major buyer of Kuwaiti oil, other than BP, acquired a discount during 1974 and 1975, Royal Dutch Shell was benefitting from favorable credit terms. Gulf objected to the advantageous terms offered to Shell since it deflated the discount Gulf received. After the Nationalization Agreement was executed, Gulf was advised that Shell's contract was altered to eliminate the favorable credit terms. 36 As an accrual method taxpayer using the calendar year as its tax year, Gulf is required to report recognized accrued gains and losses each calendar year. 21 Thus, on its 1975 consolidated federal corporate income tax return, Gulf reported a total I.R.C. Sec. 1231 capital gain of $276,517,903 related to the Kuwait Concession nationalization, and a foreign tax credit of $315,674,245 for Kuwaiti foreign income taxes paid or accrued. 37 Of the reported capital gain amount, $1,117,956 represented the difference between Kuwait's stated cash payment to Gulf for physical assets in Kuwait as nationalization proceeds ($25,250,000), and Gulf's adjusted basis in those assets for tax purposes ($24,132,044). 22 The $275,399,947 balance represented the present value of the discount Gulf was to receive over the five-year term of the Crude Oil Supply Agreement, which Gulf asserts was also part of the nationalization proceeds. The Commissioner disagreed that the nationalization proceeds included the crude oil discount. Thus, the Commissioner fully disallowed the reported I.R.C. Sec. 1231 capital gain, allowed a loss under I.R.C. Sec. 1231 of $133,638, and determined that Gulf realized ordinary income of $952,469 23 under the nationalization agreement. Before the Tax Court, the Commissioner also asserted alternatively that, if the discount were part of the nationalization proceeds, a discount on future purchases had no discernable fair market value in 1975. Thus, no gain could be accrued and reported in 1975. Although the Tax Court held that the present value of the discount was properly accrued and reported in 1975 since the amount could be ascertained with reasonable accuracy in 1975, the court determined that the value of the discount was not part of the nationalization proceeds; therefore, the accrued amount must be recognized as ordinary income and not as Sec. 1231 capital gain. 38 Of the reported foreign tax credit amount, $151,469,970 related to tax accrued on the crude oil discount included as nationalization proceeds. 24 The Commissioner disallowed this credit because (except for taxes accrued before the March 5, 1975 nationalization date and limited by I.R.C. Sec. 907) it did not represent a creditable tax under I.R.C. Sec. 901. Thus, the Commissioner allowed a foreign tax credit of $94,763,164 25 for Kuwaiti income tax accrued or paid before March 5, 1975. For the period March 5 through December 31, 1975, the Commissioner determined that the accrued Kuwaiti foreign income tax was not an allowable foreign tax credit, 26 but allowed a $36,209,447 deduction (rather than a credit). For the period beyond December 31, 1975, the Commissioner disallowed any credit or deduction for tax allegedly accrued. Although the Tax Court agreed that the income tax related to the discount was a deduction and not a foreign tax credit, the court held that the tax was a properly accrued and reported deduction in 1975 since the amount could be calculated with reasonable accuracy by mere mathematical extrapolations from the present value of the discount. 39 We turn first to the threshold issue of whether or not the Crude Oil Supply Agreement's price discount is compensation for the Kuwait Concession nationalization, a question of fact from which Gulf's tax implications are twofold. If the discount is not considered as nationalization compensation, Gulf will not receive the benefit of preferred capital gains tax treatment on the income from the discount. Second, Gulf will not receive the benefit of a foreign tax credit for the Kuwaiti income taxes due related to the Crude Oil Supply Agreement; rather, those income taxes will have to be reported on its tax return as a deduction. We will then address the final issue of whether the Tax Court correctly permitted Gulf to accrue in 1975 the five-year taxes, a matter invoking our plenary review since it involves construction of the Internal Revenue Code. 40
41 Gulf argues that the Tax Court's holding that the discount did not constitute nationalization compensation is clearly erroneous because the overwhelming evidence presented ... clearly establishes that ... the Crude Oil Supply Agreement [discount] constituted the major part of the consideration [Gulf received] for the 1975 nationalization of its remaining 20 percent interest in the Kuwait Concession. Gulf urges us to review the totality of the circumstances rather than the Kuwait Government's public declarations, chiefly, that Gulf and Kuwait engaged in lengthy negotiations throughout most of 1975, attempting to conclude a mutually satisfactory settlement for the nationalization. 27 Gulf and BP rejected two Kuwaiti counterproposals as economically inadequate before finally accepting the official one. Gulf asserts that at all times during negotiations, it considered the discount as nationalization compensation; in fact, both parties treated the discount as compensation during the nationalization negotiations. Indeed, the Kuwait Minister of Oil advised that Gulf and BP deserved some special consideration for past contributions to Kuwait, and that some discount should be given to them to repay them for their contributions. 42 Gulf urges us to consider that the nationalization documents are contemporaneous and interrelated 28 in such a way that the owners of the Kuwait Concession received a discount on crude oil while others did not. Gulf Kuwait and BP Kuwait, as owners of the Kuwait Concession, were the only large purchasers who obtained the right to purchase crude oil at a discount. Kuwait unilaterally terminated Royal Dutch Shell's favorable credit terms in direct response to Gulf's objection that any such benefit would reduce the value of Gulf's crude oil discount as compensation. Kuwait wanted to justify publicly the discount given to Gulf. The discount was not a mere commercial arrangement given to Gulf in exchange for a package of separate items, since these items involved future commercial arrangements to be negotiated at arm's length. 43 While the evidence presented could be viewed as supporting Gulf's argument that the discount constituted nationalization compensation, we cannot reverse the Tax Court on this issue unless the Tax Court determination was clearly erroneous, since the intent of the parties is a question of fact which must be determined by the factfinder. To interpret contracts with some consistency and to provide contracting parties with a legal framework with a measure of predictability, courts must bind parties by the objective manifestations of their intent rather than by ascertaining subjective intent. Mellon Bank, N.A. v. Aetna Business Credit, Inc., 619 F.2d 1001, 1009 (3d Cir.1980). Moreover, we have said: The subjective meaning attached by either party to a form of words is not controlling on the scope of the agreement between the parties unless one party knows or has reason to know of a particular meaning attached by the party manifesting assent. Brokers Title Co. v. St. Paul F. & M. Ins. Co., 610 F.2d 1174, 1184 (3d Cir.1979), citing Restatement (Second) Contracts Sec. 226, Comment b. 44 Although the Tax Court agreed that Gulf intended to negotiate for as good an overall package with Kuwait as possible in connection with the Kuwait Concession relinquishment, the court found that Kuwait did not intend at any time to pay any more as nationalization compensation than the amount set under the OPEC formula. Although the two agreements were signed on the same date, the Tax Court concluded that the documents served separate purposes: the Nationalization Agreement nationalized the Kuwait Concession; the Crude Oil Supply Agreement set forth guidelines for future commercial arrangements. The Tax Court was not convinced that the two documents were sufficiently interrelated to warrant a conclusion that the discount was additional nationalization compensation. The court found that the objective facts were far more consistent with the official Kuwaiti position than with the characterization urged by Gulf. In arriving at its decision, the court stated that Gulf's position was supported by no more than the statements of Gulf's employees as to the goals that it wished to achieve in the negotiations. 45 After our review, we are not left with the definite and firm conviction that the Tax Court erred. Therefore, we cannot hold that the Tax Court's findings are clearly erroneous. We will affirm the Tax Court's decision that the discount from the Crude Oil Supply Agreement was not compensation for the 1975 nationalization of the Kuwait Concession.
46 Section 901(a) of the Internal Revenue Code provides a credit for income taxes paid, or accrued during the taxable year, to any foreign country or United States possession. I.R.C. Sec. 901(b)(1). Income taxes paid or accrued during the taxable year to any foreign country in connection with the purchase and sale of oil and gas extracted in that country, however, are not considered taxes for purposes of I.R.C. Sec. 901 if (1) the taxpayer has no economic interest in the oil or gas to which I.R.C. Sec. 611(a) applies and (2) the purchase or sale is at a price which differs from the fair market value for the oil or gas at the time of purchase or sale. I.R.C. Sec. 901(f). Since we affirmed the Tax Court's decision that the crude oil supply discount was not additional nationalization compensation, it follows that the Kuwaiti income taxes are subject to the Sec. 901(f) test. 47 Gulf conceded before the Tax Court that it did not have an economic interest in the minerals in place in Kuwait after March 5, 1975 (the nationalization effective date). Furthermore, Gulf presented no evidence that the pre-discount price set by contract as the purchase and sales price for the oil was equal to fair market value. Since the I.R.C. Sec. 901(f) requirements are met, the Kuwaiti income taxes do not qualify as a foreign tax credit under I.R.C. Sec. 901; rather, these taxes qualify as a deduction under I.R.C. Sec. 164, which allows deductions for foreign taxes paid or accrued. The Tax Court did not commit an error of law in applying Sec. 901 and, therefore, we will affirm the Tax Court in this regard; however, we disagree that the taxes can be accrued in tax year 1975.
48 With respect to the amount of the deduction to be taken in tax year 1975, the Tax Court concluded that the present value of the income from the five-year discount was properly accrued (but, as ordinary income) in 1975 because, under the terms of the Crude Oil Supply Agreement, Gulf was to purchase a specific amount (750,000 barrels per day for five years) at a constant discount ($0.15 per barrel). Therefore, computing the present value of the discount required no more than applying the contractual terms to the extrapolation from figures available in 1975. Moreover, the court found that accrual was proper in tax year 1975 because, by its terms and as manifested by the parties' actions, the 1975 Crude Oil Supply Agreement was a binding contract, not subject to ratification by Kuwaiti officials, until the actual Crude Oil Supply Contract was executed in 1976. The court also concluded that the Kuwaiti income taxes related to the discount were properly accrued since they, too, could be calculated with reasonable accuracy in 1975. Neither party disputes the fact that accrual, in 1975, of the Kuwaiti income taxes payable on the Crude Oil Supply Agreement discount depends entirely on whether or not the corresponding income from that discount can be accrued and reported in 1975. 49 We disagree with the Tax Court's holding that the value of the discount and the corresponding Kuwaiti taxes can be accrued in tax year 1975. For an accrual method taxpayer, income is includible in gross income when (1) all the events have occurred so that the right to receive the income is fixed; and (2) the amount of the income can be determined with reasonable accuracy. Treas.Reg. Sec. 1.451-1(a). Income is accruable in the year the taxpayer's right to receive that income becomes fixed and definite, even though it may not actually be received until a later year. Comm'r v. Blaine, Mackay, Lee Co., 141 F.2d 201, 203 (3d Cir.1944); see also Freihofer Baking Co. v. Comm'r, 151 F.2d 383, 385 (3d Cir.1945), Comm'r v. Security Flour Mills Co., 135 F.2d 165, 167 (10th Cir.1943), affirmed, 321 U.S. 281, 64 S.Ct. 596, 88 L.Ed. 725 (1944). An expense is deductible for the tax year in which (1) all the events have occurred which determine the fact of the liability; and (2) the amount thereof can be determined with reasonable accuracy. Treas.Reg. Sec. 1.461-1(a)(2). An expense is accruable in the year the liability becomes fixed and certain, even though it may not be paid until a later year. Blaine, Mackay, Lee Co., 141 F.2d at 203; see also Freihofer Baking Co. v. Comm'r, 151 F.2d 383, 385 (3d Cir.1943), Comm'r v. Security Flour Mills Co., 135 F.2d 165, 167 (10th Cir.1943). To satisfy the all-events test, a liability must be 'final and definite in amount,' Security Flour Mills Co. v. Comm'r, 321 U.S. 281, 287 [64 S.Ct. 596, 599, 88 L.Ed. 725] (1944), must be 'fixed and absolute,' Brown v. Helvering, 291 U.S. 193, 201 [54 S.Ct. 356, 360, 78 L.Ed. 725] (1934), and must be 'unconditional,' Lucas v. North Texas Lumber Co., 281 U.S. 11, 13 [50 S.Ct. 184, 185, 74 L.Ed. 668] (1930). United States v. Hughes Properties, Inc., 476 U.S. 593, 600, 106 S.Ct. 2092, 2096, 90 L.Ed.2d 569 (1986). 50 Since we have determined that the Tax Court did not err in ascertaining that the value of the crude oil discount did not constitute nationalization compensation, we must view the Crude Oil Supply Agreement as any other executory contract. Unconditional liability under an executory contract is not created until at least one party performs. See North Texas Lumber Co., 281 U.S. at 13, 50 S.Ct. at 184. Gulf's unconditional liability to pay for the crude oil under the contract does not arise until Kuwait performs by passing title to the crude oil. It is not until Gulf is unconditionally liable to pay for the crude that its right to the income from the discount becomes fixed. During oral argument, Gulf's counsel correctly conceded that, if this discount was not found to be nationalization compensation, the income from the discount is not properly accruable in 1975. In view of the above, we find that the Tax Court erred in holding that both the income from the discount and the corresponding Kuwaiti income taxes payable were properly accrued in 1975.
51 We will affirm the Tax Court's decisions that the price discount is not additional compensation for Kuwait's nationalization of its crude oil resources and that the corresponding Kuwaiti income taxes payable do not constitute a foreign tax credit. We will reverse the Tax Court's holding that both the income from the discount and the corresponding Kuwaiti income taxes payable were properly accrued in 1975.