Corporation Challenges Disallowance of NOL Carryback in Tax Court

PDV HOLDING, INC.,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION

PDV Holding Inc. (“PDV”) hereby petitions for a redetermination of an income tax deficiency asserted by the Commissioner of Internal Revenue (“Commissioner”) in his Notice of Deficiency dated October 16, 2018, and alleges as follows:

PETITIONER

1. PDV maintains its principal office at 1293 Eldridge Parkway, Houston, TX 77077.

2. PDV is a corporation formed under the laws of Delaware, and was the common parent of an affiliated group of corporations that joined in filing a consolidated federal income tax return for the tax years ending December 31,2006 (“2006 Tax Year”) and December 31, 2009 (“2009 Tax Year”).

3. PDV timely filed its consolidated federal income tax returns for the 2006 and 2009 Tax Years with the Internal Revenue Service Center in Ogden, Utah.

4. PDV is a holding company for various entities that refine, transport, and market transportation fuels, lubricants, petrochemicals, and other industrial products.

5. At all relevant times, PDV was an overall accrual method taxpayer.

THE NOTICE OF DEFICIENCY

6. The Notice of Deficiency for the 2006 Tax Year is dated October 16, 2018, and was issued by the Internal Revenue Service (the “Service”) in Houston, Texas. A copy of the Notice of Deficiency is attached as Exhibit A.

7. The Notice of Deficiency determined an increase of income tax for the 2006 Tax Year in the amount of $11,633,828.

8. The Notice of Deficiency provides a brief explanation of the adjustment as:

It is determined that your allowable net operating loss carryback deduction is decreased by the amount of $33,239,508.00 from the amount reported on your corporate income tax return for the 2006 tax year since adjustments made to the loss year of 2009 have decreased the amount of the net operating loss available to be carried back.

Accordingly, your taxable income is increased in the amount of $33,239,508.00 for the 2006 tax year.

EXPLANATION OF THE SERVICE'S ADJUSTMENT

9. During audit, the Service determined that PDV's taxable income for the 2009 Tax Year should be increased by $33,239,508 because of a certain partnership item that flowed through to a wholly-owned subsidiary of PDV for the 2009 Tax Year. Specifically, the Commissioner determined that PDV was required to include additional income in the amount of $195,583,107 for the 2009 Tax Year representing PDV's partnership liabilities that were assumed when the interest of its wholly owned subsidiary in a partnership was purchased by an unrelated partner as of August 28, 2009.

10. Because PDV carried a Net Operating Loss (“NOL”) from the 2009 Tax Year back to the 2006 Tax Year, the Commissioner decreased PDV's NOL deduction for the 2006 Tax Year by $33,239,508, which created an income tax deficiency in the amount of $11,633,828 for the 2006 Tax Year.

11. PDV disputes the entire increase in taxable income for the 2009 Tax Year and the corresponding decrease in PDV's NOL deduction and income tax deficiency for the 2006 Tax Year.

12. PDV believes that the proper period to realize the increase in taxable income resulting from the assumption of its partnership liabilities upon the termination of the partnership when its partnership interest was purchased is the tax year ending December 31, 2017 (“2017 Tax Year”).

ASSIGNMENT OF ERROR

13. The Commissioner erroneously determined that PDV had discharge of indebtedness income in the amount of $195,583,107 attributable to the 2009 Tax Year. In its determination, the Commissioner failed to follow prevailing authority which requires PDV to realize $195,583,107 from the discharge of its partnership indebtedness in the 2017 Tax Year when “all events” had occurred to fix PDV's obligation to recognize that item of income

FACTUAL BASIS FOR ASSIGNMENT OF ERROR

14. In 2009, PDV owned a 50 percent interest in Merey Sweeny LP (“MSLP”) through its two wholly-owned subsidiaries, PDV Sweeny, Inc. (“PDV Sweeny”) and PDV Texas, Inc. (“PDV Texas”). ConocoPhillips Company, an unrelated third-party, owned the other 50 percent interest in MSLP through its wholly-owned subsidiary Sweeny Coker Investor Sub, Inc. (“Sweeny Sub”) (collectively with its subsidiaries referred to as “Conoco”). PDV Sweeny and Sweeny Sub were limited partners in MSLP, each owning 49.5 percent. The remaining one percent interest in MSLP was controlled by the general partner, Sweeny Coker, LLC (“Sweeny Coker”), which was owned in equal parts by PDV Texas and Sweeny Sub.

15. MSLP was established in 1999 to construct and operate oil refining facilities within a complex owned by Conoco in Texas.

16. MSLP and its operations were governed by a number of agreements, including, but not limited to the: Second Amended and Restated Limited Partnership Agreement; Amended and Restated Crude Oil Supply Agreement (the “COSA”); Amended and Restated Supplemental Crude Oil Supply Agreement; and, Amended and Restated Transfer Agreement (the “Transfer Agreement” and collectively, the “Agreements”).

17. The Transfer Agreement included provisions that required the “mandatory transfer” of a party's interest in MSLP to the other party in the event of a breach of the Agreements. Conoco's right to purchase PDV Sweeny's and PDV Texas's interests in MSLP was provided by a “Call Option” provision in the Transfer Agreement. The Call Option provided two formulas for calculating the purchase price of PDV Sweeny's and PDV Texas's interests in MSLP: (1) 40 percent of the fair market value of MSLP; or (2) 80 percent of the sum of the party's capital contributions to the joint venture (plus any outstanding obligations of the party), minus all capital distributions from MSLP to the party. Conoco could choose either formula to calculate the purchase price.

18. In January of 2009, an affiliate of PDV, and a party to the COSA, was unable to supply crude oil to Conoco as outlined in the Agreements because of restrictions placed on the distribution of oil by the Venezuelan government. As a result, and pursuant to provisions in the COSA, Conoco claimed that it was entitled to certain monetary damages for the months of January, March, April, June, July, and August of 2009.

19. PDV Sweeney and PDV Texas did not pay the damages asserted by Conoco.

20. On August 28, 2009, Conoco informed PDV Sweeny and PDV Texas that: (1) failing to pay damages under the Agreements constituted a breach of the Agreements; and (2) Conoco was exercising the Call Option to purchase the interests of PDV Sweeny and PDV Texas in MSLP.

21. Pursuant to the Call Option, Conoco elected to calculate the purchase price of PDV Sweeny's and PDV Texas's interest in MSLP based upon 80 percent of PDV Sweeny's and PDV Texas's capital contributions to MSLP minus all capital distributions from MSLP. Because PDV Sweeny and PDV Texas had received dividends in excess of their capital contributions, Conoco did not have to make any payment to PDV Sweeny or PDV Texas. As a result of the exercise of the Call Option, however, Conoco assumed PDV Sweeny's share of MSLP's outstanding debt obligations.

22. PDV Sweeny and PDV Texas disagreed that they had breached the Agreements and that Conoco had the right to exercise the Call Option.

23. To contest Conoco's exercise of the Call Option and pursuant to the terms of the Agreements, on February 25, 2010, PDV Sweeny and PDV Texas filed a request for arbitration with the International Court of the International Chamber of Commerce (the “ICC”) against Conoco and Sweeny Sub alleging that the breach of the Agreements was excused under the force majeure clauses in the Agreements and Conoco's exercise of the Call Option was invalid. Additionally, PDV Sweeny and PDV Texas challenged the validity of the Call Option under New York State law.

24. On April 14, 2014, the ICC arbitration tribunal (the “ICC Panel”) issued a “Partial Award” concluding that the Call Option was valid and enforceable, and that Conoco had validly exercised the Call Option to acquire the interests of PDV Sweeny and PDV Texas in MSLP as of August 28, 2009. On August 25, 2014, the ICC Panel delivered its “Final Award” setting forth calculations of interest and certain other damage amounts.

25. PDV Sweeny and PDV Texas disagreed with the ICC Panel's determination. Pursuant to the Federal Arbitration Act, 9 U.S.C. §§ 1-12 and 301-307, on July 11, 2014, PDV Sweeny and PDV Texas filed a petition in the United States District Court for the Southern District of New York (“Southern District Court”) against Conoco and Sweeny Sub, seeking to vacate the portions of the Partial Award that determined that the Call Option was valid, that Conoco had properly exercised the Call Option, and had validly acquired the interests of PDV Sweeny and PDV Texas in MSLP as of August 28, 2009.

26. On September 1, 2015, the Southern District Court issued its decision denying the petition and confirming the ICC Panel's Partial Award in Conoco's and Sweeny Sub's favor. See PDV Sweeny, Inc. v. ConocoPhillips Co., 2015 WL 5144023 (S.D.N.Y. Sept. 1, 2015). On December 21, 2015, the Southern District Court's judgement was amended to reflect the affirmance of both the Partial Award and Final Award, and to reflect the monetary sums awarded to Conoco. See PDV Sweeny, Inc. v. ConocoPhillips Co., 2015 WL 9413880 (S.D.N.Y. Dec. 21, 2015).

27. PDV Sweeny and PDV Texas disagreed with the Southern District Court's decision to affirm the determination of the ICC Panel. On January 15, 2016, PDV Sweeny and PDV Texas timely filed a Notice of Appeal to the United States Court of Appeals for the Second Circuit seeking to reverse the Southern District Court's decision.

28. On November 7, 2016, the Second Circuit affirmed the Southern District Court's decision to confirm the decisions and awards of the ICC Panel. See PDV Sweeny, Inc, v. ConocoPhillips Co., 670 Fed. Appx. 23 (2d Cir. 2016). The 90 day period to file a writ of certiorari with the United States Supreme Court to review the Second Circuit's decision expired on February 6, 2017. PDV Sweeny and PDV Texas ultimately decided not to seek review by the Supreme Court of the Second Circuit's decision.

29. Sweeny Coker, as the Tax Matters Partner of MSLP, timely filed a short-year final return, Form 1065, Partnership Return, for MSLP for January 1, 2009 through August 28, 2009, taking the position that the partnership terminated as of August 28, 2009, pursuant to Internal Revenue Code (the “Code”) section 708(b).

30. On November 15, 2016, after examining the short-year return of MSLP, the Service issued a Final Partnership Administrative Adjustment (“FPAA”) determining that MSLP had not terminated as of August 28, 2009. In the alternative, the FPAA determined that if MSLP had terminated as of August 28, 2009, PDV Sweeny was required to include $195,583,107 in income because Sweeny Sub assumed its share of MSLP's liabilities.

31. On January 17, 2017, Sweeny Coker, as Tax Matters Partner for MSLP, filed a petition in the U.S. Tax Court challenging the Service's adjustments in the FPAA, including the Service's determination that MSLP had not terminated as of August 28, 2009. See Merey Sweeny LP v. Comm'r, No. 1261-17.

32. On August 21, 2017, the U.S. Tax Court ruled that as of August 28, 2009: (1) PDV Sweeny transferred its interests in MSLP to Sweeny Sub; (2) Sweeny Sub had assumed PDV Sweeny's share of MSLP's liabilities; and (3) the amount realized by PDV Sweeny from the sale or exchange of its interest in MSLP on August 28, 2009, included the $195,583,107 of partnership liabilities assumed by Sweeny Sub when MSLP terminated. See Merey Sweeny LP v. Comm'r, No. 1261-17 at *4. A true and correct copy of the decision is attached hereto as Exhibit B.

33. At all times prior to the U.S. Tax Court's decision, PDV Sweeny and PDV Texas had maintained that MSLP did not terminate when Conoco exercised the Call Option. For tax years starting in 2009 and pursuant to Code section 6222(b), PDV filed with its original federal income tax returns, Form 8082, Notice of Inconsistent Treatment of Administrative Adjustment Request. On the forms, PDV asserted that it disagreed with the position adopted by the Tax Matters Partner of MSLP that MSLP had terminated as of August 28, 2009.

34. On its original federal income tax return for its tax year ending December 31, 2016 (“2016 Tax Year”), PDV mistakenly realized additional income attributable to the discharge of the indebtedness in the amount of $196,583,107.

35. PDV reported taxable income in the amount of $35,618,477 resulting from realizing $196,583,107 of discharge of indebtedness income on its original tax return for the 2016 Tax Year after the Second Circuit affirmed the ICC Panel's awards. This reporting, however, was before Sweeny Coker, as the Tax Matters Partner, filed the petition in Tax Court challenging the Service's determination that MSLP had not terminated as of August 28, 2009.

36. The Service's determination that PDV is required to realize $195,583,107 of discharge of indebtedness income in 2009, which was reflected as a decrease in the NOL carryback in the amount of $33,239,508 to the 2006 Tax Year, is erroneous.

37. PDV was not required to realize discharge of indebtedness income until there was a final determination that Sweeny Sub had validly exercised the Call Option and purchased PDV Sweeny's and PDV Texas's interests in MSLP, and that MSLP had terminated. That final determination did not occur until 2017 when the U.S. Tax Court ruled that MSLP terminated when Sweeny Sub purchased PDV's interest in MSLP and the 90 day period to file a writ of certiorari with the U.S. Supreme Court to review the Second Circuit's decision expired.

38. PDV should realize additional income for the 2017 Tax Year in the amount of $195,583,107 relating to the discharge of its indebtedness.

39. PDV has not had the opportunity to have the Service's Appeals Division review the adjustments in the Notice of Deficiency.

REQUEST FOR RELIEF

WHEREFORE, Petitioner, PDV, respectfully requests that the Court:

Respectfully submitted,

Kevin Spencer
Tax Court Bar No. ST0461
Counsel for Petitioner
McDermott Will & Emery LLP
500 North Capitol Street, N.W.
Washington, DC 20001-1531
(202) 756-8203
kspencer@mwe.com

Kathryn Vouri
Tax Court Bar No. VK0038
Date: November 16, 2018
Counsel for Petitioner
McDermott Will & Emery LLP
500 North Capitol Street, NW.
Washington, DC 20001-1531
(202) 756-8817
kcvmisso@mwe.com

Date: November 16, 2018