Corporation Petitions Tax Court, Argues Settlement Was Deductible

ANADARKO PETROLEUM CORPORATION,
Petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

UNITED STATES TAX COURT

PETITION

Anadarko Petroleum Corporation ("Petitioner") hereby petitions for redetermination of the proposed deficiencies in income tax set forth by the Commissioner of Internal Revenue (the "Commissioner") in a Notice of Deficiency dated September 19, 2018 (the "Notice") for the taxable years ended December 31, 2004, December 31, 2005, and December 31, 2006 ("2004", "2005", and "2006", respectively). As a basis for this proceeding. Petitioner alleges as follows:

1. Petitioner. Petitioner is a corporation organized under the laws of Delaware with its principal office located at 1201 Lake Robbins Drive, The Woodlands, Texas 77380. Petitioner's principal place of business at the time of the filing of this petition is The Woodlands, Texas.

2. Notice of Deficiency. A copy of the Notice, including the material statements and schedules accompanying the Notice, is attached hereto and marked as "Exhibit A." The Notice was issued by the Commissioner's Internal Revenue Service Small Business and Self-Employed Division office located in Houston, Texas.

3. Amounts in Dispute. The Commissioner rejected Petitioner's Form 1139 claim filed on March 15, 2016 (the "Form 1139"), and thus determined the following deficiencies in income tax, all of which is in dispute: (1) $20,732,410 for 2004, (2) $360,384,223 for 2005, and (3) $477,003,978 for 2006. Petitioner is entitled to retain the payments in those amounts made to Petitioner pursuant to Petitioner's Form 1139. In addition to the foregoing. Petitioner is entitled to a refund of overpaid federal income taxes for 2004, 2005, and 2006 in the respective amounts of $636,600, $212,201, and $18,799. The amounts by which Petitioner overpaid its federal income tax differ from the deficiencies determined by the Commissioner in the Notice as a result of the resolution of items for other tax years and Petitioner's filing of its superseding Form 1120 (the "Superseding Form 1120") for its taxable year ending December 31, 2015 ("2015").

4. Assignments of Error. The Notice is based on the following errors:

(a) Erroneous Determinations. The Notice is based on the Commissioner's erroneous determinations set forth below.

(i) The Commissioner erred in determining that the payment of $5.15 billion by Petitioner's consolidated subsidiary Kerr-McGee Worldwide Corporation ("Kerr-McGee Worldwide") during 2015 (the "Settlement Payment") was not deductible and therefore did not result in a net operating loss ("NOL") in such taxable year. See the Notice (Explanation of Items).

(ii) The Commissioner erred in determining that the payment of $5 million in cash and the assignment of a $20 million fee mineral interest by Anadarko E&P Company LP ("AE&P") during 2015 to settle litigation with Northwood Energy Corporation ("Northwood") was a capital expenditure and not an ordinary and necessary expense deductible under I.R.C. § 162(a).

(b) Erroneous Correlative Impacts. In addition to the Commissioner's erroneous deficiency determinations described in paragraph 3 above, as a result of the Commissioner's erroneous determinations described in paragraph 4(a) above, the Commissioner erred in determining the following correlative computational adjustments in the Notice:

(i) Based on its determination that Petitioner had no NOL in 2015, the Commissioner erred in determining that there is no NOL carryback from 2015 under I.R.C. §§ 172(b)(1)(C) and 172(f)(1)(iv) (the "NOL Carryback") as a result of the Settlement Payment.

(ii) The Commissioner erred in rejecting Petitioner's Form 1139, and thus erred in making the following determinations:

(A) The Commissioner erred in denying Petitioner's claim that the NOL Carryback triggered a $61,818,321 reduction in the utilization of Petitioner's allowable Foreign Tax Credit for 2006. As a result of Petitioner's filing of the Superseding Form 1120, Petitioner's claim is that the NOL Carryback triggered a $99,835,634 reduction in the utilization of its allowable Foreign Tax Credit for 2006.

(B) The Commissioner erred in denying Petitioner's claim that the NOL Carryback triggered a $26,195,078 reduction in the utilization of Petitioner's allowable Alternative Minimum Tax credits for 2006. As a result of Petitioner's filing of the Superseding Form 1120, Petitioner's claim is that the NOL Carryback triggered a $26,177,148 reduction in the utilization of its allowable Alternative Minimum Tax credits for 2006.

(C) The Commissioner erred in denying Petitioner's claim that the NOL Carryback triggered a $1,602,812 reduction in Petitioner's I.R.C. § 199 Domestic Production Activities Deduction for 2005. As a result of the resolution of items for other tax years and Petitioner's filing of the Superseding Form 1120, Petitioner's claim is that the NOL Carryback triggered a $1,677,817 reduction in its I.R.C. § 199 Domestic Production Activities Deduction for 2005.

(D) The Commissioner erred in denying Petitioner's claim that the NOL Carryback triggered a $20,732,410 reduction in the utilization of Petitioner's I.R.C. § 38 general business credit for 2005, As a result of the resolution of items for other tax years and Petitioner's filing of the Superseding Form 1120, Petitioner's claim is that the NOL Carryback triggered a $21,369,010 reduction in the utilization of Petitioner's I.R.C. § 38 general business credit for 2005.

(E) The Commissioner erred in denying Petitioner's application of the unused general business credit from 2005 to 2004 to reduce Petitioner's taxes by $20,732,410 for 2004. As a result of the resolution of items for other taxable years and Petitioner's filing of the Superseding Form 1120, Petitioner's claim is that the unused general business credit from 2005 is applicable to reduce Petitioner's income tax liability by $21,369,010 for 2004.

(iii) To the extent' that the Court's decision in this case properly results in any correlative adjustments. Petitioner reserves the right to apply such adjustments.

5. Supporting Facts. The facts upon which Petitioner relies as the basis for this proceeding are as follows:

(a) Deductibility of Litigation Settlement Payment. Petitioner incorporates by reference allegations in the preceding paragraphs.

(i) Petitioner is a Delaware corporation that is the common parent of an affiliated group of corporations that joined in the filing of a consolidated U.S. federal income tax return for 2015. Petitioner timely filed Form 1120, U.S. Corporation Income Tax Return, for 2015 electronically on or about February 25, 2016, and such return was processed by the Ogden, Utah Service Center. Petitioner timely filed the Superseding Form 1120 for 2015 electronically on or about September 15, 2016, and such return was processed by the Ogden, Utah Service Center.

(ii) At all times relevant to this case. Petitioner was engaged in the oil and gas business through various subsidiaries, partnerships, and joint ventures.

(iii) Kerr-McGee Worldwide is a subsidiary of Petitioner that is a member of Petitioner's affiliated group and joined in the filing of Petitioner's consolidated U.S. federal income tax return for 2015.

(iv) Kerr-McGee Worldwide was formed on September 30, 2002 by Kerr-McGee Corporation ("New Kerr-McGee").

(v) Petitioner acquired New Kerr-McGee on August 10, 2006.

(vi) Prior to being acquired by Petitioner, New Kerr-McGee and its subsidiaries, partnerships, and joint ventures (and their predecessors) engaged in a variety of businesses involving the chemical, mining, and oil and gas industries.

(vii) A wholly owned subsidiary of New Kerr-McGee that was also previously known as Kerr-McGee Corporation ("Old Kerr-McGee") accumulated significant environmental and tort liabilities (the "Environmental and Tort Liabilities").

The Kerr-McGee Restructurings

(viii) Beginning in May 2001, Old Kerr-McGee and its subsidiaries engaged in a series of corporate restructurings (the "Restructurings") with the objective of separating the chemical business from the oil and gas business.

(ix) As part of the Restructurings, Old Kerr-McGee and its affiliates engaged in a series of related transactions that ended with the merger of Old Kerr-McGee into Kerr-McGee Chemical Worldwide LLC, a wholly owned subsidiary of Old Kerr-McGee that was disregarded as separate from Old Kerr-McGee for U.S. federal income tax purposes. After this merger, Old Kerr-McGee became a disregarded subsidiary of Kerr-McGee Worldwide. These transactions were reported and properly treated as an I.R.C. § 368(a)(1)(F) reorganization (an "F Reorganization"), pursuant to which Kerr-McGee Worldwide was treated as the resulting corporation in a "mere change in identity, form, or place of organization" of Old Kerr-McGee.

(x) I.R.C. § 381(a) applies to the F Reorganization of Old Kerr-McGee. As a result, under I.R.C. § 381(a)(2) and Dover Corporation and Subsidiaries v. Commissioner, 122 T.C. 324 (2004), Kerr-McGee Worldwide inherited the tax attributes and operating history of Old Kerr-McGee in the F Reorganization and is viewed as if it had always conducted the business of Old Kerr-McGee. Thus, for U.S. federal income tax purposes, Kerr-McGee Worldwide is treated as having operated the historic businesses of Old Kerr-McGee that gave rise to the Environmental and Tort Liabilities.

(xi) Under I.R.C. § 381(c)(16), after the completion of the F Reorganization of Old Kerr-McGee, Kerr-McGee Worldwide is entitled to deduct liabilities of Old Kerr-McGee when paid or accrued.

(xii) By 2005, New Kerr-McGee, through its subsidiary companies, was principally engaged in the oil and gas business. However, some subsidiaries of New Kerr-McGee were still engaged in the chemical business.

(xiii) On May 17, 2005, Kerr-McGee Worldwide formed New-Co Chemical, Inc., later renamed Tronox Incorporated ("Tronox"), as a wholly owned subsidiary.

(xiv) In September 2005, Kerr-McGee Chemical Worldwide LLC (an entity disregarded as separate from Kerr-McGee Worldwide for U.S. federal income tax purposes which, after the F Reorganization described in paragraph 5(a)(ix), owned the former assets and businesses of Old Kerr-McGee), was renamed Tronox Worldwide LLC. By the end of 2005, Kerr-McGee Worldwide had contributed any remaining subsidiaries that operated chemical businesses, including Tronox Worldwide LLC, to Tronox.

(xv) On March 30, 2006, the Tronox shares were distributed from Kerr-McGee Worldwide to New Kerr-McGee, and then to the shareholders of New Kerr-McGee (the "Spin-Off").

The Tronox Bankruptcy and Lawsuits

(xvi) On January 12, 2009, Tronox and certain of its subsidiaries (the "Tronox Debtors") filed petitions under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court in the Southern District of New York (the "Bankruptcy Court"). Among the largest creditor claims were claims related to the Environmental and Tort Liabilities asserted by the United States, a number of states and municipalities, an Indian tribe, and numerous toxic tort claimants.

(xvii) On May 12, 2009, the Tronox Debtors filed an Adversary Complaint against New Kerr-McGee, Kerr-McGee Worldwide, KM Investment Corporation, Kerr-McGee Shared Services Company LLC, Kerr-McGee Credit LLC, Kerr-McGee Stored Power Company LLC (collectively, the "Kerr-McGee Defendants") and Petitioner. The Tronox Debtors alleged that the Kerr-McGee Defendants undertook the Restructurings and the Spin-Off with the goal of "avoiding responsibility altogether for . . . potentially massive historic liabilities." The Tronox Debtors sought to place responsibility for the Environmental and Tort Liabilities on the Kerr-McGee Defendants by alleging actual and constructive fraudulent conveyances, arguing that the Tronox Debtors were "entitled to avoid the Transfers [i.e., the transfer of valuable assets from Tronox] and Obligations [i.e., the liabilities, including the Environmental and Tort Liabilities, transferred to or assumed by Tronox]."

(xviii) In an order entered on March 31, 2010, the Bankruptcy Court denied a motion to dismiss the Adversary Complaint filed by Petitioner and the Kerr-McGee Defendants. In order to reach, the conclusion that the Adversary Complaint should not be dismissed as time-barred by the four-year statute of limitations for fraudulent transfers, the Bankruptcy Court relied on the premise that "the [Adversary] Complaint adequately alleges that it is only when the spin-off was complete and the Legacy Obligations were imposed on the Plaintiffs, rendering them insolvent and undercapitalized, that an actionable fraudulent transfer occurred."

(xix) On June 17, 2009, the United States filed a complaint-in-intervention on behalf of the U.S. Environmental Protection Agency (the "EPA") and certain other federal agencies in an effort to satisfy the environmental liabilities owed to the United States (together with the litigation instituted by the Tronox Debtors in the Adversary Complaint, the "Lawsuits").

(xx) In the Lawsuits, neither the Tronox Debtors nor the United States sought specific performance to recover any valuable assets transferred from Tronox.

(xxi) The United States (along with the other creditors asserting environmental claims) and the toxic tort creditors agreed to settle with the Tronox Debtors as part of Tronox's proposed plan of reorganization (the "Tronox Bankruptcy Settlement"). Pursuant to the Tronox Bankruptcy Settlement, the Tronox Debtors agreed to transfer all of their interests in the lawsuits to the Anadarko Litigation Trust (the "Litigation Trust"), a trust formed to pursue claims for the benefit of environmental and tort creditors against Petitioner and the Kerr-MCGee Defendants. Neither Petitioner nor the Kerr-McGee Defendants were parties to the Tronox Bankruptcy Settlement.

(xxii) A 34-day trial on the Lawsuits took place between May and September 2012.

(xxiii) Following the trial, the Bankruptcy Court issued a Memorandum of Opinion on December 12, 2013 (the "Memorandum of Opinion") in which it found that the Kerr-McGee Defendants could not escape responsibility for the Environmental and Tort Liabilities because the Restructurings and the Spin-Off amounted to an actual and constructive fraudulent conveyance. The Memorandum of Opinion was not a final judgment, however. Neither the Bankruptcy Court nor any other court issued a final judgment or award of any damages in the Lawsuits.

The Settlement Agreement

(xxiv) On April 3, 2014, Petitioner and the Kerr-McGee Defendants entered into a settlement agreement with the Litigation Trust and the United States (the "Settlement Agreement"). Pursuant to the Settlement Agreement, on January 23, 2015, Kerr-McGee Worldwide paid the Settlement Payment to the Litigation Trust in the following amounts: a principal sum of $3,980,665,791.37 and interest from May 12, 2009 until April 3, 2014 amounting to $1,169,334,208.63. In addition, Kerr-McGee Worldwide paid post-settlement interest in the amount of $64,991,060.

(xxv) In exchange for the Settlement Payment and post-settlement interest. Petitioner and the Kerr-McGee Defendants fully and finally settled the Lawsuits. In addition, Petitioner and the Kerr-McGee Defendants entered into mutual releases with the Litigation Trust and mutual covenants not to sue with the United States. Petitioner and the Kerr-McGee Defendants also received contribution protection against future claims arising out of or related to the environmental liabilities. In addition, the Settlement Agreement includes a provision asking the court to approve the settlement and to issue a permanent injunction prohibiting (with limited exceptions) the assertion of claims against Petitioner and the Kerr-McGee Defendants that were or could have been asserted in the Lawsuits or that are related to or duplicative of such claims (the "Permanent Injunction").

(xxvi) The Settlement Agreement provides that it "will constitute a judicially approved settlement for purposes of Section 113(f)(2) of CERCLA [the Comprehensive Environmental Response, Compensation, and Liability Act]." Thus, the Settlement Parties intended and agreed that the Settlement Agreement resolve liability of Petitioner and the Kerr-McGee Defendants under CERCLA.

(xxvii) The Bankruptcy Court recommended approval of the settlement after concluding that the Settlement Agreement is "fair, reasonable, and consistent with environmental law."

(xxviii) The Bankruptcy Court also recommended approval of the Permanent Injunction on the basis that Petitioner and the Kerr-McGee Defendants would not have agreed to pay an historic price to settle if they faced the threat of re-litigating the same claim — the Environmental and Tort Liabilities — which they settled in the case.

(xxix) On November 10, 2014, the U.S. District Court for the Southern District of New York ("SDNY Court") approved the Settlement Agreement as the "largest-ever environmental cleanup recovery in the Government's history." The SDNY Court evaluated the settlement under the standards applicable to "liabilities under federal environmental law," and found that "it is clear that the Court has the authority to enter the [Settlement Agreement] under section 113(b) of CERCLA, 42 U.S.C. 9613(b), and the Government has, the authority to enforce it under sections 107 and 113, id, 9607, 9613. Section 113(b) of CERCLA states that United States district courts have jurisdiction "over all controversies arising under [CERCLA]." Thus, the SONY Court expressly found that the controversy that Petitioner and the Kerr-McGee Defendants were resolving by way of the Settlement Agreement was a controversy arising under CERCLA.

(xxx) The SDNY Court acknowledged that the Settlement Agreement was executed to provide funding to address the underlying Environmental and Tort Liabilities that prompted the litigation, describing the Settlement Agreement as "historic, providing $4.4 billion for the removal of pollution and environmental contaminants, the largest such recovery in American history." The SDNY Court further praised the Settlement Agreement for "promot[ing] federal environmental law's objectives of . . . impos[ing] liability on responsible parties."

(xxxi) The SDNY Court also issued the Permanent Injunction preventing any party from pursuing Petitioner and the Kerr-McGee Defendants for claims arising from the same underlying harm, i.e., the environmental damage and torts that gave rise to the Environmental and Tort Liabilities. The SDNY Court acknowledged that Petitioner and the Kerr-McGee Defendants wanted "to ensure that they would not have to re-litigate the claims they aim to settle here, and without the requested injunction they may have paid billions of dollars for nothing."

(xxxii) Petitioner and the Kerr-McGee Defendants intended that the Settlement Agreement discharge not only the Kerr-McGee Defendants' responsibility for the Environmental and Tort Liabilities but also any claim that could have been asserted or is related to, derivative of or in any way arises from such liabilities. Consistent with that intent, the Settlement Agreement discharged Petitioner's and the Kerr-McGee Defendants' responsibility for such liabilities.

(xxxiii) Kerr-McGee Worldwide's payment of the Settlement Payment satisfied the Environmental and Tort Liabilities that it is treated as having generated for federal income tax purposes as a result of the F Reorganization of Old Kerr-McGee under I.R.C. § 381(a)(2) and Dover Corporation and Subsidiaries v. Commissioner, 122 T.C. 324 (2004). Thus, the Settlement Payment was an ordinary and necessary expense of Kerr-McGee Worldwide's trade or business and is therefore deductible by Kerr-McGee Worldwide under I.R.C. §§ 162 and 381(c)(16).

(xxxiv) In the alternative, the Settlement Payment is deductible by Kerr-McGee Worldwide under I.R.C. § 165.

(xxxv) The Settlement Payment is a specified liability loss under I.R.C. §§ 172(b)(1)(C) and 172(f) (1) and thus results in a NOL for 2015 that can be carried back to each of the 10 taxable years preceding 2015.

(xxxvi) The Settlement Payment was not made to pay for fraudulent conveyance damages. No fraudulent conveyance damages were ever assessed against the Kerr-McGee Defendants.

(xxxvii) The Settlement Agreement does not provide that Petitioner and the Kerr-McGee Defendants paid the Settlement Payment because they were liable for actual or constructive fraudulent conveyance. To the contrary, the Settlement Agreement reaffirms that "to date, the Bankruptcy Court has not issued a final judgment, and further provides that the Settlement Payment "will enable the investigation, remediation, cleanup, and recovery of natural resource damages and other compensation with respect to environmental sites."

(xxxviii.) The Litigation Trust is a qualified settlement fund within the meaning of I.R.C. § 468B and Treasury Regulations § 1.468B.

(xxxix) By transferring money, in the form of the Settlement, Payment, to the Litigation Trust to resolve claims against it that are described in Treasury. Regulations § 1.468B-1(c)(2), Kerr-McGee Worldwide is a "transferor" to the Litigation Trust as that term is defined in Treasury Regulations § 1.468B-1(d)(1).

(xl) The fact of Kerr-McGee Worldwide's liability, and the amount of such liability within the meaning of the "all events" test of I.R.C. § 461 were established by the terms of the Settlement Agreement. Kerr-McGee Worldwide's payment of the Settlement Payment constituted economic performance pursuant to Treasury Regulations § 1.461-4(g) and thus the Settlement Payment was properly deductible in 2015.

(xli) Tronox did not transfer the Settlement Payment to the Litigation Trust. Kerr-McGee Worldwide did not transfer the Settlement Payment to the Litigation Trust on behalf of Tronox to satisfy claims against Tronox.

(xlii) The Settlement Payment is not deductible by the Litigation Trust or Tronox.

(xliii) The Settlement Payment did not discharge liabilities of the type that would require capitalization under I.R.C. §§ 263(a) or 263A.

(xliv) The Settlement Payment was not made to defend title to property.

(xlv) The Commissioner, relying on his reading of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), takes the position that the Settlement Payment relates back to the alleged undercapitalization of Tronox prior to its being spun-off, and that the Settlement Payment is a substitute for a capital contribution New Kerr-McGee should have made to Tronox prior to the Spin-Off.

(xlvi) The Settlement Payment is not a substitute for any capital contribution that New Kerr-McGee should have made to Tronox prior to the Spin-Off.

(xlvii) To the extent that the origin of the claim doctrine applies to this case, the origin of the claim is the pursuit of recovery for the Environmental and Tort Liabilities by environmental and tort claimants, and the assertion by such claimants that the Kerr-McGee Defendants could not avoid responsibility for such liabilities through the Restructurings, and the Spin-Off and thus were obligated to satisfy such liabilities.

(b) Deductibility of Northwood Settlement Payment. Petitioner incorporates by reference allegations in the preceding paragraphs.

(i) AE&P sued Northwood for damages for a breach of a contract, and Northwood counterclaimed against AE&P for damages. Pursuant to a settlement agreement dated October 6, 2015, the parties settled the litigation with AD&P paying $5 million in cash and the assignment of a $20 million term mineral interest and a 20 percent royalty in October 2015. This settlement payment was not a capital expenditure, and is instead deductible by AE&P as an ordinary and necessary expense under I.R.C. § 162(a).

(ii) AE&P's basis in the term mineral interest was $45,462,365 and it basis in the royalty interest was $30,929,314. Accordingly, Petitioner is entitled to a deduction of $81,392,679 in 2015 under I.R.C. § 162(a).

WHEREFORE, Petitioner hereby prays that the Court hold that: (i) there are no deficiencies in income tax for 2004, 2005, and 2006; (ii) Petitioner's consolidated NOL for 2015 is $2,886,940,376 all of which is a specified liability loss under I.R.C. §§ 172(b)(1)(C) and 172(f)(1); (iii) Petitioner's Superseding Form 1120 correctly resulted in overpayments of its federal income tax liability for 2004, 2005, and 2006 in the respective amounts of $21,369,010, $360,596,424, and $477,022,776; (iv) Petitioner is entitled to retain the amounts paid to it pursuant to its Form 1139 for 2004, 2005, and 2006 in the respective amounts of $20,732,410, $360,384,223, and $477,003,978; (v) in addition to the foregoing, Petitioner is entitled to a refund of overpaid federal income taxes for 2004, 2005, and 2006 in the respective amounts of $636,600, $212,201, and $18,799; (vi) the correlative adjustments determined by the Commissioner as described in paragraph (4)(b) are erroneous; (vii) the proposed determinations described iii the Notice are erroneous; and (viii) grant such other relief to Petitioner as may be appropriate.

Respectfully submitted,

George M. Gerachis
Tax Court No. GG-0267

Gary R. Huffman
Tax Court No. HG-0482

Juliana D. Hunter
Tax Court No. HJ-1599

Elizabeth A. Snyder
Tax Court No. SE-0694

Counsel for Anadarko Petroleum Corporation

VINSON & ELKINS L.L.P.
1001 Fannin Street
Suite 2500
Houston, Texas 77002-6760
Telephone: (713) 758-1056
Fax: (713) 615-5612

Dated: 11/20/18